Recently states have been more aggressive in developing new ways to generate tax revenues. They are pushing boundaries and enacting new tax legislation that is slow to be challenged by taxpayers. One new trend that some states have started to utilize is called economic nexus. Economic nexus laws are geared towards businesses that do not have a physical presence in a state but benefit from the state’s commerce.
For an out-of-state company to have a state income tax filing requirement it must have nexus or a connection in that state. Typically if an out-of-state company has a physical presence (i.e. property or payroll) and sales in a state then it has sufficient nexus in that state for income tax purposes. However some states have started to incorporate a factor presence into their tax laws which can create nexus and thus tax filing requirements for a company even without a physical presence. A factor presence is dictated by the amount of property, payroll or sales a company has within a state and each factor is considered individually in determining whether nexus is created. A state that has adopted a factor presence nexus test may say that an out-of-state company has nexus if its business activities exceed any of the following bright-line tests: $50,000 in-state property; $50,000 in-state payroll; or $500,000 of in-state sales. Therefore, in this example, even if a company has no property or payroll in the state it has economic nexus and state income tax filing
requirements if it has sales of more than $500,000 in that particular state.
If a company is operating in the multistate arena, its only protection from income tax filing requirements may be through Public Law 86-272. This federal law prohibits states from imposing an income tax on a company if the company’s only activity within that state is the solicitation of orders of tangible personal property, which are sent out of state for approval and are filled from outside the state. However, for a company to rely on Public Law 86-272, it must also be aware of the law’s limitations. One of the biggest limitations of Public Law 86272 is that it only applies to the solicitation of sales of tangible personal property. Companies that go beyond the limited solicitation of sales activities, provide services, or sell/license intangible assets in another state are not protected from the state’s taxing requirements by Public Law 86-272. Another limitation of Public Law 86-272 is that it only applies to income tax. Companies doing business in a state that has another method of taxing like a gross receipts tax or franchise tax, e.g., California, Connecticut, Ohio, or Washington state are not protected. Public Law 86-272 does provide some protection from state tax reporting requirements to companies operating in the multistate arena however given the changing laws of the states, companies may find themselves under the scope of economic nexus.
Although the majority of the states have not implemented economic nexus legislation, states seeking to generate more revenues and to tax out-of-state businesses benefiting from the states’ commerce may adopt them in the future. Taxpayers must be aware of the states where they have sales and should also be aware of the changing state tax statutes. With just sales activity in a state, they may have nexus.
As a follow up to this article, we will be addressing the current issues with sales tax nexus.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.