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State Tax Nexus and the New Frontier

March 18, 2024 4 Min Read Alerts, State and Local Tax Services
Thomas M. Frascella
Thomas M. Frascella Director, Tax Strategies, State & Local Tax Group Leader

This is part one of a four-part series that provides important information on State Tax Nexus.

There was a point in time when the rules regarding a state’s ability to subject out of state businesses to tax within their state were much simpler. Unfortunately, due to case law, administrative overreach, and organizations dedicated to promulgating standards for states, the rules related to what constitutes doing business in a state have become very complicated.

Understanding Nexus

The connection a business has with a state is generally referred to as nexus and unless a business has nexus with a state it cannot be subjected to the taxes imposed by that state.

To protect businesses from the overreach of state taxation, Congress enacted Public Law 86-272.  The law restricted states from imposing net income taxes on out of state businesses when the only activity within the state was related to the solicitation of sales of tangible personal property. While there are different tax types such as income, sales, net worth, and gross receipts taxes, the standard for nexus was fairly consistent and required some form of physical presence in the state before a business established nexus with the state.

Shifting Nexus Standards

Over the years, the federal law has come under attack through various measures. For example, some states have expanded the scope of “unprotected activity,” which represents actions that are more than just solicitation as defined in the Statement issued by the Multistate Tax Commission. Most recently, the Multistate Tax Commission took its interpretation of “unprotected activity” to new heights by advocating that the evolution of technological advances and certain internet activities can result in a presence within the state that could create nexus.

One state that adopted this broader nexus standard is California. In 2022, California issued guidance related to the reinterpretation of the federal law that sought to tax out of state businesses. In a recent taxpayer victory regarding a challenge to the California guidance, the California Court decided that the state violated procedural guidelines in the way that it adopted its guidance. The California Franchise Tax Board has already said that it will appeal the decision.

California is just one state that has undertaken measures to reinterpret the federal law to be able to reach and tax out of state businesses. The California court decision has implications for these states as well as for the Multistate Tax Commission’s statement regarding the reinterpretation.  States are closely watching what happens in California to determine how they will proceed.  This is just one example of how states have responded to the question of nexus for income tax purposes. 

Other nexus considerations include income tax for service-based businesses and non-income tax types, such as gross receipts taxes and net worth taxes. Service-based businesses must accept the fact that there is no federal protection from the imposition of state income tax. In response to the Supreme Court decision in Wayfair, states have redefined what constitutes nexus based upon the presence of payroll, property, and sales factors. Often, states that have adopted this nexus standard ensnare out of state businesses based upon the level of sales to customers located within their state. 

Understanding Which Activities Can Trigger Nexus for Your Business

Although the imposition of a state income tax at one time required a physical presence, states are taking measures to reinterpret and create a new nexus standard. Physical presence is no longer a requirement in many situations when it comes to determining if an out of state business has nexus with a state. While businesses engaged in the sale of tangible property are afforded the most protections, those protections are constantly under attack and quickly being eroded. Shifting nexus standards have made it difficult for businesses to determine when they have created nexus in a state. They need to be diligent when reviewing their business practices and operations to determine what the implications are for nexus and the requirement to file taxes in a state.

Stay tuned for part two in our series which will cover additional information on State Tax Nexus. If you have any questions, please contact your Kreischer Miller relationship professional or any member of our State and Local Tax Group.

Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.

Contact the Author

Thomas M. Frascella

Thomas M. Frascella

Director, Tax Strategies, State & Local Tax Group Leader

State and Local Tax Services Specialist

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