MWE_Headshots_Thumbnail_JoePizzimentiAs we launch our 2014 Multistate Tax Road Trip, we will stop periodically at areas that despite their familiarity still warrant our time and attention. Today, we will visit with the concept of nexus. Even in 2014, state tax nexus continues to be a lightning rod for discussion, controversy and concern. Let’s begin our journey with a brief pit stop at corporate income tax nexus.

 

State Tax Nexus

Before a state can subject an entity that has derived income from interstate commerce to one or more of its taxes, the state must establish that the company has “nexus.” In general, state tax “nexus” is the minimum level of contact or activity within a state necessary for a state, city or locality to constitutionally subject an entity to that state, city or locality’s tax provisions and potentially taxation. In theory, each state may independently adopt state tax “nexus” or “doing business” provisions that define the level of activity or connection that is necessary to establish nexus for the respective state’s taxes. However, every state’s nexus provisions as well as each state’s application of their provisions must comport with the limitations as set forth by the U.S. Constitution, i.e. in the Commerce and Due Process Clauses, as interpreted by the U.S. Supreme Court decisions and federal statutes that define nexus.

Nexus – The Type of State Tax Matters

Subject to the limitations mentioned above, states may have established specific state nexus thresholds for different state taxes; i.e. net income, franchise taxes based net worth or capital, gross receipts or sales taxes.  During our road trip, we will discuss the historic as well as the recent state tax income and sales tax nexus issues facing multistate taxpayers.

Corporate Income Tax Nexus – Some Context

Historically, corporate income tax nexus provisions typically required that the out-of-state corporation derive revenue from sources within the state and that the out-of-state corporation have some physical presence in the state.  Recently, states began to adopt ever increasingly aggressive nexus provisions – factor based and economic based corporate income tax nexus provisions. As businesses began to generate revenue from interstate commerce without having physical presence in remote states, state corporate income tax nexus provisions evolved by eliminating the physical presence requirement from their corporate income tax “doing business” and nexus provisions. In general, factor based state tax nexus provisions define the level of contact with the state necessary to subject a remote corporation to the state’s tax provisions based on the remote corporation’s receipts, payroll or property in the state. Economic based state tax nexus provisions define sufficient contact with the state based only on the remote corporation’s receipts determined to be sourced to the state pursuant to the state’s revenue apportionment/allocation provisions. Therefore, a corporation may be deemed to have sufficient nexus in a state that applies an economic nexus standard without having any physical presence or activities in the state. Public Law 86-272 may provide out-of-state entities (whose state activities are limited to the mere solicitation of orders for the sale of tangible personal property that are accepted and shipped from outside the state) with potential immunity from being subject to state taxes based on or measured by net income. 

In general, if a corporation’s activities in a state are limited to those permitted under P.L. 86-272, state factor based and economic based state corporation under the law.

However, as revenue streams broaden beyond those exclusively derived from the sale of tangible personal property, the potential protection afforded by P.L. 86-272 may become increasingly limited.

In addition, the application of such factor based and economic based nexus provisions may have significant state tax ramifications in states that have also adopted mandatory combined filing requirements for entities that are determined to be members of a unitary group.

The Take Away – Don’t Rely On Same As Last Year {“SALY”} Assumptions

Now more than ever, states’ increasing dependence upon factor based and economic based nexus standards demand that multistate businesses continuously monitor their activities, vendor relationships and related party transactions. Relying on SALY nexus analysis in determining your corporate income tax nexus may have significant and costly state tax ramifications.

Our next post will explore the inter-play of factor based and economic based nexus provisions with the corporate income tax nexus benchmark, Public Law -86-272.  There may be some good news for businesses – recent court decisions appear to signal reluctance by certain state courts to accept factor based or economic based corporate income tax nexus provisions without some additional connection to the state by the out-of-state taxpayer.