Telehealth State and Local Tax Considerations

A previous version of this article was posted in November edition of Healthcare News.

The public health emergency of COVID-19 has rapidly increased the demand for telemedicine given state and federal requirements and waivers, social distancing requirements, and the need for more efficient health care services.

While the telemedicine industry is fast-paced, it’s important to take pause to consider state and local tax compliance as the telemedicine industry continues to evolve and expand. For any organization considering new partnerships, capital raises, mergers, or acquisitions, state and local tax compliance can be an important component of a due diligence examination prior to entering into a proposed transaction with another party.

Proper diligence done by telemedicine entities to consider state and local tax compliance can help protect the balance sheet from significant risk coming at a variety of different angles. For example, telemedicine entities may create sales tax obligations, including intercompany sales tax obligations, through the provision of telemedicine services.

Additionally, the presence of remote workers, depending on the reason for working remotely, has the potential of creating nexus for various tax types, such as sales tax or income tax. The combination of these issues make state and local tax compliance and exposure dramatically more complicated.

In this article, we offer insight on various state and local sales tax, gross receipts tax, income tax, and payroll tax issues as they relate to the telemedicine industry and COVID-19.

State Sales Tax and Gross Receipts Tax

Telemedicine is an innovative way to provide health services without the physician having to be in the same location as the patient. Generally, medical practitioners and patients communicate with each other in real time using electronic communications and software. Often, one entity will be providing the telemedicine platform, and a separate entity will be providing the medical professionals.

Following the concept that the provision of medical services is generally nontaxable, telemedicine entities generally believe that providing these types of services aren’t subject to state sales tax. The reality of the situation is the taxability of telemedicine services isn’t so black and white but is rather quite dynamic. Telemedicine entities must consider the nature of the services being provided, location of their operations, the medical professionals, and the patients to understand the taxability of their services.

Additionally, some states, in lieu of or incremental to a sales tax, impose a gross receipts tax, such as the Washington Business and Occupation (B&O) tax, the Oregon Commercial Activity Tax (CAT), the Hawaii General Excise Tax (GET), or Nevada Commerce Tax on a telemedicine entity’s gross receipts attributable to that state. This is distinguishable from state sales tax whereby the sales tax is only owed on taxable transactions—such as retail sales.

Gross receipts taxes are generally borne by the telemedicine entity; however, there are situations where the telemedicine entity can pass down the gross receipts tax to the patient. Similar to state sales tax, a telemedicine entity must have nexus with a state for that state to impose its gross receipts tax on the telemedicine entity. Another similarity to state sales tax—gross receipts tax rates may vary depending on whether the telemedicine entity is providing a taxable service subject to retail sales tax or a nontaxable service. This means a telemedicine entity should pay special attention to the taxability of their service.

Nexus Considerations

Entities that use telemedicine and have sales tax nexus with a state are generally required to register for a sales tax license, file returns, and, if applicable, collect and remit state sales tax. The same is true for gross receipts tax. For both state sales tax and gross receipts tax purposes, nexus is generally triggered one of two ways: physical presence or economic presence.

Physical Presence

Physical presence is generally triggered when property—such as office location or inventory—or payroll—such as employees or independent contractors—are in the state, or by having some other contact—such as a traveling salesperson—with the state. For example, consider a situation in which Telemedicine Entity based in California has contracted Physician providing telemedicine services from Washington to Patient in New Mexico. Telemedicine Entity likely has physical presence nexus in California for state sales tax purposes and Washington for state sales tax and gross receipts tax purposes. Additionally, assuming Telemedicine Entity does not have physical presence in New Mexico, gross receipts tax nexus could still exist if economic nexus is triggered.

Economic Presence

The concept of economic nexus stems from the 2018 US Supreme Court case South Dakota v. Wayfair, which provides that a telemedicine entity can still have state sales tax nexus with a state, despite not being physically present in that state. This concept has been used by states imposing a gross receipts tax in lieu of, or incremental to, a state sales tax, as well.

Economic nexus is triggered by exceeding a sales or transaction threshold, typically $100,000 of gross or retail sales or 200 separate transactions in a given state. Every state, except for Alaska, Delaware, Florida, Missouri, Montana, New Hampshire, and Oregon, has adopted an economic nexus standard; however, not all economic nexus standards are the same.

State Standards

Some states have economic nexus standards utilizing only the sales threshold—or no-transaction threshold—such as Washington’s $100,000 retail sales threshold for Washington retail sales tax. Distinguishably, some states attribute gross sales—for example, taxable and nontaxable sales—to the sales threshold, such as California’s $500,000 gross sales threshold or Washington’s $100,000 gross sales threshold for Washington B&O tax, as opposed to just retail sales—such as taxable sales.

Oregon is unique in the sense that CAT nexus is triggered for registration purposes upon exceeding $750,000 of taxable commercial activity sourced to Oregon; however, Oregon CAT is not owed until $1 million or greater taxable commercial activity has been sourced to Oregon. Additionally, the Oregon CAT provides for certain subtractions that may be deducted before arriving at taxable commercial activity. These subtractions are for cost inputs—such as costs of goods sold—and labor costs—such as employee compensation—attributable to Oregon. These subtractions must be considered to help ensure an accurate Oregon CAT nexus determination is made.

Taxability of Telemedicine Services

As previously stated, often in the telemedicine industry, one entity will provide the telemedicine platform and a separate entity will provide the medical professionals. The entity billing the patient or patient’s insurance typically has the option of either charging for the services of the medical professional separately, for a separately stated price on an invoice, or combining the charge for the use of the telemedicine platform for one, non-itemized price on an invoice.

Separate Charges

In the case of charging separately on an invoice for the medical professionals’ services and for the use of the telemedicine platform, we examine the taxability of the two services separately. Typically, the provision of medical services is nontaxable because the sale of services is exempt from sales tax in most states, unless specifically enumerated as taxable. However, it is worth noting a few states, such as Hawaii and New Mexico, find medical services taxable because the sale of services, in those states, are presumed taxable unless specifically exempted.

The taxability of charges for use of a telemedicine platform will vary from state to state depending on factors such as:

  • Whether or not the platform is hosted by the telemedicine entity or downloaded by the patient
  • The patient’s ability to interact with or customize the telemedicine platform
  • Whether or not any information, such as messages or medical records, are transmitted over the platform
Combined Charges

Generally, states refer to services provided over a web-hosted platform as the software-as-a-service (SaaS) business model. Charges for SaaS are subject to state sales tax in about 16 states, including Washington. Further analysis is required if charges for access to a telemedicine platform and charges for medical services are provided on an invoice for one, non-itemized price, particularly in states where the taxability of medical services and SaaS offerings differ.

The provision of a taxable service and nontaxable service for one non-itemized price is commonly referred to as a bundled transaction. In these situations, a bundled transaction analysis, such as the true object test utilized in California and Washington, is necessary to determine the appropriate taxability of the transaction. For example, in Washington, if a telemedicine entity charges a patient one price for the provision of medical services (nontaxable) and access to the telemedicine platform (taxable), the true object test is employed to determine if the transaction is taxable or nontaxable.

Washington-Specific Standards 

It should further be noted that, in Washington—a state that imposes both a retail sales tax and gross receipts tax—a determination that a telemedicine entity’s services provided in Washington are not subject to Washington retail sales tax does not let a telemedicine provider off the hook. Washington B&O tax under the retailing classification at a rate of 0.471% is generally applied incrementally to sales subject to Washington retail sales tax. Conversely, other B&O tax classifications, such as the service and other business activities classification at a rate of 1.75% or 1.5%, are generally applied to sales not subject to Washington retail sales tax.

Sourcing for State Sales Tax and Gross Receipts Tax Purposes

Sourcing of telemedicine services for state sales tax and gross receipts tax purposes can be complex and can vary on a state-by-state basis. Generally, with regards to sales of services subject to state sales tax, sales of these services are generally sourced to where the service is received. This can be the buyer’s business location, where the service is delivered, where the buyer actually receives the service, or some other place. Added confusion arises when taxable services are received in several different states.

While similar to state sales tax, sourcing for gross receipts tax can incrementally include a “where the benefit of the service is received” analysis. Determining where the benefit of a service is received is a complex analysis that can depend on factors such as whether the service relates to tangible personal property or the customer’s business activities, whether the services requires the customer’s presence, and other variables. This is particularly true for services subject to Washington B&O under the service and other classification—such as nontaxable services for Washington retail sales tax purposes.

State Income Tax

Similar to state sales tax and gross receipts tax, state income tax considerations include nexus and sourcing of sales. Given the remote nature of the telemedicine business model, special considerations must be made.

State Income Tax Nexus Considerations

For state income tax purposes, a telemedicine entity can establish nexus one of three ways: physical presence, economic nexus, and factor-presence nexus. Similar to sales tax and gross receipts tax, state income tax physical presence nexus is generally triggered by, but not limited to, having property, employees, or offices in the state.

Additionally, some states, such as Delaware, provide that state income tax nexus can only be triggered through physical presence. For example, if Telemedicine Entity’s only contact with Delaware is the provision of telemedicine services from a remote location to Patient located in Delaware, then Telemedicine Entity likely does not have nexus with Delaware.

Economic nexus for state income tax purposes is generally established from a state’s “deriving income from this state” income tax nexus provision. While “deriving income from this state” is generally not a defined term, states have been using South Dakota v. Wayfair as a foothold to take the position that if a telemedicine entity with no physical presence in a state has economic nexus with a state for sales tax purposes, then economic nexus is likely triggered for state income tax purposes.

Consider the following example: Telemedicine Entity has no physical presence in Arizona. Arizona utilizes an economic nexus standard for both state income tax and sales tax purposes. Arizona’s economic nexus standard for sales tax purposes is $150,000 of gross sales into Arizona for the 2020 tax year. Telemedicine Entity provides in excess of $150,000 in telemedicine services to patients located in Arizona. Therefore, Arizona has a reasonable position to impose income tax on Telemedicine Entity because Telemedicine Entity has exceeded Arizona’s sales tax economic nexus threshold, meaning it is likely “deriving income from” Arizona.

Finally, states such as California and Colorado utilize a factor-presence standard to determine nexus for income tax purposes. Typically, factor-presence nexus is established by having one or more of the following:

  • $50,000 of property
  • $50,000 of payroll
  • $500,000 of sales
  • 25% of total property, payroll, or sales in a state

These amounts have been inflated annually from their original imposition dates. For example, California’s factor-presence nexus thresholds for the 2019 tax year were $60,197 in property, $601,967 in sales, $60,197 in payroll, or 25% of total property, payroll, or sales in California.

Sourcing of Sales for State Income Tax

The sourcing of a telemedicine entity’s sales is relevant for states that impose economic presence or factor-presence nexus standards for state income tax purposes. The two methodologies for sourcing sales are market-based sourcing and cost-of-performance-based sourcing.

Under market-based sourcing, receipts are sourced to the state where the benefit of the service is received. In the context of telemedicine entities, the source state is likely going to be the state where the patient receiving the telemedicine services is located. Most states, such as California and Oregon, implement, or are in the process of implementing, market-based sourcing.

States that implement the cost-of-performance sourcing approach, such as Arizona, source receipts to the state where the income-producing activity takes place wholly within the state or, if the activity took place within and without the state, the state where the greatest cost of performing the service occurred. This approach is likely most problematic for telemedicine entities because such a place could be determined to be where the servers are that support the telemedicine platform or perhaps the location of the physicians providing the medical service component of the telemedicine services.

Payroll Tax

From a payroll tax perspective, perhaps the most relevant concern for telemedicine entities is ensuring contracted physicians are properly classified as either employees or independent contractors. Typically, states place the burden of proving an individual is an independent contractor as opposed to an employee.

ABC Test

The California Supreme Court’s 2018 landmark decision Dynamex Operations West, Inc. v. Superior Court (Dynamex) redefined the employment relationship between entities and independent contractors and introduced one of the most stringent standards in the United States for classifying individuals as employees or independent contractors. The court adopted a three-pronged ABC Test, requiring a hiring business to demonstrate that it meets all of these requirements if classifying an individual as a contractor:

  1. The individual is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact.
  2. The individual performs work that is outside the usual course of the hiring entity's business.
  3. The individual is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

An individual who fails any of these criteria is presumed to be an employee in California. As applied to telemedicine entities, the B test is likely most problematic given that both a telemedicine entity and a physician are both in the business of providing medical services. Consequences of misclassification may impact several aspects of a telemedicine entity’s operations including, but not limited to:

  • Tax exposure
  • Employee benefits
  • Compliance with wage and hour antidiscrimination laws
  • Compliance with Stark and anti-kickback laws

COVID-19 Guidance Applied to Telemedicine Entities

In response to COVID-19, several states, including Oregon, have released guidance that indicates the presence of teleworking employees of an entity in a state during a set emergency period—March 8, 2020, through November 1, 2020, for Oregon—won’t be treated as a relevant factor when making a nexus determination if the employees in question are regularly based outside of the state.

Additionally, other states, such as Massachusetts, released guidance stating that individuals who, prior to COVID-19, were receiving compensation for performing services in State A and, due to COVID-19, are now telecommuting from State B, will continue to be treated as State-A residents subject to individual income tax and personal income tax withholding.

Given the remote aspect of the telemedicine industry, these provisions are extremely impactful from a sales tax, gross receipts tax, and state income tax nexus perspective—as well as an employment tax perspective. However, states such as Washington and California that haven’t issued such guidance should be monitored closely. If telemedicine entity employees or independent contractors have changed telework locations to these states, new nexus events and resident or non-resident withholding obligations may arise.

Additional Resources

For regulatory updates, strategies to help cope with subsequent risk, and possible steps to bolster your workforce and organization, please see the following resources:

Contact Us with Questions


Enter security code:
 Security code