States are increasingly emboldened about imposing nexus on out-of-state entities, both in sales tax and corporate income tax, according to the latest Bloomberg Tax & Accounting Survey of State Tax Departments.
Now in its 22nd year, the annual survey queried state tax officials about how their jurisdictions approach a number of gray areas of corporate income tax and sales and use tax laws, in addition to the laws regarding the taxation of pass-through entities. This year’s survey, totaling close to 500 pages, focused on corporate income tax nexus policies, responses to the Tax Cuts and Jobs Act and the CARES Act, apportionment and sourcing policies, pass-through entities, non-U.S. entities, sales tax nexus, and voluntary disclosure agreements.
“We addressed nexus policies for both income and sales and use taxes and the sourcing of receipts for income tax purposes,” said Emilie Burnette, practice lead for state tax at Bloomberg. This year, a large majority of states, plus the District of Columbia, participated in both the income tax and sales tax portions of the survey.
“Wayfair creep,” or nexus creep, the increasing tendency of states to impose nexus, has triggered some pushback. “It’s worth noting that the Wayfair decision was decided on a 5-4 vote,” Burnette observed. “Since then, three new justices have been added. And this court has shown that it is not afraid to overrule precedent. Another case could conceivably narrow or even overturn Wayfair.”
The phenomenon has flowed through to localities as well as the states, Burnette added. “Municipalities were not even contemplated by the Wayfair decision, but they have likewise felt emboldened,” she said. “The Halstead Bead case, in the aftermath of Wayfair, illustrates the extent of the decision’s impact.”
In Halstead Bead, a small family-owned business is challenging the Louisiana system, alleging that it crosses the line set by the Wayfair decision. The state’s constitution requires each of its 64 parishes to collect sales and use taxes, with each parish setting its own tax rates and categories. State law requires out-of-state businesses that sell to Louisiana customers to register and file reports in each individual parish where sales are made.
The continued prevalence of remote working drew attention to the states’ positions on whether telecommuting creates nexus, Burnette noted.
“The vast majority of states responded that various telecommuting situations would trigger nexus, with 36 states saying that one to six employees who perform nonsolicitation activities would create nexus for an out-of-state corporation if the employee is telecommuting from within their state,” she said. “The answers varied only slightly for having telecommuting employees who perform back-office administrative functions, with 33 states saying this would create corporate income tax nexus. For having telecommuting employees who perform product development functions, 34 states responded in the affirmative,” she said. “Notably, Mississippi was the only state that responded ‘No’ to all three questions.”
The surprise revelation that having telecommuting workers creates nexus will lead many taxpayers to take advantage of voluntary disclosure agreements, Burnette suggested.
“This year, we added a section of questions to the survey regarding VDAs offered by the states for corporate income and sales and use taxes,” she said. “The states were almost unanimous in responding that they’re currently offering VDAs, with 38 states saying they’re offering VDAs for corporate income taxes and 35 states saying that they offer them for sales and use taxes.”
The survey found that only six states said that issues missed on a corporate income tax audit qualify for inclusion in these programs.
Sourcing and more
A consequence of nexus changes is that sourcing will become more of an issue, according to Burnette: “How income or sales is sourced will be increasingly important.”
The survey asked states to identify their general sourcing method for receipts from sales other than sales of tangible personal property. Twenty-nine states said that they use a market-based sourcing approach, while only six states said they use a cost-of-performance approach. Fifteen states said they apply different sourcing methods to different categories of receipts.
The survey also asked states to identify the sourcing method used to source receipts from cloud computing or software-as-a-service transactions. Twenty-two states said that they use market-based sourcing, three states reported that they use cost of performance, and three states said that they use a sourcing method other than cost of performance or market-based sourcing for cloud computing transactions.
The survey also looked at whether the states have industry-specific sourcing rules. According to this year’s responses, the most popular industries for which states have special sourcing rules are airlines (27 states), banks and financial services companies (26 states), and trucking companies (25 states).
“As in previous years, we asked the states to identify which formula they use to apportion an out-of-state corporation’s business income to their state,” said Burnette. “As expected, the sales-factor-
only formula was most popular, with 27 states responding ‘Yes.’”
Other key takeaways from the survey include:
- Twenty-two states, up from 15 last year, said they impose an entity-level tax on pass-through entities. However, these states were split on whether the entity must pay their entity-level tax: seven states said their pass-through entity tax is mandatory and 15 states said their tax is optional.
- In their responses, states gave critical information on how their economic nexus thresholds are calculated. While most states use sales made in a calendar year to determine whether a seller has established economic nexus, four states said they use sales made in the previous four calendar quarters. Additionally, almost every state responded that they include sales of tax-exempt items in calculating their economic nexus thresholds, but only about half the states include sales for resale in their calculations.
- As companies adjust to a more remote workforce, nexus created by teleworking employees continues to create complexity for companies trying to determine where they have tax filing and payment obligations. Thirty-three states indicated that one to six employees who perform nonsolicitation activities would create nexus for an out-of-state corporation if the employee is telecommuting from within their state.
- The states have continued to refine their responses to the CARES Act. All but three states responded that they conform to Section 1106(i) of the CARES Act, which provides that Paycheck Protection Program loan forgiveness will not be included as taxable income. Conversely, only seven states said that they conform to IRC Section 172 as amended by the CARES Act, which modifies the net operating loss deduction.
