Crossing State Lines - Beware of Economic Nexus – The New Standard?

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As clients continue to cross state borders and state deficits soar, nexus and what establishes nexus, has become a hot topic.  For many years, certain out of state activities were protected by Public Law 86-272.  PL 86-272, as described below, provides companies income tax protection for their solicitation activities. 

PUBLIC LAW 86-272

 

Jurisdiction to tax is not present where a state is prohibited from imposing its tax because the

Corporation’s activities do not exceed the standard of mere solicitation of sales established by

Public Law 86-272. Public Law 86-272 provides in pertinent part:

No state, or political subdivision thereof, shall have power to impose a net income

tax on the income derived within such state by any person from intrastate commerce if

the only business activities within such state by or on behalf of such a person during the

taxable year are either, or both, of the following...

1. The solicitation of orders by such person, or his representative, in such State for sales

of tangible personal property, which orders are sent outside the State for approval or

rejection, and, if approved, are filled by shipment or delivery from a point outside of the

state and

2. The solicitation of orders by such a person, or his representative, in such State in the name of or for the benefit of a prospective customer of such a person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph.

As states try to find ways to decrease their deficits and balance their budgets, new standards are being developed to circumvent this protection.  Enter the economic presence standard.  Economic presence nexus focuses on out of state companies who profit from a state’s commerce but does not have the physical presence necessary to establish income nexus.  For example, Ohio’s Commercial Activities Tax taxes a company’s gross receipts derived in the state.  Michigan also incorporates an economic nexus standard for establishing tax liability.  The Michigan Business Tax is applicable if an entity derives $350,000 in receipts from the state.

The Multistate Tax Commission has adopted the following economics standards -

Substantial nexus is established if any of the following thresholds is exceeded during the tax period:

(a) a dollar amount of $50,000 of property; or

(b) a dollar amount of $50,000 of payroll; or

(c) a dollar amount of $500,000 of sales; or

(d) twenty-five percent of total property, total payroll or total sales.

Other states are establishing taxes such as net worth taxes to avoid the protection of PL 86-272.  Therefore, a company could have an employee in another state whose activities are limited to solicitation and not be subject to income tax liability.  If the state has a franchise tax, these activities may expose the company to the franchise tax. 

The multi-state compliance area has become increasingly complicated and requires an ongoing awareness of changes in state tax law and applicable case law.  Court cases have had significant influence on the way practitioners have interpreted state tax law and advised their clients.  As this area grows, I predict there will become a tremendous need for dedicated state and local tax law professionals.  The ever changing tax law at the federal and state levels keeps accountants, especially tax accountants, in high demand.  Indirectly, the state tax courts and politicians are providing job security, thank you!  

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If an employee moves to MI and works from home for an out of state corporation, does that constitute doing business in MI? If down the line, the employee solicits sales within MI for the out of state company, will that then be considered doing business in MI and therefore has to register as such?

Any views on extra territorial tax grabs with nexus ? ie UK software sales to the USA. How would it be enforced with zero USA presence.