Discussion:What is nexus?

But I keep hearing about NEXUS, first heard it from the CPA I worked with here, but I don't know what it is and when it comes up in a discussion, I don't really understand it. Sounds like a new hair gel to me, so I'm pretty sure that's wrong.

http://m-w.com/dictionary/nexus

Nexus = connection. If you have nexus with a state, they can grab you and tax you. If you don't, they can't. Think of it like an electric socket. If you have no nexus it can't shock you, but stick your finger in it and watch your hair curl.

I think you and I (along with many other NJ practitioners) will be hearing more about the telecommuting issues in the next few years. Much like the IT-203 days-working-outside-NY tax notices which went out a few years ago, I suspect NY will try to see how much potential tax is out there from NJ telecommuters.

I.E. Client of mine may NOT have had nexus in a state...sold taxable goods in that state. Initially the revenue agencies will look to the purchaser of the product for the use taxes, but most states indicate that the burden of collection then falls on the seller if the buyer does not pay.....I dealt with this and it is not equitable, but I had 3 states in the US which shifted the burden to the client who did not establish nexus....

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In that case, the TN resident actually spent ~25% of his time physically present in NY.

The opinion here.

However, the Court set a higher standard under the commerce clause. While some earlier cases referred to a "minimal connection" for due process purposes, the 1977 _Complete Auto Transit_ case uses the term "substantial nexus" for commerce clause purposes. The _Quill_ case had to do with use tax collection responsibility, and the Court followed its 1966 _National Bellas Hess_ decision, holding that for use tax collection purposes the commerce clause requires that there be a physical presence in the state in order to have the requisite "substantial nexus."

The distinction between due process and commerce clause nexus throws the issue into the lap of Congress. Before _Quill_, it was unclear whether Congress could legislate authority for the states to require remote sellers to collect sales and use taxes on sales shipped into the state. Congress has the power to regulate interstate commerce, but Congress cannot legislate away due process. Since systematic exploitation of the market has been held to constitute due process nexus, Congress may, if it wishes, enact legislation authorizing states to require remote sellers to collect use taxes. So far it shows no inclination to do so, however.

Whether the physical presence requirement applies to other business activity taxes is an unresolved question. The U.S. Supreme Court recently denied certiorari in two state supreme court cases, one holding that a physical presence IS required, and another holding that it IS NOT required. In every business activity tax case the Court has decided over the years where commerce clause nexus was found to exist, there was a physical presence. However, those are all pre-_Quill_ decisions. Relying on language such as that in the U.S. Supreme Court decision in _Tyler Pipe_ and _National Can_, state courts have held that engaging in activities that help to maintain and exploit the market in a state is enough to create commerce clause nexus even when there is no physical presence. For example, the South Carolina Supreme Court found in _Geoffrey_ (1992, post-Quill) that a Delaware intangible holding company (IHC) that owns the trademarks, trade names, etc. of Toys R Us was subject to South Carolina tax because the use of the intangibles was licensed to TRU stores in South Carolina. Geoffrey had no physical presence in the state. The U.S. Supreme Court denied certiorari in that case.

Legislation pending in Congress (the Business Activity Tax Simplification Act, or BATSA) would provide a physical presence requirement for all business activity taxes.

Federal legislation (Public Law 86-272, 1959) limits states' authority to impose taxes ON OR MEASURED BY INCOME on out-of-state companies whose activities in the state are limited to solicitation of sales of tangible personal property. Obviously if you have sales personnel located or regularly traveling into the state, you have a physical presence there, and you have due process/commerce clause nexus. However, Public Law 86-272 protects you from net income taxes as long as your personnel in the state don't do anything other than soliciting sales, which are approved outside the state and shipped from outside the state. P.L. 86-272 does not protect a seller from other state taxes, such as use tax collection responsibility, franchise taxes measured by capital stock or net worth, gross receipts taxes (e.g., Washington B&O or Ohio CAT), or employer taxes. Whether the new Texas "margin tax" is subject to 86-272 protection is questionable, although the Texas statute itself says that it is not.

A note on New York's screwy "convenience of the employer" rule, at issue in the _Huckaby_ case referred to by Taxref and TinCook: The issue here is not exactly the same as the business "nexus" issue. The rules for individuals are a little bit different, arising from a different line of U.S. Supreme Court jurisprudence. In general, states have the power to tax all of the income of a resident, and all income of nonresidents arising from sources within the state. Generally, states take the position that the source of income from the personal services of an individual is the state where the services are performed. New York takes this a step farther and says, if you work for a NY employer, and you spend ANY time at your NY employer's premises, ALL of your earnings from that employment are from a NY source, unless your services were performed outside NY out of necessity (i.e., they could not, by their nature, have been performed elsewhere) and not for the convenience of either the employer or the employee. (This is colloquially known as the "convenience of the employer" rule.) So Mr. Huckaby, who lived in Tennessee and spent about 25% of his time working at his employer's location in NY and the rest working at his home in Tennessee, was subject to NY tax on 100% of his salary. This was especially painful for Mr. Huckaby because Tennessee does not have a comprehensive individual income tax -- TN only taxes interest and dividend income of residents. He'd have been even worse off, though, if he had lived and worked at home in an income tax state, e.g., California, because while California would have given him credit for the tax he paid to NY on the 25% of his salary that he earned working in NY, he would have received no credit for the tax paid to NY on the other 75% that he earned working in California. So he'd have paid tax to both states on the same income, with no credit relief. The same would be true in many other states.

We had high hopes for _Huckaby_ -- the NY regulation has been on the books for many years and was upheld by the NY Court of Appeals (the high court in NY) in the 1970's, but the world has turned a few times since then. However, the Court of Appeals upheld the regulation again, and the U.S. Supreme Court denied cert. So there you are.

NY has made some changes in the "convenience of the employer" rule, effective in 2006. Now a day working in a home office can be considered a day working outside NY if the home office is a "bona fide employer office." Determining whether the home office qualifies requires going through a Byzantine series of tests. For details, look at New York Technical Service Bureau Memorandum TSB-M-06(5)I, 05/15/2006.

As for creative people: So far, I think the place where the work (writing, painting, sculpting, whatever) takes place is the source of the income. However, if an artist consigns a painting to a dealer in NY, and the NY dealer sells it, it's pretty clear the artist has sold tangible personal property in NY and has NY source income. This is a source issue, not really a nexus issue, although the two are intertwined.

The corporate income tax has already eroded as a source of state revenue (due in large part to the activities of folks like me, who have gone around for 25 years restructuring businesses to take advantage of differences in state laws that create planning opportunities) to such an extent that some states have enacted new (actually archaic) kinds of taxes to replace it -- such as the Texas "margin tax" and the Ohio Commercial Activity Tax. However, BATSA would invalidate the broad statutory nexus standards in the Ohio CAT -- which are probably unconstitutional anyway.

As far as I know, though, nothing has been proposed that would affect the validity of the New York "convenience of the employer" rule. Sad to say.

Thats been challenged and worked arounf a lot....and now...some States are straightfowardly asking the Supreme Court to revisit the issue and rule taht a financial presence would be enough to give rise to nexus....calling it financial nexus. The lead case has to do with a credit card company, who owns nothing, only solicits business through very broad ads, etc., but has many customers carrying their cards in any State....they argue that the fact the CC biz gets $ from the residents of the State is enough to give it nexus. They very well may win.

Many states are asserting jurisdiction to tax out-of-state businesses on an "economic presence" basis, and so far the U.S. Supreme Court has not been willing to stop them. The credit card company case to which CorpTaxPro refers is MBNA National Bank NA v. West Virginia, 640 SE 2d 226 (2006), in which the West Virginia Supreme Court held that the bank that solicited West Virginia residents and issued credit cards to them had due process/commerce clause nexus and is subject to the corporate income tax. The U.S. Supreme Court denied certiorari in that case (Dkt No 06-1228, 6/18/2007).

In a very similar case, the Tennessee Supreme Court in 1999 held that an out-of-state credit card issuer did not have nexus because it had no physical presence in the state. J.C. Penney National Bank, 19 SW 3d 831 (1999). The U.S. Supreme Court denied certiorari in that one too (Dkt No 00-2005, 8/3/2000).

So, go figure. The Court seems unwillling to tackle the issue. I don't know what they are waiting for; surely they couldn't have found a case with cleaner facts than MBNA. No legal inference can be drawn from the denial of certiorari; it does not imply that the Court approved of the result in the state court. It only means the Court decided, for whatever reasons, not to take the case. So the credit card companies DO have nexus in West Virginia, and DO NOT in Tennessee. Other states will doubtless follow one or the other, but neither decision is controlling in any other state.

Further twist: ACME also hires local contractors to work these out-of-state contracts, but they never leave state A (let's say they are writing software remotely, and communicating it via the internet). Do these subcontractor S Corps have nexus in the states that the software is written for, even though there is no physical presence?

Most states DO have nexus questionnaires and you can remain anonymous when filling them out to make sure you understand the different state requirements.

Some states would consider seminars nexus and others will not. Depends on how aggressive they are.

As a practical matter, many contractors work in other states for short periods of time and escape notice. The legal ability of the state to impose the tax is not really in question; it's more a matter of the resources the state devotes to enforcement and the luck of the draw.

Also, although the subcontractor clearly has nexus in every state where it performs services, the operation of the apportionment formula may result in little or no taxable income or tax liability. Most states use a variation of the UDITPA three-factor formula of property, payroll and sales. Movable property generally is assigned to the numerator of the property factor on a time basis. Payroll generally goes to the state where the employee is covered for unemployment insurance purposes -- it isn't broken up on the basis of time. Sales of services are generally assigned to the place where the greatest proportion of the income-producing activity occurs; some states would prorate sales of services performed in more than one state on the basis of time. There are a few states that assign sales of services, not to the location where the income-producing activity takes place, but to the place where the benefit of the service is enjoyed -- i.e., not where the work is done, but where the customer is located. Georgia, Ohio, Minnesota and Iowa are states that use this market-based approach to sales of services.

The State A subcontractor that performs all of its services in State A generally wouldn't have nexus in any other states; however, the states are getting more aggressive in that area. Ohio, for example, asserts jurisdiction to impose its Commercial Activity Tax (CAT) on any entity that has more than $500,000 of "Ohio taxable sales" in a calendar quarter, or that has more than 25% of its property, payroll OR sales during the year in Ohio. The catch here is that Ohio assigns sales of services, not to the place where the services are performed (or the place where the greatest proportion of the income-producing activity occurs), but to the place where the benefit of the service is enjoyed. Thus a Minnesota contractor, performing all of its services in Minnesota, would be subject to the CAT if more than 25% of its revenue was earned by performing services for Ohio customers, even if it never set foot in Ohio. This statutory provision may not withstand constitutional scrutiny in that extreme case, but a taxpayer may have to go to court to get out of it. Now, if the subcontractor performs its services on behalf of the contractor, who is in Minnesota, and the contractor's customer is in Ohio, I'm not sure where Ohio would source the contractor's receipt ... but you see the issue.