Although the continuing thirst of states for more dollars to fuel spending increases has led to a variety of efforts to augment tax revenue, they differ widely on what they consider sufficient contact with a business to give them the authority to tax it."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 that it seeks to tax, and the Commerce Clause, which prohibits states from unduly burdening interstate commerce.

In addition, Public Law 86-272 further limits the 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. To complicate matters even further, the law only applies to nexus for purposes of imposing income tax, but does not apply to sales tax nexus.

The consequence is that while the solicitation of orders within a state might not give the state sufficient nexus to impose income tax on a business, it may well be sufficient to establish nexus for sales tax purposes.

Moreover, the activities of a corporation within a state sufficient to create a taxable nexus vary so much from state to state that the same company with little activity in one state might be subject to tax in that state, yet not be subject to tax in a state in which its activity is greater. And it is possible that a company can fall into nexus unintentionally, according to George Farrah, director of state tax services for BNA Tax Management.

For example, in at least nine states, simply driving trucks through a state without stopping can cause a company to have nexus in that state for income tax purposes.

"Case law has developed separately for income tax nexus and sales tax nexus," noted Farrah. "Ultimately they're both bound by the Constitution, but the Supreme Court hasn't joined the two."

Each year, BNA conducts a survey of state tax departments. This year, 48 states, the District of Columbia and New York City participated in the survey, which poses questions aimed at clarifying tax department positions on the grey area of corporate income tax.

"This is the first year that we included sales tax as well as income tax, and it's the first year that New York has participated," said Farrah.

He stressed that even when a state indicates that the performance of a particular activity, by itself, will not trigger nexus, it does not guarantee that nexus will not arise if any additional activity is performed in the state.

The state of the states

Among the significant findings, Farrah noted that New York was among the 37 states that said that telecommuters would subject their employers to income tax nexus, while New Mexico joined the three states from last year - Connecticut, Kentucky and Mississippi - that said that telecommuters would not create income tax nexus for their employers.

There was wide disparity on whether nexus would result from such business activities as registering to do business, having a Web site server located in the state or maintaining an in-home office in the state. There was also divergence on whether a simple phone listing in a state would trigger nexus.

Although most jurisdictions said that registration alone would not subject an out-of-state corporation to their income tax, the number that would has grown from four last year to seven this year, and now includes the District of Columbia, Florida, Massachusetts, Ohio, Kansas, New Mexico and New York.

There was an almost even division as to whether the reimbursement of in-state salespersons by an out-of-state corporation would create nexus. A total of 24 jurisdictions, including New York, said that it would, while 21 said that it would not.

Farrah said that on sales tax issues, most states agreed that an out-of-state corporation that makes remote sales into their jurisdiction - by telephone, the Internet or direct mail - would trigger nexus by having an employee make an in-state visit four or more times during the year, sending an employee or independent contractor to repair or install property, or using an employee or third party to investigate or resolve customer complaints.

While 13 states said that sales or use tax nexus would be triggered by participation in a trade show within their borders, 34 said that nexus would only result if sales were made or orders were taken at the trade show. California said that retailers with trade show activities of 15 days or less in any 12-month period and no more than $100,000 in net income from California trade show activities in prior years would not be deemed to be "doing business" in the state for tax purposes.

In most of the states, authorizing an in-state affiliate to accept customer returns would create nexus. However, the states were divided on the issue of whether a corporation that makes remote sales into a state would trigger nexus by having an affiliate operate a retail store in the state: 15 states said that they would, while 20 states said that they would not.

"The survey showed that it is difficult to know when you are 'doing business' in a state for both income and sales tax purposes," said Farrah. "It shows the complexity and uncertainty of the system."

"States want to make sure that every company that should be paying tax is paying tax," he continued. "When states have revenue shortfalls, there's an incentive to be more aggressive in making those determinations. The survey shows they can be somewhat arbitrary as to what creates nexus."

Meanwhile, in an effort to bring about simplicity to state income tax nexus, proposed legislation has been introduced in the House to extend the effect of Public Law 86-272 by imposing a federal physical-presence standard for determining when a state may tax a company that earns income within its borders. The bill, H.R. 1956, has 40 co-sponsors, but is opposed by the National Governors Association.

In a recent letter, the NGA called on the House Judiciary Committee to vigorously oppose the bill. The letter called the bill "an unwarranted federal intrusion into state affairs that would create numerous loopholes allowing companies to avoid and evade state business activity taxes; increase the tax burden on small businesses and individuals; alter established constitutional standards for state taxation; and cost states more than $6 billion annually."

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