Discussion:Do sales of insurance over the internet establish nexus?

Client is selling insurance over the internet from his website ONLY - Life, Health, Accident. Does he have nexus in the states that he does business in? Is he afforded protection under PL 86-272?

For instance... Sale of real estate, inventory inspection by salesperson, leasing tangible property, occasional instate delivery via company owned truck, listing company in phone book, instate awrranty repair performed by unrelated third parties for a charge, etc.

I have not been able to find any guidance regarding insurance however.

The Quill decision, to which JR refers, clearly requires a physical presence for purposes of use tax collection responsibility. With respect to business activity taxes (income taxes, franchise taxes, gross receipts or gross margin taxes), however, most commentators and state authorities believe the Court did not draw that line. That is the main reason why the Business Activity Tax Simplification Act (BATSA) is pending in Congress.

I presume the client is an agent, not an underwriter. As long as he is not physically located in the states where his customers are located, and does not travel there, and does not own property there (e.g., a server on which his web site is located), he probably will not establish nexus in the customers' states. However, states are increasingly aggressive in asserting business activity tax jurisdiction over entities that exploit the marketplace even though they have no physical presence. The U.S. Supreme Court recently denied certiorari in two cases where state supreme courts upheld such "economic nexus" claims. In addition, some states may assert jurisdiction. For example, the Ohio Commercial Activity Tax (measured by gross receipts) is imposed on any business, wherever located, that makes more than $500,000 of sales to Ohio customers in any calendar quarter, or that has at least 25% of its property, payroll, OR sales in Ohio. Sales of services are attributed to Ohio if the benefit of the service is enjoyed there -- in other words, such sales are assigned to the location of the customer, not the location of the service provider.

So there are no hard and fast answers here. You also need to be aware that the insurance business is subject to different rules in many states. Those rules generally would apply only to an underwriter, not an agent who sells policies on commission; but there may be exceptions.

In general, though, you can take the position that he does not establish nexus outside his home state, or any state where he physically visits to solicit customers or has real or tangible personal property (owned or rented) used in the business. Just be aware that there continues to be some risk.

Thanks, that was more or less my conclusion. I found examples and such for everything I could think of but not insurance.

I am talking about the Philadelphia Business Taxes, but suspect New York City would rule the same. So would this give the person nexus in those places? I would doubt it, but it is worth considering. Also the fact that certain policies may not qualify for sale in certain states is another factor that enters into the equation.

This is from the RIA SALT update e-mail this morning:

"Out-of-state credit card banks using Massachusetts economic market and resources are subject to financial institution excise. The Massachusetts Appellate Tax Board ruled that out-of-state credit card banks were subject to the financial institution excise even if they had no physical presence in Massachusetts based on their deliberate and targeted exploitation of the Massachusetts economic market and their use of Massachusetts' governmental infrastructure and resources. These in-state activities constituted substantial nexus with Massachusetts justifying the imposition of the financial institution excise. The credit card banks met the statutory presumption that they are engaged in business in Massachusetts and the requirement of physical presence in Massachusetts did not apply to an income-based excise such as the financial institution excise tax. Capital One Bank v. Commissioner of Revenue, Massachusetts Appellate Tax Board, Dkt. No. C262391, 06/22/2007"

They're after financial institutions right now, but internet businesses may not be far behind.

"In the event of non-payment by its customers, the Banks worked with collection agencies and attorney networks to collect delinquent accounts. These agencies and attorneys provided collection services to the Banks related to their Massachusetts customers, and instituted legal proceedings on behalf of the Banks in Massachusetts courts. Capital One Services, Inc. (“COSI”), 5 a subsidiary of COFC that provided advertising, marketing, administrative and management services to the Banks, engaged Massachusetts attorneys to bring actions against customers in default on behalf of the Banks.

"In furtherance of the Banks' collection efforts in Massachusetts, the Banks obtained garnishments or liens against personal property and secured writs of execution against Massachusetts real estate. If court actions were brought in Virginia against Massachusetts residents under the Virginia long-arm statute, those judgments were at times domesticated to Massachusetts for further enforcement proceedings. The Massachusetts Attorney General's Office also helped mediate disputes between the Banks and Massachusetts residents during the years at issue, offering assistance through its Consumer Complaints and Information Section and nineteen Local Consumer Programs located throughout Massachusetts.

.....

"The Board found and ruled that the Banks' activities constituted “substantial nexus” with Massachusetts so as to justify imposition of the FIET, irrespective of whether the Banks had a physical presence in Massachusetts during the years at issue. The Banks' purposeful, targeted marketing of their credit card business to Massachusetts customers, their required quarterly filing of Credit Card Issuer's Reports with the Massachusetts Division of Banks, their use of Massachusetts court system and the Massachusetts Attorney General's Office to collect delinquent accounts and resolve disputes with Massachusetts customers, their use of a sophisticated network, including Visa and MasterCard as well as Massachusetts acquiring banks, which linked them with Massachusetts customers and merchants and by which they, through the customers' use of “Capital One”-branded cards, guaranteed payment to the merchant on behalf of the customer, and their deriving of hundreds of millions of dollars in income from millions of transactions involving Massachusetts residents and merchants constituted substantial nexus with Massachusetts.

"The Board further found and ruled that the privileges related to the Banks' right to do business and its sale of financial services in the Commonwealth is a “commodity” and the FIET is a “reasonable excise” upon that commodity for purposes of the Massachusetts Constitution."

Paul Frankel and others from MoFo represented the taxpayer in this case, so you know the taxpayer didn't lose because its counsel didn't know what they were doing.

Each state however defines nexus in their own context...so check out the nexus requirements in each state to determine how the respective DOR's define it....

And JR's point about the connections the insurance agent may need in the customer's state is very well taken.

That is why I hear all the time about people wanting to incorporate in a state where it is "friendly" per nexus standards, but this can be trumped as well you know. FL defines nexus pretty favorably for many persons if they have no sales tax nexus in the State. Since FL has no state income tax for individuals they do not aggressively pursue nexus establishment unless the person also has a sales/use tax presence in the state. So for internet sales, many times you will see that FL is not a state that defines nexus unless you actually have a PHYSICAL presence or have sales which would be subject to sales tax.

You really know court cases Katie!! WTG girl!!!  :)

Sens. Schumer and Crapo have introduced a bill that would define federally what states could consider taxable economic activity. This follows the denial of cert by the Supreme Ct in the two cases mentioned above by Katie.

These "intangible holding companies," or IHCs, are a state income tax planning tool ("State Tax Planning 101") that has been around for many years but has been successfully challenged in a number of states, including South Carolina (Geoffrey), New Jersey (Lanco), and New Mexico (KMart Properties) by the state asserting jurisdiction to tax the income of the IHC.

Geoffrey (the Giraffe) is a prime example of this tax planning structure. Toys R Us has retail stores nationwide, including in South Carolina, which is a separate filing (i.e., not a unitary combined reporting) state. TRU transfers its trademarks, trade names, etc. to Geoffrey, a subsidiary organized and operated in Delaware, in exchange for Geoffrey's stock. Geoffrey then licenses the use of the intangibles to TRU. This structure reduces TRU's state income tax in all separate filing states, because the net income apportioned to the states where the stores are located is reduced by the royalties paid to the IHC. Often the parent corporation borrows the money back from the IHC and pays interest on the loan, further reducing its own income subject to apportionment. Organizing and operating the IHC in Delaware results in no state income tax for the IHC, because Delaware law exempts from the corporate income tax the income of corporations whose activities in Delaware are limited to the management of intangible assets (Del. Law Sec. 1902(b)(8)). States with no corporate income tax, such as Nevada and Wyoming, are also popular locations for IHCs.

States have attacked this structure in several different ways. One approach is to assert jurisdiction over the IHC, as SC, NM and NJ did. Another is to attempt to adjust the intercompany royalty to an arm's length amount (not usually fruitful if the taxpayer has done its homework) under an IRC Sec. 482 analogue, or simply to find that the IHC is a sham availed of only for tax avoidance purposes, with no business purpose or economic substance, and therefore deny the licensee (over which the state clearly has jurisdiction) the royalty deduction. Some states have been successful with the latter approach, although again, if the taxpayer has done its homework, it isn't easy. The Massachusetts Supreme Judicial Court allowed the deduction to Sherwin-Williams, for example.

In the past 5 years many separate filing states (I think we are up to 13 or 14 now) have enacted statutes requiring the addback of royalties, interest, and sometimes other payments made to related entities. This seems like a simple solution to the states' problem -- no nexus issue here, the state clearly has jurisdiction over the entity with stores or whatever in the state, just disallow the deduction by statute. But in practice it is a total nightmare, because nobody wants to disallow legitimate business expenses. So there are different "safe harbors" and "out" clauses in the various state statutes.

The REALLY simple solution to this problem, from the states' perspective, is the unitary combined report. In a combined report, the income and apportionment factors of all members of the unitary business group are included to calculate the income and tax liability of those members that are taxpayers in the state. So in the simple, TRU/Geoffrey example, the net incomes of TRU and Geoffrey are added together and apportioned to the state by a formula that includes TRU's in-state property, payroll and sales in the numerators, and the total property, payroll and sales of the group in the denominators. The intercompany sale (royalties, interest) between TRU and Geoffrey is eliminated. The resulting income and tax liability of TRU is the virtually the same as if Geoffrey did not exist, since its (real and tangible) property and payroll are minimal. Voila, problem solved.

The number of combined reporting states remained the same for 25 or 30 years, but in the last 4 years, 4 additional states (VT, NY, WV, TX) have adopted it, and several other states are seriously considering it (e.g., NM, MO, AR, PA, MI). The IHC problem is one of the big reasons for this. If Congress imposes a physical presence nexus standard, there will be even more impetus for states to move to unitary combination.

Rick Pomp says states that don't use unitary combination should post a sign at the border, "COME ON IN AND PICK OUR POCKETS" <g>.