State Nexus Issues

August 17, 2011

by Robin Mandell, CPA

Many states are becoming aggressive in taxing corporations based on the privilege of conducting business or deriving income within a state.   Florida has just ruled on a case subjecting a corporation to income tax even though it has no physical presence in Florida.

A corporate taxpayer had nexus with Florida and was subject to the state corporate income tax because some of its products were shipped or delivered inside the state. The taxpayer’s business activity in Florida consisted of the solicitation of sales of gifts and products the taxpayer’s customers use to reward their employees. Some of the products were shipped from the taxpayer’s warehouse outside the state while others were shipped directly to the customers from unrelated vendors’ warehouses, some of which are in Florida. To be protected from nexus, shipment or delivery must be from a point outside the state. Despite the fact that the taxpayer had no other business activity in Florida, because some of the shipments were made from within Florida, the taxpayer was not protected and was subject to Florida corporate income tax.

For sales tax purposes, states watch for is internet activity as many states have implemented “click through” nexus standards as well.  From a recent seminar I attended, the following states have enacted “click through” nexus standards for sales tax –

  • North Carolina  – 8/1/09
  • Rhode Island – 7/1/09 ($5,000 threshold)
  • Illinois – 7/1/11 ($10,000 threshold)
  • Arkansas  – 7/1/11 ($10,000 threshold)
  • Connecticut – 7/1/11($2,000 threshold)
  • Texas – letter ruling 3/24/11.

We expect many other states will be following suit.

The following states have enacted economic nexus standards in addition to Florida –

  • California – effective for taxable years beginning after 1/1/11
  • Iowa – case that went to Iowa Supreme Court, 4/28/11
  • New Jersey – issued 1/10/11, applies retroactively to tax years beginning in 2002

Minimizing Nexus

An important facet of tax planning is the minimization of corporate income tax nexus with unfavorable taxing jurisdictions. This can be accomplished by segregating activities from income producing operations. The first method of segregation is to separately incorporate certain portions of the business. Examples include creation of sales and distribution companies, contract manufacturers, service companies, or research and development companies. A second method of segregation is to create a pass-through entity, such as a limited liability company. A third method is the creation of an intangible holding company to license out the intellectual property of the corporation. Each of these methods of segregation has benefits and attendant risks, varying from state to state, but consideration of one or more of these tools can lead to successful tax planning through isolation of income producing activities from less favorable taxing jurisdictions.