State Taxation: Physical Presence Nexus versus Economic Presence Nexus
The federal tax liability is often a primary focus for many companies. However, the complexity and additional tax liability added by state filing requirements should not be overlooked. As a starting point, it is important to remember the similarities among the state tax laws. However, when it comes to state taxes, there are essentially 50 different sets of rules and tax forms to deal with.
One of the most important pieces of the multi-state taxation puzzle is nexus. Nexus is when a company has a taxable presence in a state. As a result, a state’s nexus rules describe a state’s ability to tax a company’s income. These rules are instilled when a company has a sufficient connection with a state and, while all states have nexus provisions, they can vary widely from one state to the next.
Historically, the determination of sufficient connection was established by a company’s physical presence in a state. For example, physical presence was created when activities such as the following occurred:
- Property is located in a state, such as the presence of an office
- Payroll sourced to a state as a result of employees working there or traveling to a state to conduct meetings, perform consulting services, install machinery, etc.
Alternatively, factors such as online sales and an ever evolving technological landscape have allowed many companies to generate sales in states throughout the country without ever leaving their home office.
To counter this decrease in physical presence, some states are adopting an Economic Presence Standard to show that nexus has been established. The Economic Presence Standard is met when the level of sales is deemed sufficient to impact a state’s economy by directing economic activity in the state or exploiting the state’s market. The standard is generally based on a specific volume of sales. For example, a taxpayer delivers goods in state X. These goods exceed either $500,000 or 25% of the taxpayer’s total sales, and therefore can create economic nexus. Some of the states that have already adopted the economic presence standard of nexus include:
- New York
It’s clear that companies can no longer rely on their lack of physical presence in certain states to determine their multi-state tax filing obligations. States continue to make changes to their taxation structure by tweaking it from year to year or by implementing a tax overhaul to address changes in the business landscape. It is crucial that companies review their contracts, business models, and how they are impacted by emerging state tax laws on a regular basis to ensure the multi-state tax impact is monitored regularly.