Income Tax Factor Presence Nexus Standard

To tax an out-of-state business a state must show that nexus exists between it and the business’ income producing activities. States are now adopting the factor presence standard to figure out if nexus exists.

Nexus 

Nexus, a connection between a business and the state, must exist for a state to impose income tax. States establish the rules to use when determining how much in-state activity by an out-of-state business creates nexus.

Nexus standards have evolved over time. The physical presence standard was largely replaced by an economic nexus concept. The economic presence standard better fit the expanding use of e-commerce. States using the economic presence standard can impose tax on out-of-state companies doing business in the state, but that do not have a physical presence in the state. Now states are applying a factor presence nexus standard to provide a more certain numerical standard.

Factor Presence Nexus Standard

Under factor-based nexus, or factor presence nexus, an out-of-state company has nexus if it has property, payroll, or sales that exceed certain thresholds during the tax period. The Multistate Tax Commission (MTC) adopted a factor presence nexus standard model statute. The model includes threshold amounts to use in determining if enough substantial nexus exists to subject a business to state income tax.

Factor presence nexus provides an easily ascertainable standard. Still, some states view factor presence standards as only an alternative method in figuring out nexus. Thus, states can still establish nexus even if the taxpayer does not meet the factor presence thresholds.

Factor Presence Standard Thresholds

Under the MTC’s factor presence nexus standard, a company is doing business in a state if the property, payroll, or sales exceed these thresholds during the tax period:

  • $50,000 of property;
  • $50,000 of payroll;
  • $500,000 of sales; or
  • 25% of total property, total payroll, or total sales.

The model statute allows the threshold amounts to be adjusted for inflation on an annual or other basis.

Thresholds by State

A number of states have adopted the factor presence nexus standard. Some of these, along with the threshold amounts, include the following:

  • Alabama’s thresholds are:
    • $54,000 of property;
    • $54,000 of payroll;
    • $538,000 of sales; or
    • 25% of total property, total payroll, or total sales.
  • California’s thresholds are:
    • $61,040 of property;
    • $61,040 of compensation paid;
    • $610,395 of sales, including sales by agents or independent contractors; or
    • 25% of total property, total compensation paid, or total sales.
  • Colorado’s thresholds are:
    • $50,000 of property;
    • $50,000 of payroll;
    • $500,000 of sales; or
    • 25% of total property, total payroll, or total sales.
  • Connecticut’s threshold is reached when receipts from business activities attributable to state sources exceed $500,000 (“bright-line” test).
  • In Massachusetts, corporations create nexus and are subject to corporate excise tax jurisdiction if in-state sales, including sales of unitary business affiliates, from either economic or virtual contacts exceed $500,000.
  • In Michigan, nexus is established if the taxpayer actively solicits sales within the state and gross receipts from state sources is at least $350,000.
  • In New York, tax is imposed on corporations deriving receipts from activity in the state if receipts within the state are $1 million or more in a taxable year; or if it has at least 1,000:
    • credit cards issued to in-state customers; and/or  
    • in-state locations covered by merchant customer contracts where payments were remitted for credit card transactions. 
  • Ohio’s thresholds are:
    • $50,000 of property; 
    • $50,000 of payroll; 
    • $500,000 of gross receipts; or 
    • 25% of total property, total payroll, or gross receipts. 
  • Tennessee’s thresholds are:
    • $50,000 of property; 
    • $50,000 of payroll; 
    • $500,000 of receipts; or 
    • 25% of total property, total payroll, or total receipts.

Some states adjust their thresholds on an annual or other basis.

Voluntary Disclosure Programs

Taxpayers who discover they may be in violation of state tax laws are encouraged to voluntarily register and bring their accounts into compliance by disclosing past tax liabilities. Most states offer voluntary disclosure programs (VDPs) with penalties often waived if certain conditions are met.

By Tralawney Trueblood, J.D., M.B.A.

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CCHTaxGroup

All stories by: CCHTaxGroup