The variation in states’ use of economic presence in determining nexus for sales tax is one of the key takeaways from the 2018 Bloomberg Tax Survey of State Tax Departments. With the Supreme Court’s decision in South Dakota v. Wayfair in the offing, 16 states indicated that they have economic presence nexus standards for sales tax — despite the fact that they are currently disallowed under the court’s 1992 ruling in Quill v. North Dakota, which established that a physical presence test be met before states can require remote sellers to collect sales tax on sales into the state. While the Quill decision addressed only sales tax nexus, it left open the question of nexus for corporate income tax.
Nexus is the minimum amount of contact between a taxpayer and a state allowing the state to tax a business on its activities (income tax nexus) or require it to collect and remit sales tax (sales tax nexus). The requirement arises from two clauses in the Constitution: the Commerce Clause and the Due Process Clause. The Commerce Clause prohibits a state from unduly burdening interstate commerce, and the Due Process Clause requires a minimum connection between a state and the entity it seeks to tax.
In addition to questions on nexus, Bloomberg Tax asked questions of senior tax officials in each state on the tax treatment of pass-through entities and intangible holding companies, conformity to federal tax reform, methods of sourcing income, sales tax refund actions, requirements for reporting federal changes, enforcement, and collection policies. The survey also addressed the states’ general apportionment formula and sourcing method, and pass-through entity level nexus. “State variances in taxation create complexity and risk for businesses, which is magnified in today’s economy,” said Bloomberg Tax editorial director George Farrah.
“As the survey reveals, states continue to struggle in dealing with taxation of cloud computing and digital goods,” observed Richard Cram, director of the Multistate Tax Commission’s National Nexus Program.
Sales tax issues
“This year, two of the biggest topics discussed were about tax reform and the Wayfair sales tax nexus issue,” explained Chreasea Dickerson, tax law editor for Bloomberg Tax, who helped oversee the survey. “Sixteen states indicated that their policy was based on economic nexus, while five states said that they have an economic nexus that is not currently being enforced due to pending litigation or an effective date in the future.”
“This year we also asked about notice and reporting requirements,” she said. “Eleven states indicated that they require in-state retailers to report in-state sales to the Department of Revenue, and seven states said that they require out-of-state retailers to notify customers of their use-tax obligation.”
Many states are holding back on the issue of sales tax nexus and reporting requirements pending the outcome of the Supreme Court decision in Wayfair, she suggested.
One state that went ahead and jumped the gun is Georgia, which passed an economic nexus standard in early May. The legislation requires online retailers that make at least $250,000 or 200 sales a year in Georgia to either collect and remit sales taxes on purchases, or send “tax due” notices each year to customers who spend at least $500 on their sites.
“Some states are using use-tax notification requirements to strong arm out-of-state taxpayers into registering for sales tax purposes,” suggested Stephen Bradshaw, a senior manager at Atlanta-based Top 100 Firm Bennett Thrasher. “The tax notification reporting requirements are burdensome, and penalties for noncompliance are high,” he said.
The majority of states indicated that merely attending a trade show or attending a seminar was not enough to create sales tax nexus. However, a majority also said that holding at least two one-day seminars was sufficient to create nexus.
Regarding e-commerce, or click-through nexus, states are taking a closer look at whether arrangements with affiliates utilizing internet tools have the potential to create nexus, according to the survey.
Eighteen states said that using an internet link or entering into a linking arrangement with a third party in the state is sufficient to create nexus for sales under $10,000. The number of states imposing nexus increases to 26 when the relationship results in more than $10,000 in sales, the survey noted.
Overall, a majority of states said that selling remote access to digital products would not create nexus, the survey found. This year, nine states said that selling remote access to canned software would create sales tax nexus. When the software is considered to be “custom” software, only four states indicated that remote sales would create nexus.
“However, states almost unanimously agreed that nexus is created when a representative visits the state in order to customize canned software,” the survey reported.
Selling a digital version of a tangible magazine or newspaper would not create nexus in the majority of states.
The survey also asked states about “cookie” nexus, according to Dickerson. Cookie nexus would impose nexus on an out-of-state retailer if the retailer requires visitors to its website to download cookies. “Only two states indicated that requiring visitors to download internet cookies onto electronic devices would create nexus,” she said.
Two other states said that it depends, while 31 states said “No” to cookie nexus.
Eighteen states, one fewer than in 2017, indicated that entering the state solely for the purposes of providing disaster relief was enough to create sales tax nexus.
The survey breaks down income tax nexus into three categories: states that follow a physical presence standard based on the presence of employees or property within their borders; states that follow an economic presence test based on sales into their state; and states that have constructed a factor presence nexus standard based on taxpayers exceeding a specified threshold of physical or economic presence in the state.
“This year, an additional state indicated they have factor presence nexus,” Dickerson said. “Last year, 13 states indicated they had factor presence nexus, while this year 14 said they had factor presence nexus.”
“Any trend is toward broadening the state’s authority to get more revenue,” she explained.
The income tax side
“Most of the activity on the income tax side was related to tax reform over the last six months,” Dickerson said. “One aspect of tax reform has been enhanced expensing provisions. Because most states operate on a one- or two-year budget, 100 percent expect an impact in Year One on how much tax revenue they collect. Many states also have a balanced budget requirement, meaning they can’t run a deficit, so they’re doing a lot of analysis into figuring out whether they will conform to tax-reform provisions.”
“A large portion of this year’s survey was about sourcing,” said Dickerson. “This year we asked states about their general sourcing method used to source receipts from sales. As we expected, most indicated they follow a market-based sourcing approach. However, a few states indicated their sourcing method varies depending on the types of receipts. For example, sales of services would differ from the sales of intangibles.”
Market-based sourcing looks to the state where a service is received, rather than the state where the provider is located. In recent years, there has been some movement away from cost-of-performance sourcing to market-based sourcing. Specifically, 19 states indicated that they use market-based sourcing, nine states reported that they use cost-of-performance sourcing, and four states said that they use a sourcing method other than either cost-of-performance or market-based.
“There was not a lot of movement from cost-of-performance to market-based sourcing this year,” Dickerson said.
