A Changing Nexus EnvironmentNovember 14, 2012
Tony Switajewski, CPA
Do You Know Your State and Local Tax Obligations?
In an effort to curtail budget deficits, states are becoming increasingly aggressive in asserting their right to tax out-of-state businesses exploiting their marketplace. These “nexus” assertions can apply to business entity income and franchise taxation, pass-through entity (e.g., limited liability companies, partnerships and S corporations) owner income taxation, sales and use taxation and other tax types.
Legislative and Judicial Environment
The nexus environment is continually changing. State tax laws have been enacted to assert attribution/representative nexus. States are looking to their drop-shipper sales tax statutes to assert sales tax collection obligations on manufacturers which drop-ship products to their customer’s customers. Some states pursue businesses with trailing nexus when it is deemed that the lingering effects of a business’ presence in their state continue to generate sales for a period of time thereafter. And, judicial decisions have sided with states asserting not only “physical presence” but also “economic presence” nexus.
States are finding themselves in a powerful position to impose taxes on an out-of-state business. Through creative nexus assertions, they are, more than ever, aggressively pursuing non-compliant businesses.
Besides income taxes, a significant source of revenue for most states is sales and use taxes. States have been frustrated with lost “use tax” revenues from the rapid growth in remote sellers, such as internet retailers, who haven’t been required to collect sales tax. To collect this revenue, states have enacted or are currently considering enacting so-called “Amazon.com” or “click-through” attribution sales tax nexus legislation. This initiative has been led by New York and has recently been followed by Connecticut (among many other states). Massachusetts is now considering H. 3673, An Act to Promote Sales Tax Fairness for Main Street Retailers, as a path toward requiring remote sellers to collect sales tax on sales to its residents.
Since 1992, the U.S. Supreme Court has historically denied certiorari with respect to nexus petitions, creating disagreement among states and businesses concerning the nexus standard that gives states the right to tax an out-of-state business. Just recently, the U.S. Supreme Court declined to hear a Connecticut Supreme Court case, which held that a Missouri-based company that sells books to school students by distributing catalogs to school teachers was subject to a sales tax collection obligation in Connecticut because the school teachers who participated in the company's program acted as its representatives, and their activities provided the requisite nexus under the Commerce Clause of the United States Constitution to justify imposition of taxes on the company's sales. This decision will cost the company millions of dollars in uncollected and unpaid Connecticut sales taxes, interest and penalties (as well as in other states that may take a similar position). (Scholastic Book Clubs, Inc. v. Commissioner of Revenue Services, Conn. S. Ct., Dkt. No. SC 18425, 03/27/2012 , 304 Conn 204 , 38 A3d 1183 (2012), petition for cert. denied, U.S. S.Ct., Dkt. No. 11-1532, 10/09/2012.).
The U.S. Supreme Court is seemingly leaving the nexus standard in the hands of the U.S. Congress. Seeing no action from the U.S. Supreme Court and listening to the budget woes of state governments, there has been a wave of bipartisan support in the U.S. Congress to pass federal legislation that would give states the authorization to require remote sellers to collect sales taxes, irrespective of their presence [The Marketplace Equity Act (House version, H.R. 3179); The Marketplace Fairness Act (Senate version, S. 1832)].
If federal legislation is passed, it is anticipated that this would create billions of dollars of new revenues for state and local governments. For businesses, this would mean that they would need to comply with the myriad of complex sales tax rules outside their home state.
In short, states aren’t fooling around. They are aggressively imposing taxation assertions to the fullest extent allowed by the U.S. Constitution. In addition, they are getting Congress’ attention.
Understanding Your Nexus and Tax Risk
Within this revenue-generating environment, businesses must continuously be aware of their multi-state activities in order to comply with their state and local tax obligations. The failure to comply with state and local tax laws, knowingly or unknowingly, often results in surprisingly significant tax, interest and penalty assessments.
To help you better understand whether you have nexus and tax risk, please answer the following questions:
- Do you know what types of activities create nexus in another state allowing that state to impose its business entity level taxes upon your business or impose personal income taxes upon a pass-through entity’s owners?
- Do you know what your business’ potential state and local tax exposure may be, by tax type?
- Do you know whether your business has multijurisdictional nexus requiring your business to charge, collect and remit sales taxes?
- Are you equipped to comply with multijurisdictional sales tax compliance?
- Do you know your state and local tax obligations and are you complying with all of them?
If you have answered “no” to any of these questions, please contact BlumShapiro to learn more about how we can help.
Tony Switajewski is a tax partner at BlumShapiro, the largest regional accounting, tax and business consulting firm based in New England, with offices in Connecticut and Massachusetts. The firm, with nearly 300 professionals and staff, offers a diversity of services which includes auditing, accounting, tax and business advisory services. In addition, BlumShapiro provides a variety of specialized consulting services such as succession and estate planning, business technology services, employee benefit plans, litigation support and valuation and financial staffing. The firm serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.