Bright-line, factor presence nexus has become an increasingly popular issue in state taxation in recent years. While the rules and thresholds vary from state-to-state, the Multistate Tax Commission’s (“MTC”) model rule exemplifies how factor presence nexus works. Specifically, the MTC’s model rule provides, in part, that “substantial nexus” (i.e., a taxable presence) exists for corporate income tax purposes if an out-of-state taxpayer has total sales in the state exceeding $500,000 during any given taxable period. Several states–including Alabama, California, Colorado, New York, Ohio, and Tennessee–have adopted factor presence nexus rules; however, to date, there have been very few cases that have considered the constitutionality of bright-line, factor presence nexus standards.

In Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760, the Ohio Supreme Court became the first state high court to rule on the constitutionality of a factor presence nexus law. At issue in Crutchfield was whether an out-of-state company maintained “substantial nexus” with Ohio for purposes of the commercial-activity tax (“CAT”), despite lacking physical presence in the state. The Court held that the physical-presence requirement recognized by the U.S. Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) applies for purposes of use tax collection but “does not extend to business privilege taxes such as the CAT.”

The CAT is an annual gross receipts tax imposed on the privilege of engaging in income-producing activity in Ohio. An out-of-state business with “bright-line presence” is required to register with the Ohio Department of Taxation and pay the CAT. Ohio law further defines “bright-line presence” to exist if an out-of-state taxpayer has at least $500,000 in taxable gross receipts from Ohio sources in any taxable period.

Crutchfield Corp. argued the Ohio tax commissioner’s assessments were unconstitutional pursuant to the dormant Commerce Clause–that is, it did not have “substantial nexus” with the state as required by the U.S. Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), even though it had $500,000 in taxable sales to Ohio customers. According to Crutchfield, a “local incident” had to physically connect the company with the state before the state could assert its jurisdiction to impose a gross receipts tax. The Ohio Supreme Court rejected this argument, finding the “substantial nexus” prong articulated in Complete Auto did not require physical presence in this case. The Court further held that the physical presence requirement articulated in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), for use tax substantial nexus “does not apply to a business-privilege tax such as the CAT, as long as the privilege tax is imposed with an adequate quantitative standard that ensures the taxpayer’s nexus with the state is substantial.” The Court then concluded that the $500,000 Ohio sales-receipts threshold adequately ensured that a taxpayer’s nexus with the state is “substantial.” Although the CAT is a unique, gross-receipts based tax, other states may now point to the Ohio Supreme Court’s decision when defending the constitutionality of their factor presence nexus thresholds.

In the dissent, one of the Ohio Supreme Court justices astutely noted that the “physical presence requirement is grounded in the reasoning that the dormant Commerce Clause is designed to prevent regulation and taxation from being an undue burden on interstate commerce.” Accordingly, the dissent argued that the physical-presence requirement of Quill should apply to Ohio’s CAT and “federal legislation is necessary before Ohio can impose the CAT on out-of-state businesses. It is not the role of this court to bless a state’s attempt to regulate interstate commerce though a taxing scheme just because Congress has been silent.” Whether the U.S. Supreme Court will find these arguments compelling enough to grant certiorari on a possible future appeal remains to be seen.

Given the growing number of states that have adopted factor presence nexus standards and the U.S. Supreme Court’s historic silence (i.e., declining to grant certiorari) on the issue of whether Quill’s physical-presence requirement applies outside of the sales and use tax context, a grant of certiorari by the U.S. Supreme Court on a possible future appeal of the Crutchfield case could have wide-reaching implications.