Businesses Face a Landmine of State and Local Tax Issues as States Keep Pace with 21st Century Business by Karen Lake
Posted on June 09, 2014
To sustain financial stability and fill budget gaps left over from the recession, states across the country are continuing to look for new ways to generate tax revenue. Introducing new legislation and stepping up enforcement of existing state and local taxation (SALT) laws are just the tip of the iceberg in the aggressive steps that state and local governments are taking to bolster their coffers.
A most significant trend has states looking outside their borders to assert economic nexus by attempting to establish a connection between the state and businesses, which would enable the state to collect taxes from that business, including corporate income tax, sales and use tax and franchise tax. The result is a dangerously fragile landscape on which businesses will need to tread carefully to examine their out-of-state business connections and identify nexus-creating activities that could result in levies of additional federal, state and local taxes.
What Constitutes Nexus?
Nexus is as a minimum connection a business must have in order for a state to tax the business or force it to collect taxes on the state’s behalf. Complicating nexus determinations is a general lack of one unified standard across the 50 states and 11,000 jurisdictions that collect business taxes.
Sometimes, nexus is obvious, such as when a business has a physical presence in a particular state. This can be in the form of a warehouse or another building that the company owns. At other times, a business may have “economic ties” to a particular state, which may make the nexus determination more difficult, especially when the rules governing these economic ties vary from one state to the next. These may includes situations in which a business conducts sales and other transactions online, or if it owns an out-of-state subsidiary or employs tele-commuters, sales forces or independent contractor located outside of its home state.
For example, the New York State Department of Taxation and Finance ruled that out-of-state companies who used New York-based independent contractors to direct traffic to their websites constituted a New York nexus. In Washington, the department of revenue interpreted an even narrower definition of “physical presence,” which a business may satisfy if an employee or independent contractor makes as little as two to three visits to the state during a year. Similarly, the state of Virginia recently required an out-of-state company to file a Virginia corporate income tax return because one single employee, who tele-commuted from her home office in Virginia, created nexus for the employer in that state.
These divergent nexus determinations represent a sampling of just how muddied connections may be and how inconsistent they are from one state to the next. Businesses may not recognize the impact of seemingly insignificant out-of-state or Internet-based activities and as a result, may go on for years without recognizing the established nexus until taxing authorities come knocking on their doors.
Once nexus has been established, or even when it may be presumed, businesses should err on the side of caution and begin filing returns in those states and paying appropriate taxes on income it earns. Failure to do so can have devastating consequences that may include demand for back taxes, including penalties and interest, that could date as far back as the year a company started doing business in a particular state.
Nexus in E-Commerce
The prevailing law governing nexus relating to remote catalog or 21st century online transactions is Quill Corp. v. North Dakota, in which the Supreme Court ruled that no state can force a business to collect sales taxes unless the business has a physical presence, such as a store, office or warehouse, in the state. Furthermore, the decision granted Congress, and only Congress, with the powers to grant tax collection powers to states. Despite this, many states are seeking to work around the Quill decision by making their own interpretations of what constitutes “physical presence.”
In 2008, New York enacted a “click-through nexus” statute that considers out-of-state sellers to be doing business in the state, and therefore required them to collect sales and use taxes, when the sellers provide referral commissions through sponsored links on websites owned by New York residents. Since that time, numerous other states have enacted similar “Amazon laws,” named after the e-tail behemoth Amazon.com. Texas, for example, demanded $269 million in back use taxes from Amazon, which later negotiated and reached a deal to pay its fair share of the tax to the state. Both Amazon.com and Overstock.com sought to repeal the law, to which the Supreme Court said “no” and kicked the issue back to Congress to address state tax collection.
In May 2013, the U.S. Senate voted to pass the Marketplace Fairness Act (MFA), which would allow the 24 Streamline Sales Tax State Agreement (SSTSA) member states to compel business to collect sales and use tax on all sales transactions, even when retailers do not have a physical presence in the state where the purchaser resides. The MFA currently awaits a vote by the House of Representatives.
Nexus in the Cloud
The increased use of Internet-based software, applications and cloud storage has provided states with new opportunities to expand their tax bases and treat previously non-taxable licenses as taxable purchase or rentals of tangible personal property. For example, some states, such as New Jersey, have chosen not to tax Internet-based application service providers (ASPs) when end-users do not possess nor download their applications. States such as Florida impose sales and use tax on software licenses delivered on a tangible medium while other states, such as New York and New Mexico, tax access-only service at the location where the end-user is located. Still, several other states have concluded that certain cloud transactions constitute nontaxable services, based largely on the determination that they involve the sale of services rather than the sale of tangible personal property.
It does not appear that there will be any abatement in the states’ efforts to push the nexus envelope in order to increase their tax bases. Monitoring evolving statutes and addressing relevant nexus issues should be paramount among 21st century companies that rely on disbursed workers, marketing affiliates and Internet and cloud-based services to operate their businesses.
The tax advisors and accountants with Berkowitz Pollack and Brant understand the nuances in state and local tax laws and have extensive experience working with businesses of all sizes and in various states to conduct nexus studies and meet their related tax obligations.
About the Author: Karen A. Lake, CPA, is a State and Local Tax (SALT) specialist in Berkowitz Pollack Brant’s Tax Services practice. For more information, call 305-379-7000 or email firstname.lastname@example.org.