Article featured on Thomson Reuters’ Taxnet Pro , December 2019

On June 21, 2018, the U.S. Supreme Court decision in South Dakota v. Wayfair (“Wayfair”), 585 U.S. ___ (2018), overturned the long-standing precedent embraced 26 years earlier in its 1992 decision in Quill v. North Dakota requiring physical presence for sales and use tax nexus. In Wayfair, the U.S. Supreme Court held that in-state, physical presence is no longer necessary for a state to require a business to collect and remit sales tax but, rather, merely having either a certain amount of sales or transactions in a state (commonly referred to as economic nexus) may create such sales tax obligations for out-of-state sellers. Over the past 19 months since the Wayfair decision, nearly all states have adopted economic nexus for sales tax. 

However, the impact of the Wayfair decision is stretching beyond sales tax and is giving rise to state and local income and gross receipts tax implications. Wayfair has emboldened certain states to adopt economic nexus and enforce pre-existing economic nexus standards for income and gross receipts taxes.

Pre-Wayfair Economic Nexus for State Income and Gross Receipts Tax

Prior to Wayfair, Alabama, Colorado, California, Connecticut, Michigan, New York and Tennessee adopted factor presence nexus, or a comparable economic nexus standard, that provides a bright-line test for income tax nexus if a taxpayer’s annual sales in the state exceed a threshold amount. Other states that impose gross receipts taxes, such as Ohio and Washington, have adopted similar factor presence nexus standards. 

For example, New York enacted an economic nexus standard as part of its corporate income tax reform, which took effect for tax years beginning on or after January 1, 2015, and asserts that a taxpayer is doing business in the state if it has receipts of $1 million or more in the state. Other states have laws comparable to the model statute adopted by the Multistate Tax Commission in 2002, which provides that income tax nexus is established if any of the following thresholds are exceeded: (1) $50,000 in property, (2) $50,000 in payroll, (3) $500,000 in sales, or (4) 25% of total property, total payroll, or total sales.

In addition to factor presence nexus, certain states have asserted economic nexus over out-of-state taxpayers from the in-state use of intangible property (i.e., trademarks, trade names, etc.). In the landmark case decided in 1993, Geoffrey, Inc. v. South Carolina Tax Commission, S.C. Sup. Ct., 437 SE2d 13; cert. denied, 114 S. Ct. 550, the South Carolina Supreme Court held that the licensing of trademarks and trade names by an out-of-state (Delaware) corporation for use in South Carolina established income tax nexus even without any physical presence in the state. Following Geoffrey, certain states have asserted economic nexus under similar circumstances through statutory, judicial and regulatory authority.

Post-Wayfair Economic Nexus for State Income and Gross Receipts Tax

In light of Wayfair, states have been emboldened to adopt economic nexus standards for income and gross receipts taxes. A brief overview of some of these states include:

Hawaii (SB 495): In July 2019, Hawaii adopted an economic nexus standard for taxing out-of-state businesses on their business income earned in Hawaii. Effective for tax years beginning after December 31, 2019, a taxpayer that lacks physical presence in Hawaii is presumed to have income tax nexus if, during the current or preceding calendar year, the taxpayer either engages in 200 or more business transactions or has gross income of $100,000 or more in Hawaii.

Massachusetts (830 Mass. Code Regs. 63.39.1): Massachusetts promulgated a regulation in October 2019 which generally asserts that a corporation has income tax nexus when its Massachusetts sales for the taxable year exceed $500,000. 

Oregon (HB 3427): Oregon recently enacted a commercial activity tax, effective January 1, 2020, which uses a “bright-line presence” standard if the taxpayer has at least $750,000 of Oregon receipts for the calendar year.

Pennsylvania (Tax Bulletin 2019-04): Pennsylvania issued a tax bulletin in September 2019 announcing that a rebuttable presumption of corporate income tax nexus exists when a corporation lacks physical presence but has gross receipts of $500,000 or more sourced to Pennsylvania per year. The Department indicated that it will apply such threshold for tax periods beginning on or after January 1, 2020. 

Texas (34 Tex. Admin. Code § 3.586): In December 2019, Texas amended its franchise tax regulation to adopt an economic nexus threshold for reports due on or after January 1, 2020. The amended regulation provides that an out-of-state taxable entity without physical presence in the state is presumed to have nexus if it generates Texas receipts of $500,000 or more during its federal income tax accounting period. 

Washington (SB 5581): In March 2019, Washington amended its law to replace the existing factor presence nexus threshold with an economic nexus threshold effective January 1, 2020. Under the new standard, an out-of-state business without physical presence in Washington is deemed to have substantial nexus for the business and occupation tax if, in the current or immediately preceding calendar year, it has more than $100,000 of cumulative gross receipts in Washington. 

City of Philadelphia, Pennsylvania (Business Income and Receipts Tax Reg. § 103): In January 2019, Philadelphia amended its regulations to adopt an economic nexus standard for its business income and receipts tax (BIRT), effective for tax years beginning on or after January 1, 2019. Economic nexus is established if a business without physical presence in Philadelphia generates at least $100,000 of gross receipts in the City during any 12-month period ending in the current year, and has sufficient connection with the City to establish nexus under the U.S. Constitution. 

City of San Francisco (Proposition D): Effective for tax years beginning on or after January 1, 2019, San Francisco adopted an economic nexus standard for its gross receipts tax. Economic nexus is established if a business has more than $500,000 of gross receipts in San Francisco during the tax year. 

Don’t forget about Public Law 86-272 (“P.L. 86-272”)

P.L. 86-272, a federal law passed by Congress in 1959, prohibits a state from imposing a net income tax on a taxpayer whose only in-state activity consists of the solicitation of orders for the sale of tangible personal property if the orders are sent out of state for approval and shipped from out-of-state locations. In light of the growing reach of states asserting economic nexus for income tax purposes, a taxpayer that lacks physical presence in a state, but exceeds the economic nexus threshold, should nonetheless consider whether P.L. 86-272 precludes the imposition of state income tax. 

However, there are certain limitations with regard to P.L. 86-272. Notably, P.L. 86-272 only applies to the solicitation of orders for the sale of tangible personal property and not services or intangibles. Thus, service providers may establish economic nexus in instances where sellers of tangible goods may be precluded from having nexus under P.L. 86-272. Additionally, P.L. 86-272 only applies to income taxes, and taxpayers are not afforded any protection under P.L.86-272 for gross receipts taxes, such as in Ohio, Oregon and Washington, or franchise taxes, such as in Texas.

Which comes first…Nexus or Sourcing?
Historically, nexus drove the need for taxpayers to analyze state apportionment and sourcing rules. However, as more states enact economic nexus standards, taxpayers may need to consider sourcing rules before nexus is even established. 

Complexity often arises when sourcing receipts from the provision of services as states typically use a cost of performance or market-based sourcing methodology. A majority of states have adopted market-based sourcing rules for services, which look to the location of the customer or where the benefit of the service is received, whereas states using cost of performance sourcing rules look to where the service provider incurs the costs to perform such services.

For instance, service providers that perform services for customers in other states should consider whether those other states have adopted market-based sourcing and economic nexus standard. As noted above, since P.L. 86-272 does not apply to service providers, they may find themselves subject to income tax in states that have enacted an economic nexus standard and market-based sourcing rules even without any physical presence in the state.

A&M Taxand Says

After almost 19 months following Wayfair, states have been swift to act, with nearly all states enacting economic nexus standards for sales tax. States have shifted their attention to expanding the application of Wayfair beyond sales tax to income and gross receipts taxes. Thus, the prospect of more states enacting an economic nexus standard for income and gross receipts taxes is ever more likely to grow. 

Every business that sells good or services across state borders should be considering the impact of Wayfair on their income tax and gross receipts tax obligations, which may create new tax filing obligations. A&M Taxand has a team of state and local tax specialists with deep industry-specific and jurisdictional expertise who can help your company navigate through these complex tax rules. We will continue to closely monitor these changes, and we welcome the opportunity to have an exploratory conversation to further discuss how A&M Taxand may be of assistance to you.