In the state tax world, one of the most important concepts is that of “nexus”. Nexus is the term that we use to describe the minimum connection that a company (taxpayer) must have with the state in order for the state to be able to subject that company to its state taxing scheme (including sales tax, income tax, gross receipts tax, and others); otherwise known as “taxable presence”. Great! So what does that all really mean? And can we really cover it all in this blog article? (The short answer is no – but it’s a good start to a series!)
Let’s start with the basic premise that physical presence in a state will give a company nexus. Thus, if a company has “boots on the ground” in terms of employees or third party contractors working in the state, or has inventory or other personal property or real property in the state, the company likely has nexus with the state.
People: When we consider the people that a company may have in a state and that can create nexus, note that it can be more far reaching than people think. All of the following can create nexus (both for sales tax and income tax purposes) if engaged in activities in the state:
- Engineers or salespeople working from their homes,
- Employees traveling regularly into the state from other states (often this includes salespeople or consultants engaged on-site with customers),
- Third-party contractors (“1099’s”) working on the company’s behalf or representing the company. (An example would be independent contractors that engage in training or trouble-shooting at customer locations periodically, or those that engage in product installation.)
Note that there is a “safe harbor” for income tax only under Public Law 86-272. The Federal P.L. 86-272 prohibits a state from imposing its income tax on a company if the company’s only activity in the state is the solicitation of orders of tangible personal property, where those orders are approved from out of state AND shipped to the customer from inventory located outside the state. (Note that all of these requirements must be met in order for the activity to be protected from creation of nexus under the Public Law.) While this may seem like a broad exception, it is actually fairly narrow considering today’s more service-based economy. We often encounter clients that would meet the exception for their sales of widgets into a state (at first), but then the complete customer service package often includes the installation of the widget, training on how to use the widget or frequent visits to the customer location to customize the widget. Once the company begins to sell services or engage third party contractors for training and installation, the protection of P.L. 86-272 is lost.
Property: When property is physically located in a state and the company retains title to that property while in the state, nexus has likely been created. Some examples of property that generally create nexus in a given state:
- The rental of a warehouse to hold inventory (both the rental and the presence of inventory create taxable presence),
- The rental of office space,
- Maintenance of assets in the state, to include computers, servers, R&D equipment, etc. used by employees,
- Rental or lease of company property to customers. (This one often trips-up companies. An example would be where a company leases a point-of-sale device to an ultimate customer and those items are physically located in a state. Often the lease or placement of this small device is not the main source of revenue, but its presence in the state can pull in other revenue because it creates nexus.)
Keep in mind that there is a concept of de-minimis property. How much inventory or how much personal property can a company have in a given state before nexus is created? The answer, of course, is “it depends.” And each case should be analyzed in an overall manner, taking into account the entire fact pattern.
Economic nexus and other “advanced” topics!
As states get hungrier for a piece of the tax pie, they are stretching the limits of nexus because once this taxable presence is established, the state can impose sales tax collection and income tax compliance. But, based upon the U.S. Constitution, states cannot tax without representation (“nexus”) nor unduly burden interstate commerce. As states reach further, many have laws which incorporate the concepts of economic nexus (i.e.; does a trademark in the state constitute “doing business”?), agency nexus (i.e.; does a relationship with a corporate affiliate create nexus?), and click-through nexus (i.e.; does having a link on a website in the state create nexus?).
Each of those topics may be worthy of their own blog, so stay tuned for updates here soon. In the meantime, companies should be aware of the increasing effort by states to require companies to file by virtue of a minimum amount of taxable presence. We specialize in assisting companies with identifying both nexus and taxability of products in various states. Contact us with questions at firstname.lastname@example.org.