Nexus for state corporate income tax.

Rarely does a week go by when a state court does not issue an opinion on state corporate income tax nexus. When a court does address the minimum connection necessary to impose a tax return filing requirement, state tax practitioners everywhere scurry to apply the holding and reasoning of the new case to their clients' facts. Despite years of searching for conformity among state and Federal laws, corporate income tax nexus remains one of the most confusing, misapplied and misunderstood of all state tax issues. At the same time, however, the search for a common standard does produce opportunities for significant overall state tax savings.

P. L. 86-272

Forty years ago, in response to cries from interstate taxpayers for multistate nexus conformity, Congress enacted Public Law 86-272. Under the law, states cannot impose a "net income tax" on "any person" if the only contact with a state is limited to the solicitation of orders for sales of tangible personal property, which are approved outside the state and are filled from a stock of goods located outside the state and delivered via common carrier or the U.S. Postal Service.

Like most simplification or conformity legislation, P.L. 86-272 necessarily led to questions, interpretation and ultimately to court. Even so, the language of P.L. 86-272 is clear in nearly all respects. Few could disagree with the meaning or intent of approval, inventory or delivery from outside a state. However, states and taxpayers spent years debating the meaning and application of the words "solicitation of orders"

It took nearly 33 years, but the U.S. Supreme Court addressed the meaning of this term in Wisconsin v. Wrigley, 505 US 214 (1992). The following is a noninclusive list of activities that will likely exceed the standard applied in Wrigley if performed in a state:

* Post-sale activities, including training, installation, consulting, etc. (activities clearly exceeding a request for orders or sales and therefore nexus-creating);

* Pre- (or post-) sale activities, including repairs to products, credit checks and investigations, customer services, inventory testing or analysis (again, activities that will likely exceed current nexus standards).

Finally, the Court in Wrigley did provide for a de minimis standard for activities that (while technically not considered solicitation of orders) do not result in a "nontrivial additional connection with the state." Therefore, like nearly all state and local tax issues, facts and circumstances will dictate nexus under P.L. 86-272.

Sales of Services and Other Property

An often-misconstrued point is that EL. 86-272 applies to all taxpayers and states. In fact, P.L. 86-272 applies only to sellers of tangible personal property and state income taxes. Taxpayers that sell services, intangible or real property or any other form of transaction do not fall under P.L. 86-272. States like Michigan, Texas, Washington and others, that impose a franchise tax on capital, are not subject to the limitations of P.L. 86-272.

In non-P.L. 86-272 cases, the standard applied is "constitutional nexus," recently discussed as the "substantial nexus" test of Quill v. North Dakota, 504 US 298 (1992), and with its roots in prior Supreme Court decisions. In general, if a taxpayer owns property or maintains more than a de minimis physical presence in a state or both, nexus for income (or other type of) tax is likely. Activities in a state by a seller of other than tangible personal property that may give rise to nexus include:

* Performance of services, ownership of property (whether income producing or not, in most cases) or resident salespersons.

* Maintenance of an office (even if entirely dedicated to solicitation of orders), franchise contracts, some licensing arrangements, lease transactions or secured (or collateralized) property.

When a taxpayer sells both tangible personal property and services, most states would be inclined to view the P.L. 86-272 limitation narrowly. The reason for this is that the plain language of the law contains a clear limitation (i.e.,"the only business activities within the state") that states are unlikely to extend if not specifically required.

Economic Nexus

If there can be a "latest thing" in state and local tax, economic nexus is it--an income (or other type) tax filing requirement that a state imposes on a taxpayer that performs no solicitation, maintains no physical presence and is otherwise not "doing business" in the state. Geoffrey v. South Carolina, 437 SE2d 12 (S.C. Sup. Ct., 1993), cert. den., is illustrative of economic nexus, but falters because it provides only a conclusion and not legal support or a definable applicable standard.

Perhaps the best example of an economic nexus standard was described in Tyler Pipe Industries, Inc. v.. Washington, 483 US 232 (1987), dealing with Washington state's business and occupation tax (a nonincome tax) and a taxpayer that solicited sales through an independent contractor in Washington. The Supreme Court stated that the taxpayer's activities in the state "created or established a market for the taxpayer's goods and services in the state" and, under state law, a tax return filing requirement was proper.

As more and more taxpayers expand operations into other states (whether via electronic commerce or otherwise), multistate nexus issues will become even more prevalent. The following tips may help:

* Make certain to apply the appropriate standard for the type of activities performed or products sold in the state.

* Be thorough in applying the selected standard to a company's facts and circumstances.

* Always provide a detailed response (never a "yes" or "no" answer) to a state's nexus questionnaire.

FROM THOMAS DELONG, CPA, ZAINER RINEHART CLARKE DFK CPAs, SANTA ROSA, CA

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA