written by Kevin Hogan
In order to fund their ever increasing budget deficits, states have stepped-up their efforts to collect taxes from out-of-state businesses. States have done so in recent years by shifting from a more restrictive “physical presence” test used for many years to collect tax, to a less restrictive “doing business” test. So businesses, more than ever, must be mindful of state tax filing requirements when conducting business across state lines. This article presents a brief summary of the taxing authority states have for assessing a business tax against an out-of-state entity.
A state’s taxing authority is based on specific state statute and case law, which can vary from state to state. However, for years states have been prohibited under federal law (Public Law 86-272) from imposing a net income tax on an out-of-state business when the only connection with the state is the solicitation of orders for sales of tangible personal property, if such orders are accepted and shipped or delivered from outside the state.
The principles of P.L. 86-272 are based on the concept of business nexus, which describes the amount and degree of business activity that must be present before a business becomes subject to a state’s net income tax. Under the general rules of nexus, a business with more than a de minimis degree of “physical presence” in a state, may be subject to that state’s net income tax. Physical presence is a factual determination, and can take the form of:
- Owning or leasing facilities or property in the state
- Installing equipment or supervising the installation of equipment
- Repairing or maintaining the company’s product
- Approving or accepting orders in the state
- Employees living and working in the state
It is important to note two elements of P.L. 86-272, 1) it only applies to tangible personal property, and so the solicitation for the sale of real property, intangible property, or services, may cause a business to have to pay income tax in a state where such solicitation occurs, even when the business does not have any physical presence in the state; and 2) it only applies to taxes on or measured by net income of the business.
More recently, many states have expanded their taxing grasp across state lines under the guidance of “doing business”. In these states, physical presence is no longer the controlling factor for collecting a business tax from remote sellers. “Doing business” simply means engaging in any activity that is conducted for, or results in gain or profit at any time during the year. For example, Ohio recently added a Commercial Activities Tax (CAT), Michigan added a Single Business Tax (SBT), while Oklahoma added a Business Activity Tax (BAT), all of which are taxed based on gross receipts, instead of net income.
These non-traditional, non-income tax based taxes have added complexity to complying with state tax filing requirements. No longer do states need to prove “physical presence” to assess a tax against a business, instead, businesses that merely sell product in the state, may be liable for filing a tax return and paying tax in that state.
Please contact us with any questions you may have about these rules and we can provide additional guidance.
Kevin specializes in tax consulting for businesses and individuals. His education includes a B.S. in accounting and business administration from the University of Kansas, a M.B.A. from the University of Kansas and a Master’s degree in Tax from Northern Illinois University.