In the last year, many states have revised the nexus standards for their corporate income tax and sales tax frameworks. By adopting these types of revisions, states broaden the scope of out-of-state companies that are subject to taxation and generate more revenue.
Several states with corporate income tax schemes have adopted the “factor presence (bright-line) nexus” standard. Under this standard, which was first recommended by the Multistate Tax Commission (“MTC”) in 2002, an out-of-state entity has nexus with a state if it meets minimum dollar thresholds for property, payroll, or sales in the state. The MTC’s model statute sets forth that a taxpayer has substantial nexus with a state if any of the following thresholds is exceeded during the tax period:
- $50,000 of property;
- $50,000 of payroll;
- $500,000 of sales; or
- 25% of total property, payroll, or sales.
Four states — Colorado, Connecticut, Oklahoma, and Washington — adopted the factor presence nexus standard in 2010. Three states, including California, had adopted the factor presence nexus standard in 2009.
In California, the factor presence nexus standard for its corporation franchise tax became effective on January 1, 2011. This new law, California Revenue and Taxation Code section 23101 (“Section 23101”), states that a taxpayer is “doing business in California” if it actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California or if any of the following conditions are satisfied:
- The taxpayer is organized or commercially domiciled in California;
- Sales exceed the lesser of $500,000 or 25% of the taxpayer’s total sales;
- Real and tangible personal property of the taxpayer in California exceed the lesser of $50,000 or 25% of the taxpayer’s total real and tangible personal property;
- The taxpayer’s payroll in California exceeds the lesser of $50,000 or 25% of total payroll.
(Cal. Rev. and Tax. Code § 23101.) The new law affects out-of-state corporations and pass-through entities (partnerships, S corporations, LLCs treated as partnerships) and their partners/shareholders/members that have property, payroll, or sales in California. Furthermore, even if the out-of-state taxpayer has less than the threshold amounts of property, payroll, and sales in California, it may still be considered “doing business in California” if the taxpayer actively engages in any transaction for the purpose of financial or pecuniary gain in California. Section 23101, therefore, greatly expands the nexus standard and increases the number of out-of-state businesses which are subject to California’s corporation franchise tax.
Also in the last year, the “Amazon tax,” which applies to sales and use tax, has received a great deal of publicity. As discussed in the December 2010 State and Local Tax Report, a New York appellate court recently upheld the constitutionality of the Amazon tax, which provides for a statutory presumption of nexus for New York sales tax law purposes. Based on agency nexus principles, the Amazon tax amended the definition of a “vendor” and created a presumption that an out-of-state seller solicits business in New York State through independent contractors or other representatives. More specifically, an out-of-state seller is required to collect sales tax on sales within New York if: (1) the seller enters into an agreement with a resident of New York; (2) under that agreement, the New York resident, for a commission or other consideration; (3) directly or indirectly refers potential customers to the seller by a link on an internet website or otherwise; and (iv) gross receipts from sales by the seller to customers in New York that were referred to the seller through the agreement exceed $10,000 during the preceding four quarters. By implementing this “Amazon tax,” New York is able to find nexus and tax the sales of internet retailers that have a New York resident “agent” who is soliciting business on the seller’s behalf. This practice also increases the reach of New York’s sales and use tax.
Other states are following suit and adopting similar rules to tax the sales made by online retailers. Just this month, Illinois Governor Pat Quinn signed into law the Main Street Fairness Act, which amends and expands the Illinois Use Tax Act’s statutory definition of an online retailer (e.g. Amazon.com) that maintains a place of business in Illinois. (See Illinois House Bill 3659.) The amendment requires out-of-state retailers to collect Illinois sales tax for internet sales based on the premise that affiliate marketers create nexus in Illinois. In other words, any sort of physical presence within Illinois, including maintaining a relationship with “affiliate” companies located in Illinois, such as deal and coupon website operators which earn commissions for directing shopping traffic to the internet retailer, will require the internet retailer to collect taxes on the Illinois sales. The Illinois amendment takes effect July 1, 2011. By expanding the nexus standard, the Illinois legislature hopes to collect the state’s 6.25 percent sales tax on all purchases made by Illinois residents, as well as level the playing field for Illinois retailers with out-of-state online competitors. In response to the new law, however, Amazon has sent out letters which terminate its relationship with Illinois affiliates, so the ultimate fiscal impact of the Main Street Fairness Act is yet to be determined.
Nevertheless, these nexus developments are a trend in state taxation, and they will likely be adopted by more states as states continue to seek additional tax revenue.