Overview of Nexus
In the context of state taxation, nexus is a term used to describe a connection between a taxpayer and taxing authority. Federal laws require businesses to have more than a minor connection to a state before a state may impose a tax. So when does nexus rise to a substantial level, you ask? That’s a great question. The problem is that federal laws do not provide a definition. With no federal statutes to define substantial nexus, the results of federal court cases have largely set precedents that most states have followed for many years. However, the relatively recent adoption of factor nexus by many states indicates a trend towards redefining substantial nexus on a state-by-state basis.
Physical Presence, Economic Nexus and Factor Nexus
Physical presence means having tangible property or people located within a state. This has long been considered to provide a substantial connection for nexus purposes. On the other hand, economic nexus means having a connection without physical presence. Prior economic nexus rules have often been very subjective, making measurement for substantial nexus difficult. Factor nexus rules are becoming the states’ answer to measurement problems. Such rules are a continuation of previous economic nexus principles that go much further in describing exactly when nexus rises to a substantial level by establishing dollar thresholds or factors that must be applied. With the expansion of factor nexus, states appear eager to help taxpayers with murky nexus decisions.
Which States?
As of August 2015, Alabama joined the list of states that have expanded their economic nexus laws to include factor nexus. Alabama’s new law expands the definition of nexus for income tax, business privilege tax and financial institution excise tax. You’ll notice that sales tax is not mentioned in this list. This is because sales tax nexus is much harder for states to modify due to certain federal laws and court cases. This means it’s even more important to analyze your company’s operations to properly identify states where your company has income tax nexus versus sales tax nexus because the answers will often vary.
For tax years beginning after December 31, 2014, nonresident individuals and business entities organized outside of Alabama may have substantial nexus if any of the following thresholds are exceeded during the tax period: (1) a dollar amount of $50,000 of property; (2) a dollar amount of $50,000 of payroll; (3) a dollar amount of $500,000 of sales; or (4) 25% of total property, total payroll or total sales. At the end of each year, the state of Alabama will review the cumulative percentage change in the Consumer Price Index (CPI) and adjust the thresholds if the CPI has changed by 5% or more since January 1, 2015 or since the date the thresholds were last adjusted. The adjusted thresholds will be rounded to the nearest $1,000.
Connecticut was the first state with income tax to modify its economic nexus laws and assert that any taxpayer meeting a bright-line test of $500,000 in sales from Connecticut-sourced business activities had income tax nexus in their state. California, Colorado and Michigan soon followed suit. New York joined the club as of January 2015 with a $1,000,000 sales threshold and Tennessee imposed its factor nexus law in May 2015. Remember, economic nexus is not always limited to income tax. Taxpayers need to be aware that Ohio, Oklahoma and Washington have instituted similar factors for determining non-income-based taxes such as the Ohio Commercial Activity Tax (CAT).
Boulay Can Help
Remember that Boulay offers state and local tax consulting services to help identify and quantify nexus exposure and sourcing requirements.