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Shades of Gray: The Changing Face of State Tax Nexus May Unsettle Many Businesses

Thomas M. Frascella Director, Tax Strategies, State & Local Tax Group Leader

This article originally appeared in the February 2015 issue of Smart Business Philadelphia.

Thomas M. Frascella, J.D.

Nexus, the degree of contact between a business and a state that allows a state to impose taxes, has always been a difficult concept to define. Defining nexus has never been a "one size fits all" concept when it comes to state taxation, but with most states allocating more resources to identifying non-filers, the risk of detection has become greater than ever.

"Businesses need to be aware of their activities in multiple states to assess whether they have a filling responsibility in those states," says Thomas M. Frascella, Director, Tax Strategies, Kreischer Miller.

Smart Business spoke with Frascella about the evolving nexus landscape.

What is important for businesses to know about the latest taxation trends?

In today’s aggressive state taxing environment, it is essential that businesses understand the types of taxes that states impose and the degree of contact with a state that could trigger a responsibility to comply with state rules.

Sales tax, for example, historically required that a business have "substantial or physical presence" in a state before it was required to collect and remit sales tax. Today, states are revisiting the traditional notion that physical presence is a necessary element to sales tax nexus by promulgating rules and regulations that adopt a nexus standard based on a business’ affiliation with another business.

Does this have significant implications for business organizations?

The affiliated nexus standard is aimed at remote sellers who may not have any other connection with a state other than through financial relationships with businesses that facilitate sales with its customers.

Businesses using these affiliate relationships could find that they have nexus in more than just the states where they have a physical presence. The issue of affiliated nexus has become so heated that the federal government has attempted to regulate the taxation of out-of-state sellers by introducing legislation to essentially protect "main street" businesses from complying with such rules.

What has been the reaction of the states to stimulate the tax flow?

States have also responded to the severe fiscal crisis they have been operating under by rushing to enact taxes that require a lesser presence and seek to establish more of a "bright line" nexus standard. For example, Ohio enacted the Commercial Activity Tax ("CAT") which adopted a factor presence standard for imposing nexus on out of state businesses.

The State of Ohio argued that because the tax was neither a sales tax nor an income tax, physical presence was not necessary to create nexus with the state. The factor presence nexus standard claims to establish substantial nexus when certain thresholds around property, payroll or sales are met. The Ohio CAT statute requires that an out-of-state business have either $50,000 of payroll in Ohio, $50,000 of property in Ohio, $500,000 of gross receipts in Ohio or at least 25 percent of the business’ total property, payroll or gross receipts in Ohio.

Is factor presence here to stay?

The popularity of the factor presence test is beginning to grow and more states are beginning to see it as a means of expanding the current taxpayer base without resorting to the unpopular measures of raising tax rates or implementing new taxes.

Factor presence has even crept into the area of state income taxes. It has begun to replace the historical physical presence test which has been the linchpin of state income tax nexus for decades.

California was the first state to adopt factor presence as it related to the Franchise Tax, a tax that is imposed on the net income of a business. Other states have followed suit, including Colorado, Connecticut and Michigan.

It is too early to tell whether the use of factor presence test will survive legal challenges that are sure to be raised. However, businesses that have customers located in states where they do not currently have a physical presence should review their current operations to assess if exposure to other state taxes, such as sales, gross receipts and even income taxes exists under these new nexus standards. ●

Thomas M. Frascella can be reached at Email or 215.441.4600.

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Thomas M. Frascella

Thomas M. Frascella

Director, Tax Strategies, State & Local Tax Group Leader

State and Local Tax Services Specialist

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