Despite the constitutional, judicial and legislative pronouncements affecting nexus, states vary widely on what level of activity renders a business liable to pay state tax.“There are plenty of gray areas, and on some issues a state will say it depends on the facts and circumstances,” said George Farrah, executive editor of state tax and accounting for BNA.

Although the 1992 Supreme Court decision in Quill concerns sales tax nexus on out-of-state corporations, the High Court left undecided the issue of whether income tax nexus is subject to the same test.

Nexus — the minimum amount of contact between a taxpayer and the state that permits taxation by the state — arises both from the Commerce Clause and the Due Process Clause of the U.S. Constitution. While states have the authority to impose income tax, the Commerce Clause prohibits them from unduly burdening interstate commerce, and the Due Process Clause requires a minimum connection between a state and the entity that it wishes to tax.

Public Law 86-272 further limits the states’ power to impose 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. Further complicating the issue, the law applies to nexus only for income tax, but does not apply to franchise taxes, which are imposed for the privilege of doing business in a state. The consequence is that while the solicitation of orders in a state may not give the state sufficient nexus to impose income tax on a business, it might be enough to create nexus for franchise tax purposes.


Each year, Farrah oversees BNA Tax Management’s survey of state tax departments. Top state tax department personnel are asked to identify which of certain specified activities or relationships would create nexus in their state — assuming that the activity or relationship is the only connection a corporation has in the state.

In this year’s survey, most states indicated that corporate income tax nexus could be triggered by conducting a certain amount of economic activity in the state, even if a corporation lacks a physical presence within that state’s borders. The exceptions were Delaware and Tennessee, which said that their corporate income tax nexus policies are based on physical presence alone.

Seven jurisdictions said that their income tax nexus policies are based on both economic presence and physical presence, while nine states said that they apply the Quill decision in making income tax nexus determinations. Of the states that said they did not apply Quill, five indicated that they had adhered to the case in the past.

“Even though state appellate courts in Geoffrey and similar cases have affirmed the use of an economic presence standard, it was still surprising to see how few states said their state nexus policy is based on physical presence,” said Farrah. “Only a handful of states said their nexus policy was based on physical presence alone.”

“There’s been a debate for the last decade as to whether the physical requirement stated in Quill should be applied to non-sales business activity tax,” which includes income tax, as well as gross receipts tax and franchise tax, said Lee Zoeller, partner and practice group leader at the law firm of Reed Smith LLP. “Quill generally does not apply to business activity tax. Courts have clearly limited it to sales tax so far, although there are still some cases percolating through the system.”

“It all started with the Geoffrey decision in South Carolina in 1993,” he said. “Geoffrey was the first decision that said using a royalty in the state is economic nexus. It spread like wildfire. There was a spattering of decisions that went the other way, but most follow Geoffrey.”

Geoffrey, a wholly owned subsidiary of Toys R Us, owned trademarks and other intangibles in South Carolina (and 44 other states), but had no tangible property or employees in the state. It received royalty payments from Toys R Us on a monthly basis.


Between sales tax and income tax nexus, income tax is by far the more contentious, according to Zoeller.

“Sales tax is straightforward now,” he said. “At the end of the day, it’s a collection issue. Barnes & Noble still has a few cases pending, but you rarely run into people refusing to collect sales tax because they don’t have nexus. They’re merely collecting tax that someone else has to pay.”

There is a wide disparity as to whether nexus could result from general business activities such as registering to do business, having a Web site server, or having an in-home office in the state, according to the survey. There was also considerable variance on whether merely having a phone listing in a state creates nexus.

Although most states agreed that registration alone would not subject an out-of-state corporation to their jurisdiction’s tax, there were 10 exceptions, three more than last year. The states were divided as to whether nexus would be triggered when an out-of-state corporation reimbursed its in-state salespersons for the costs of maintaining an in-home office, according to BNA’s Farrah.

New York and Oklahoma were the only states that said that a corporation performing consulting services within its jurisdiction for six or fewer days would not create nexus. However, New York noted that an out-of-state corporation might be subject to nexus in combination with an in-state affiliate.

Ten states — two more than last year — said that traveling through their borders six or fewer times per year in taxpayer-owned trucks without picking up or delivering goods would create nexus. Eleven states — one more than last year — would claim nexus if an out-of-state corporation traveled through their jurisdiction more than six, but fewer than 12 times.

“The trend is clearly for states to go after anyone earning income from the state,” said Zoeller. “The next battleground will be exactly how do you compute the tax. It gets complicated with companies having triple-weighted sales factors. They used to weigh property, payroll and sales evenly, but now they’re weighing the sales factor more heavily. It puts a bigger tax burden on non-home-state companies.”

Meanwhile, Zoeller noted, proposed business-activity tax legislation in Congress “would draw a line in the sand regarding nexus.”

“It’s been around for awhile. There’s been some momentum up and down to get something like that enacted,” he said.

The proposal, the Business Activity Tax Simplification Act of 2008, has sponsors in both houses of Congress. “[It] would create bright-line tests to ensure that states continue to have the ability to tax businesses that operate within their borders, employ people and have property within their boundaries, and utilize the services those states and municipalities provide,” said Tara Bradshaw, a spokesperson for the Coalition to Protect Interstate Commerce.

“However, the legislation also clarifies that ‘doing business in a state’ does not mean simply having customers in the state,” she said.

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