'Nexus' remains nebulous: States vary on who to tax

The types of activities that allow a state, under its own rules, to tax a business entity vary widely. In fact, the same company with relatively light activity within one state might be subject to tax in that state, yet not be taxed in a state where its activity is greater.

For example, in nine states, traveling through their borders six or fewer times per year in taxpayer-owned trucks without picking up or delivering goods is taxed, while in the majority of states, actual delivery of goods in firm-owned trucks owned would not, by itself, render the business subject to tax.

In state tax terms, "nexus" is the minimum amount of contact between a taxpayer and the state that would permit taxation by the state. It arises from the Constitution's due process clause, which requires a minimum connection between a state and an entity it seeks to tax, and the commerce clause, which prohibits states from unduly burdening interstate commerce.

Each year, BNA conducts a survey of the various state tax departments. Questionnaires are sent to senior state tax officials in each of the 46 states that have a state corporate income tax, as well as to the District of Columbia and New York City. Forty-six taxing jurisdictions responded this year, with New York indicating that it will participate in the future.

Despite the constitutional standards, states vary as to how they apply them to activities within their borders. Moreover, tax department positions sometimes change from year to year, according to George Farrah, director of state tax services for BNA Tax Management.

For example, the nine states that tax businesses traveling through their borders without picking up or delivering goods is one more than last year. Nine states - one less than last year - would claim nexus if the taxpayer traveled through more than six but fewer than 12 times, while 16 states - the same as last year - would claim nexus if the taxpayer made more than 12 trips.

"The states want people to know what their positions are - they're not trying to trick anyone," said Farrah. However, he noted, the survey asked only whether a particular activity, by itself, would create nexus.

"There's usually more than just one activity involved," he said. "The survey helps practitioners know whether certain activities alone create nexus, but they should also consider the interaction of more than one activity in a state. There could be a number of activities, each of which by itself would not create nexus, but when you have them together they might add up to a taxable connection."

The survey found a wide disparity as to whether nexus could result from general business activities such as registering to do business, having a Web site server in the state, or maintaining an in-home office in the state, according to Farrah. There was also considerable variance as to whether merely having a phone listing in a state would trigger nexus, he noted.

Almost all of the states agreed that registration alone would not subject an out-of-state corporation to tax. However, California and Tennessee noted that such a corporation would still be required to pay a minimum franchise tax.

The states were nearly evenly divided on the question of whether nexus would be created when an out-of-state corporation reimbursed its in-state salespersons for the costs of maintaining an in-home office. Twenty-three states - up from 22 - said that such an arrangement would result in nexus; 20 said that it would not.

It's even possible to fall into nexus unintentionally, according to Farrah. "Businesses change activities frequently, and they're not always conscious of nexus. A company might have sales in a state without having nexus, and therefore not be liable for any income tax there. But once there's nexus, the state can tax a percentage of the company's entire net income."

The number of states indicating that telecommuters would subject their employers to tax continues to fluctuate since the first survey in 2001. For 2005, 39 states said that telecommuting creates nexus, compared to 40 in 2004, 39 in 2003, 36 in 2002, and 32 in 2001. This year, Kentucky joined the only two states - Connecticut and Mississippi - that said that telecommuting would not create nexus.

The number of states that said nexus would be created by maintaining a Web server within their jurisdiction was 14 - up from 13 last year.

This year, Colorado said that nexus would result if the Web site server was used to complete sales of tangible personal property within its borders. In contrast, California said that maintaining a Web site server would not result in nexus as long as the out-of-state corporation merely leased space on a server on a non-exclusive basis.

There was also a considerable variance on whether merely having a phone listing in a state would trigger nexus. Twelve states said that an in-state telephone listing was sufficient to establish nexus. However, only eight states said that nexus could be created by a local telephone listing. Five states said that a toll-free telephone order number could create nexus.

For the second consecutive year, only 15 states said that they had a de minimis standard with regard to activities that cause nexus. Nevertheless, 35 states agreed that nexus would be created if an employee made one sale within their borders that exceeded the state's de minimis threshold.

Nexus was less likely to result from other employee activities, such as attending seminars and trade shows. Only Indiana, New Jersey, New Mexico and Vermont said that nexus would result from attending a seminar within their borders. Minnesota and Missouri said that they would find nexus if the employee traveled to the seminar in a corporate-owned plane.

However, 11 states said that attending a show for 14 or fewer days in the state would be sufficient to establish nexus, while three states said that attending an annual meeting for the same time period within their borders would trigger nexus.

The deduction of royalty payments for intangible property held by an out-of-state subsidiary has been a popular, but highly controversial, state tax planning strategy.

The survey revealed that the states are attacking these plans with a variety of approaches, including denying the deduction, requiring unitary reporting, imposing nexus on the out-of-state subsidiary due to its licensing activities, or imposing nexus because of the parent's activities. Thirty-seven of the states - up from 33 - said that they would use at least one of the four approaches.

Some 20 states indicated that they would tax the payments based on the licensing activities. However, a substantial number are using alternative methods to thwart the use of the intangible holding company strategy. Sixteen states - two more than last year - said that they would require unitary reporting. Fourteen states said that they would require the add-back of federal deductions taken for the royalty payments made to the out-of-state holding company.

"There is pressure on states to find nexus and collect taxes where they legally can without raising taxes," said Farrah. "They don't want to raise taxes, but they all need revenue."

"The major result is what we're not seeing," he said. "There's still considerable diversity, with states taking completely different positions on the same activity."