august2022 - 8

FEATURE
The
EVOLUTION of
By Richard Feldman
AS ELECTRONIC COMMERCE continues to grow and business
practices evolve, states have struggled to ensure their taxing
systems remain relevant and current. The historic Wayfair decision
significantly shifted and expanded nexus laws across states for
sales tax and has also impacted income tax.
State filing requirements are
imposed on businesses that have
nexus with a particular state, which
is generally defined as the connection
a business has with a state.
Historically, nexus was determined
based on physical presence, which
was established if a business had
either property or employees located
within a particular state.
Although states have different
criteria, in general, the presence of
a single employee or the storage of
inventory is considered a physical
presence and sufficient for a state to
assert nexus and require the filing of
income tax returns and the collection
of sales taxes. However, merely selling
merchandise via the internet or by
mail order that's delivered through a
third-party vendor located out of state
would not have met the minimum
connection standard.
WAYFAIR DECISION
The 2018 Supreme Court Wayfair
decision changed everything when it
allowed the state of South Dakota to
enforce a sales tax collection requirement
on Wayfair Inc. despite it having
no presence in the state. As a result
of the Wayfair decision, states were
given the authority to assert economic
nexus, which could be based on a business
having sales in a state without
any physical presence.
Additionally, states established
sales and transaction thresholds
that, when exceeded, are considered
economic nexus and require the business
to register and collect sales tax.
Today, virtually every state that has
a sales tax imposes economic nexus
thresholds for sales tax purposes.
While thresholds vary by state, many
use a threshold of $100,000 of sales or
200 transactions.
ECONOMIC NEXUS FOR
INCOME TAXES
Although Wayfair was strictly a sales
tax case, states have also begun to
assert economic nexus for income
tax purposes. Unlike sales tax, currently
only a handful of states have
established thresholds for income and
franchise tax purposes, including AL,
CA, CO, CT, HI, MA, MI, NY, OH, PA,
TN, TX, VA and WA. Other states are
likely to follow.
PL 86-272
Historically, the determination of
nexus for income tax was similar to
sales tax and relied only on physical
presence. However, for income tax
purposes there is an exception that
allows a slight physical presence
- yet protects businesses from the
assertion of nexus. Under a federal
statute, The Interstate Income Act
of 1959, known as Public Law 86-272
8 AUGUST 2022 ■ www.CPAPracticeAdvisor.com
(PL 86-272), nexus doesn't apply in
certain situations.
Under PL 86-272, some types
of businesses can have a minimal
physical presence in a state and
not be subject to the state's income
tax. To qualify for this protection,
the business activity in the state
must be limited to the solicitation of
sales of tangible personal property.
Thus, property and employees if
maintained in the state cannot be
involved in anything beyond sales
solicitation. Inventory must remain
at a bare minimum and be used for
display and samples only. Additionally,
all orders must be approved out
of the state. Violating these fine lines
and exceeding the minimal activity
permitted would cause the business
to lose the protection provided by PL
86-272 and allow the state to assert
nexus and create a filing and tax
obligation for the business. Because
PL 86-272 only applies to income
taxes, its protection is not applicable
in states that have gross receipts
taxes or certain franchise taxes.
In recent years, with the increase
of e-commerce, the definition of
solicitation and what it means for PL
86-272 has become an area of contention.
Because the solicitation of sales
is a protected activity, it must be
determined what is considered solicitation
in the context of e-commerce
when the solicitation is done over
the internet and not by a salesperson
physically present in the state.
UPDATED GUIDANCE
In 2021, the Multistate Tax Commission
(MTC) issued guidance regarding
which activities conducted over the
internet were protected by PL 86-272.
The guidance indicated that a static
internet site only selling tangible
personal property would not exceed
the mere solicitation of sales when
it was accessed in a state. However,
virtually any other type of interaction
with the customer via the website
could potentially exceed the mere
solicitation guidelines and thus lose
the protection of PL 86-272 and subject
the business to income taxation.
While the MTC guidance is not
enforceable, states have begun to
adopt it in various ways. In February
2022, California issued a memorandum
dealing with protected and
nonprotected activity conducted
over the internet in relation to PL
86-272. In April, New York issued draft
regulations on the same matter. The
guidance provided by the MTC was
closely mirrored by both states.
As the modern economy and the
way businesses operate continues to
evolve, states will need to update their
rules and regulations. It's imperative
that businesses and their advisors stay
current with ever-changing state compliance
requirements and the burdens
associated with them. ■
Richard Feldman is a Senior Tax Manager
at Janover LLC, where he has specialized
in tax planning, consulting and compliance
for businesses, business owners, and
high net worth individuals and families
for 25 years. He is a frequent speaker and
author on modern taxation topics with a
special focus on state and local tax issues.
NEXUSand
its
IMPLICATION for INCOME TAX
http://www.CPAPracticeAdvisor.com
august2022

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