As states face record deficits, they are looking to increase revenues through the enforcement of income tax nexus laws. For state tax purposes, “nexus” generally means the minimum level of contact a taxpayer must have with a jurisdiction to become subject to a state’s tax.
The U.S. Constitution requires a minimum connection between a state and the person, property, or transaction it seeks to tax. Constitutional protections also limit the states’ ability to tax interstate commerce.
In addition, a federal law restricts the states’ power to impose net income tax on an out-of-state business that limits its activity in a state to the solicitation of orders for tangible personal property.
Despite these constitutional and statutory protections, the states vary greatly in determining what particular activity performed within their borders might trigger income taxation.
State appellate courts have found that a company need not be physically present in a state to become subject to a jurisdiction’s income tax laws. All that is needed is a certain amount of economic activity. For example, most states say that the presence of a single telecommuting employee within their borders is enough to subject an out-of-state company to their income tax.
Vague legal standards combined with little state guidance as to exactly what types of activities will trigger the imposition of tax, makes nexus a high stakes legal issue for multistate businesses. This is especially so, given the absence of a statutory of limitations for unfiled returns.
Here are some red flags that suggest a nexus review might be in order:
- a business that started off doing business in one state grows quickly and begins operating in other states,
- recent litigation or legislation changes a state’s nexus rules,
- a merger or acquisition,
- a change in tax managers (the former manager may have taken aggressive positions),
- changes to financial reporting rules requiring a corporation to record “uncertain positions”, or
- subcontractors working in a state for a business.
If you have any questions or concerns related to nexus issues, please contact us so we can discuss your situation.
Written by Howard Flitt.