Nexus for state corporate income and sales and use taxes remains widely variable between states.
State tax nexus can change from year to year as the result of administrative change, legislation or litigation, and consequently can come as a surprise to even seasoned tax specialists, explained George Farrah, executive editor of state tax for BNA Tax Management.
For example, in this year's BNA survey of state tax departments, 32 states said that corporate income tax nexus could be triggered by conducting a certain amount of economic activity within their borders, even if the corporation lacked an economic presence in the state. Some 17 states said that they apply the physical presence rule, but 10 states said that they use both standards to make nexus determinations.
In state tax terms, "nexus" is the minimum amount of contact between a taxpayer and the state that would allow the state to impose tax. It is based on two clauses in the Constitution: the Commerce Clause, which prohibits states from unduly burdening interstate commerce, and the Due Process Clause, which requires a minimum connection between a state and an entity it wishes to tax.
The BNA survey indicated that more states this year would find nexus based solely on a company's registering to do business within their borders, said Farrah. "Thirteen states said that they would find nexus for income tax purposes based solely on a company's registering to do business within their borders. This was up from 10 last year and seven in 2007. Almost the same number of states said that merely registering to do business would result in nexus for sales and use tax purposes," he said.
"This is the first year that every state participated in our survey," Farrah revealed.
"The survey gives you a perception of how a state would respond in a given circumstance," said Michael Moore, director at the Kansas City, Mo., office of cbiz. "Often, it's sufficient for the state to make its own argument without any statute or regulation. In their discussion they say, 'That's our policy' and it's based on their response to the survey."
More states are focusing on sales tax nexus from in-state affiliates, according to Farrah. "Since New York enacted legislation targeting affiliates that sell Amazon's products from their Web site last year, we've seen an increased focus in the area by other states," he said. "Georgia and Missouri changed their answers from last year, to join the group of states that said sales tax nexus would arise for an out-of-state company with an affiliate in the state that sells services or tangible personal property."
In light of the economic downturn, many states are acting more aggressively, Moore said: "I don't know if it's a policy shift, but more clients are being hit with questions about nexus."
Activity that is associated with computer software is becoming particularly at issue, he pointed out. "Whether having licensed software is sufficient to cause nexus is the question. The presence of an intangibility in a state that you receive a royalty from and how states react to that is important, because it's a high-revenue area for the states."
The states have also been more aggressive in the last few years in pushing the nexus threshold based on warranty for parts and labor, he noted.
Gary Bingel, director of state and local tax at CPA and business advisory firm Amper, Politziner & Mattia, said that there are several ways states are dealing with nexus.
"States are trying to get around PL 86-272 [which limits states' power to impose income tax by prohibiting taxing businesses whose only activity in the state is the solicitation of orders, so long as the orders are accepted at and delivered from a point outside the state]. They're doing this by going from purely income-based taxes to gross receipts or gross margins taxes," he said. "Ohio and Texas have done this. Michigan is going from a single business tax to a blended tax that uses gross receipts as one of the bases. It's a way to get around the typical income tax nexus prohibitions."
"Also, they're using Amazon-type legislation to expand the tax base to include more out-of-state taxpayers," he said. "In an economic downturn, a net income tax won't raise money anyway if there's no income to be taxed, so they're asserting nexus for transaction-based taxes using agency nexus, representative nexus or economic nexus. They're expanding these theories and becoming more aggressive."
The survey shed light on some non-nexus tax issues. In light of the economic downturn, net operating losses have become a hot issue, both in terms of how they are calculated and how each state conforms to federal provisions, Farrah observed.
"Thirty states said that they require NOLs to be computed on a post-apportionment basis. Only 11 states require NOLs to be determined on a pre-apportionment basis," he said. "Colorado said that the question is currently under review, while Kentucky said that the question depended on the type of return that was filed."
"Most states said they conformed to Code Section 381, which allows a corporation to succeed to the NOLs incurred by a subsidiary or target corporation after a merger," said Farrah. "Similarly, most of the states said they adopted Code Section 382, which limits a corporation's ability to utilize the NOL carryover of an acquired corporation," he said.
"Massachusetts, New Jersey and New Mexico said they did not conform to Sec. 381, but did honor Sec. 382. Arizona, Arkansas, Connecticut, Montana, Tennessee and Utah said they don't conform to either provision," he said. "Only nine sates said they had a statutory or regulatory provision addressing how Sec. 382 is to be applied for purposes of computing their own corporate income tax. Among these states was California, which has a regulation pending on the issue."
Moore of cbiz found the survey useful when communicating with his clients.
"It provides a general framework of how states might react to certain activities, but I wouldn't rely on it as authority," he said. "It's useful because you can demonstrate inconsistencies within the states when you're dealing with a client that wants to go one way or another, because you can demonstrate that the states can also go one way or the other. Since that inconsistency exists, you can show the client that it's better to be prepared for those inconsistencies than just assume you're right."
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