Not so Fast! Factor Presence Nexus & Remote Service Providers
In 2002, the Multistate Tax Commission proposed a uniform law that states could adopt, as is or with modifications, to provide bright-line standards for when an out-of-state business entity has nexus for business activity taxes (typically gross receipts or income taxes) in a state. The standard enacted by states is typically $500,000 of in-state sales, $50,000 of in-state property, or $50,000 of in-state payroll (California annually adjusts these thresholds for inflation). Also, if the in-state sales, property, or payroll is 25 percent or more of the respective totals, nexus is generated. Pennsylvania and Massachusetts have begun to interpret their “doing business” statute as any out-of-state taxpayer with $500,000 or more of sales in state.
There is no specific origin of the $500,000 sales threshold, but in the case J.C. Snavely & Sons, Inc. v. Wheeler, 538 A.2d 324 (Md. App. 1988), a corporation sold approximately $500,000 worth of materials in Maryland, which was more than 2 percent of its total business, and the court held that the corporation was “doing business” in Maryland for corporate law purposes. The corporation contracted to supply materials to a company building a house in Maryland and did not have any property, bank accounts, employees, or representatives in Maryland (although the materials were shipped in by company-owned trucks).
For remote sellers of tangible personal property, the question of whether the in-state sales threshold is exceeded is usually moot for net income tax purposes given the protection afforded by Public Law 86-272. However, remote service providers could certainly be affected depending on the methodology implemented by the state in determining which sales are counted in the threshold. In determining what qualifies as “doing business” within a state, most states look to their apportionment rules to assist in making this determination. States implementing a market-based sourcing regime for services may require receipts to be sourced to where the customer is located, where the service is delivered, where the service is received, or where the benefit is received or consumed.
If the state uses an economic nexus standard with a bright-line test of $500,000 and sales and services are sourced on a benefits received basis, then taxpayers with more than $500,000 of services sourced to the state would meet the presumption of nexus in the state even if the taxpayer conducts no other activity in state. However, it is possible for the customers of a service provider to be located in one state but receive or consume the benefit of the service in another. The customer’s consumption alone may or may not provide a state with business activity nexus over the taxpayer under the Commerce Clause or the Due Process Clause of the U.S. Constitution. A similar issue also may arise in the context of gross receipts taxes and sellers of tangible personal property if the state sources sales of tangible personal property to their “ultimate destination.” Overall, taxpayers should carefully evaluate how they are sourcing sales from services before concluding that they have exceeded the sales aspect of a factor presence nexus standard.
For additional guidance on factor presence nexus standards across the states, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.