This article originally appeared in the November 2024 issue of Security Business magazine. Don’t forget to mention Security Business magazine on LinkedIn and @SecBusinessMag on Twitter if you share it.
The owners and managers of many security businesses have to worry about federal taxes; however, more often, the business’s state and local tax burden is far greater.
Today, state income taxes can cost a security business as much as 10% – or more – of its pretax income. Two of the most common state and local taxes are income and employment taxes.
State and local taxes are varied and in constant flux. Keeping abreast of the security business’s state and local tax obligations, while complex, could be worth the effort. Failing to keep abreast can significantly affect the operation’s cash flow. A thorough review can lead to new planning strategies that can result in a lower tax bill. It may uncover opportunities for automation, advantageous filing and apportioning methods, or valuable credits and incentives. As always, professional guidance is recommended.
Although 44 states levy a corporate income tax, many security integration and consulting firms are not subject to it because they are taxed as pass-through businesses – where income is reported on the owner/shareholder’s personal tax return.
Since the possibility of nonconformity is often an issue, every security business executive should be aware of whether the deductions they are planning to claim on federal tax returns will receive the same treatment at the state level. While many states follow federal tax rules, some states decouple from certain tax provisions.
Multi-state taxation is tricky, and most security businesses face an interesting challenge: what happens if you do business in more than one state? The state that the business calls home generally wants to tax every dollar of income. Fortunately, records and planning can ensure there are no overlooked or duplicate payments for taxable income earned in another jurisdiction.
Sales & Use Taxes
It is not only income taxes that differ from one taxing jurisdiction to another, there are also those cumbersome sales – and use – taxes.
A growing number of states require service-based businesses to collect sales taxes. Selling both a tangible item (such as physical security products) and a service (such as security monitoring or ongoing maintenance) may mean the operation is liable for collecting sales taxes on both.
Also keep in mind, that while some businesses may not be required to collect sales taxes on their services or products, they usually must pay them on some purchases. It is all-too-easy today to get caught ignoring the “use” tax due on purchases made in another taxing jurisdiction, via the Internet, or where sales taxes should have been collected but were not.
A comprehensive use tax review can identify exposures, as well as opportunities for refund claims and exemptions. It can also uncover ways to automate and streamline necessary processes.
Employment Taxes
Federal, state, and even local laws dealing with employees change from year to year, and all usually affect a security integration or consulting firm’s tax bill. While these laws are designed to be beneficial for employees, many businesses are finding it increasingly difficult to remain profitable.
Many states have created programs to compensate businesses for expenses related to minimum wage law changes, worker incentive programs such as paid family leave, and other laws dealing with employees; however, for the most part, these are only temporary solutions and rarely address higher payroll costs and increased payroll tax bills.
Overlooked State and Local Tax Considerations
Property taxes: One tax that is often overlooked and frequently overpaid is a tax assessed on the property, equipment, and other assets of the security business. Surprisingly, few security integrators or consultants challenge their property tax bill. While the property tax rate cannot be questioned, the assessment of the business’s property can be challenged frequently and reap savings year after year.
Independent contractors: Those in the security industry have long appreciated the absence of payroll taxes and the withholding burden associated with employees that comes with using independent contractors. Unfortunately, it is not only the IRS and the U.S. Department of Labor that are changing the definition of who is and who isn’t an independent contractor. A growing number of states are adopting the controversial, stricter definition of independent contractors.
Lack of federal tax conformity: Although slated to soon expire, the Tax Cuts and Jobs Act (TCJA) lowered the federal corporate tax rate, and made significant changes to the cost recovery possibilities and deductions available to businesses. States have largely settled on TCJA conformity, but each year, many jurisdictions change or adapt specific provisions. Be sure to check your state’s code.
AI regulation: In the last five years, 17 states have adopted almost 30 bills focusing on regulating artificial intelligence (AI). Any security business adopting new AI tools will face an added regulatory burden. While Congress has been slow to act, many states are passing (or have passed) their own AI laws governing technology with which every business operating within its boundaries must comply.
Separate Accounting
While most security integrators and consultants take a general approach to apportion income, many states allow the use of "separate accounting" – which is pretty much what it sounds like, a second set of books. The security business computes its net income based on the income and expenses in a particular state. That said, unless the operation in the state is almost a separate entity, this generally is not easy. It can also be expensive.
Overhead (salaries, expenses, etc.) must be allocated to those locations; however, despite the problems, the use of separate accounting can result in significant tax savings, especially if the operations in the state produce little or no income, and the state has a high tax rate.
Security integrators or consultants that do not operate in more than one state or tax jurisdiction can also benefit from separate accounting. While a business must compute their income using the same method used in keeping their books, they are not required to use the same method when preparing their financial statements.
When State Filing is Required
When is a business required to file a tax return in another state? Even that becomes a complicated question, with the answer depending on the rules in that particular state.
Generally, if a security business simply sends goods into a state and does not have employees working in that state, the business probably will not have to file income or sales tax returns in that state. Until Washington state began sending its questionnaires and eventually tax bills to out-of-state businesses, a business sending independent sales reps into another state was usually able to avoid filing income tax returns.
In the past, even a business with a sales office in a state – one that takes orders that have to be approved at another office out of state – has been exempted from filing income taxes in that state. Of course, once a security business has property located in a state or has employees in a state (or some other similar connection), the operation must generally file tax returns and pay taxes. Not filing could result in penalties, interest, and a host of other problems.
