Nexus! Now here’s a term that’s been used quite often these days, especially in the debate about whether internet retailers should be charging sales tax on sales to customers in states in which the e-tailers have no presence.
If you’ve been following the many reports on the “internet sales tax” dilemma, you’ve likely seen the term “nexus” often described as simply having an obvious physical presence in a state. I’m sure you’ve seen phrases such as “opening a storefront creates nexus” – end of story!
But “nexus”, that “connection” or “tie” that must exist before a state can impose its tax obligations on out-of-state businesses, can be triggered by many less obviousactivities. If you’re a tax professional, you likely well-versed in state tax nexus and are aware of some of the business activities that can create nexus.
But if you’re less familiar with nexus, you may be surprised to find out that even minimalactivities can subject an unsuspecting business to a state’s tax, filing, and reporting requirements.
To queue up the discussion, let’s look at a few different scenarios. Based on what you’ve read in the media, ask yourself whether you think the activities described in each scenario could create state tax nexus for corporate income, sales & use or other business taxes.
Scenario 1: ABC Corporation is a company headquartered in State X. The company has no physical location or resident employees in State A, but has a regional sales manager who resides in neighboring State B. Because State A is in the sales manager’s territory, he frequently travels to State A to solicit sales of widgets from existing and prospective customers but has no authority beyond sales solicitation.
Scenario 2: Assume the same facts as Scenario 1. In this scenario, however, the sales manager brings new-product inventory with him to each sales call and has the authority to sell the product; collect or approve payment; and turn purchased items over to his State A customers.
Scenario 3: In this next scenario we again have ABC Corporation, this time selling medical equipment, which is shipped by common carrier to ABC’s customers in State B. Because the equipment must be installed and the customer’s medical staff must be properly trained to use it, the company sends technical personnel from corporate headquarters in State X to the customer’s location in State B to install the equipment and train the medical staff.
Scenario 4: Now assume that ABC Corporation’s Marketing VP signs ABC up for a series of trade shows in State C. Several of ABC’s sales and marketing employees travel from State X and spend three weeks attending various trade shows in State C. Although customer leads are established during the trade show, no product is sold.
Scenario 5: In the next scenario ABC Corporation is an online retailer whose entire operations are in State X. All of its sales are made over the Internet and ABC’s merchandise is shipped by common carrier to customers in State D and all over the country. ABC has recently decided to contract with unrelated “marketing affiliates” in State D. The “marketing affiliate” contract will require affiliates to post a banner on their website which, if clicked, will send customers to ABC’s website. Marketing affiliates will earn a commission from each sale that originates from their web-link. However, other than passively directing customer’s to ABC’s website via the web-link, State D marketing affiliates will not be required to actively solicit customers for ABC.
Scenario 6: Next we have ABC Corporation hiring an engineer who is a resident of State E. Because the engineer resides over 100 miles from ABC’s corporate headquarters, ABC allows the engineer to telecommute full-time from his home in State E. As an engineer, this employee never meets with prospective customers nor does he hold his home out as an office of the company. Other than this one telecommuting employee, ABC Company has no connection to State E.
Scenario 7: How about this one? ABC Corporation is now a financial services company, again based exclusively in State X. ABC issues credit cards which contain ABC’s logo and are used by customers in State F.
Scenario 8: And finally, assume that ABC Corporation is now a subsidiary that was formed exclusively for the purpose of holding trademarks and other intangibles. ABC was incorporated in Nevada, but otherwise has no employees or operations in any other state. XYZ Corporation, a related company with retail stores in several states pays ABC a royalty fee to use the trademarks and intangibles. ABC’s trademarks are used in States L, M, N, O and P.
As you consider whether state tax nexus has been triggered in any of these scenarios, notice that none of these scenarios involve opening a physical location. I never once mention the opening of storefront, distribution center, or other facility in any other state.
But yet in every scenario I’ve described, ABC Corporation has possibly, and in some cases, definitely, created state tax nexus for at least one type of state tax.
State nexus is a complex concept, but understanding how easily nexus can be triggered can save a taxpayer many future headaches, as well as cash, since it’s much more costly to deal with delinquent taxes, penalties, and interest than it is to proactively determine a company’s state tax obligations.
Can nexus be created for one type of tax but not another? Absolutely!
For instance, in the first scenario above, ABC Corporation would have sales tax nexus but not corporate income tax nexus. This is because a federal law, Public Law (P.L.) 86-272, prohibits states from imposing a tax based on net income on out-of-state corporations whose only activity is soliciting orders for sales of tangible personal property, where the sales are approved and shipped from out of state.
Because P.L. 86-272 only applies to net income based taxes, activities other than those just described, would create nexus for sales, franchise, and other non-income based business taxes.
Beware the Nexus Questionnaire
It’s probably comes as no surprise that states are become more aggressive and sophisticated in identifying companies with nexus to their state. States are proactively viewing companies websites, using information obtained through audits of vendors or customers, and reviewing a company’s filings with other state agencies, such as with the Secretary of State.
If a state has any reason to suspect that a company may have state tax nexus, a state will almost always send out a nexus questionnaire. As you can see from these links to Texas‘ and Michigan‘s nexus questionnaire, states are looking at much more than having a physical location. Notice that these questionnaires list some of the exact activities I described in the scenarios above.
Sylvia’s Summation
State tax nexus can be triggered by so much less than an obvious physical presence. While the rules vary from state to state, and by type of tax, activities such as owning or leasing property, soliciting sales, attending trade shows, performing training, deploying employees or hiring contractors to perform services, contracting with marketing affiliates, and many more, can trigger nexus for one type of tax or another or for all taxes imposed by a state.* If your company is concerned about state tax nexus issues, seek the advice of a CPA, attorney or tax professional with knowledge of, and experience in, dealing with state tax nexus issues.
*For more on state tax nexus, I invite you to read ““Navigating Nexus,” an article I co-authored with my former colleague, Diana DiBello. Navigating Nexus was published in the November 2010 issue of the Journal of Accountancy. In Navigating Nexus, Diana and I discuss the various types of nexus, recent developments in the nexus landscape, and offer suggestions on how to chart a course through the treacherous nexus water.
