How States Are Generating Tax Revenue from Out-of-State Businesses

Margaret Amsden

Nexus is a broad and complex concern for expanding companies. Determining whether nexus has been established across state borders may be time intensive; however, taking the initiative is an important step.

States across the country have been aggressively seeking to generate tax revenue from out-of-state businesses. Historically, businesses with a multi-state presence have been able rely on Public Law 86-272 (PL 86-272) to help navigate their filing requirements. PL 86-272 created many of the basic concepts that determine “nexus”.

1. What Is “Nexus”?

The definition of nexus varies from state-to-state, but generally speaking is the minimum degree of activity, commonly thought of as physical presence, that must exist before a jurisdiction can impose an income tax on a business. The combination of each state defining the components of nexus differently and the evolution from brick-and-mortar to e-commerce has caused states to reassess nexus standards.

States are finding alternative routes to impose taxes not protected under PL 86-272, such as: franchise tax, privilege tax, net worth tax and gross receipts tax. The alternative efforts increase the likelihood for out-of-state filers to incur a tax liability. Additionally, since a statute of limitations does not begin to run until a return is filed, this could include past years.

2. What Is PL 86-272?

PL 86-272 is a federal law that provides limited protection to out-of-state companies against states looking to impose either income tax or tax based on income from business activity occurring within state borders. Each state has its own unique interpretation of PL 86-272, resulting in guidelines to follow when determining the protection provided to out-of-state companies.

PL 86-272 provides protection to out-of-state companies whose sole activity is solicitation by an employee or representative of orders for tangible personal property. The orders must be sent outside the state for approval and fulfillment and shipped from a point outside of the state. The statute specifically excludes solicitation for services or sales of intangible property.

3. What Additional Nexus Concerns Have Come Into Focus?

When expanding to a new state, companies should be aware that PL 86-272 applies only to taxes measured by net income for businesses selling tangible property. New forms of nexus that deviate from the traditional physical presence standard, such as economic, sales, payroll and click-through nexus, are causing additional concerns. Typically, each state has different thresholds or filing requirements and should be analyzed on a state-by-state basis, further emphasizing the importance of seeking guidance from a tax professional.

4. What Additional Taxes Are Being Implemented?

Aside from establishing nexus through varying ways of conducting business, states are increasingly turning to taxes other than income tax. The strategy is used specifically to avoid protection under PL 86-272. Examples of taxes being implemented and becoming closely monitored in recent years include franchise tax, sales and use tax, and privilege tax. Each state has different regulations, enforcing varying types of taxes in addition to those mentioned in this article.

If you believe your company may have triggered nexus within a state, it is critical to seek the advice of a tax professional to assist with determining whether a filing requirement exists. Ongoing changes occurring at the state level generally require the reevaluation of nexus on an annual basis.