Other States Want to Tax Your Income

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Mark J. Corey, CPA, JD

Most states want to find ways to beef up their revenue- whether it is from sales tax, income tax or payroll taxes.  The basic rule that governs a state’s ability to impose a tax on a business is a concept called Nexus.  In order for a state to have Nexus with a business there has to be some “minimum contacts” between the state and the business.  The tried and true contacts that gave rise to Nexus were the business having employees in the state, or owning/renting a building or retail location.  But in the last few years states have been pushing to expand the concept of Nexus into areas where it has not existed.

There are several traditional methods that states use to tax businesses- the most common being payroll tax, sales tax or income tax.  Payroll taxes require employees in the state.  Sales taxes are governed by a US Supreme Court case of Quill Corp v. US where the court established the principal of “physical nexus” being required for a state to apply sales tax to a company doing business in their state.  Since the Great Recession, states have been looking for a method to increase their income base, and since sales taxes were already limited by this physical presence test and payroll taxes require employees in the state, they have gone after income taxes of out of state companies doing business in their states.  This new Nexus theory is that if a company is doing business with parties in their state to a certain threshold of revenue, then that revenue earning activity is enough contact to generate Nexus and allow the state to tax that activity. 

A recent example of this expansion of state’s income tax Nexus is Ohio’s Commercial Activity Tax (CAT).  Ohio enacted their CAT to capture revenue from out of state companies who sold products or services in their state but otherwise had no other physical contact with Ohio- no buildings, no employees, etc.  The reason the CAT law is making news is because the law recently survived an Ohio Supreme Court challenge to its validity.  Many states are looking at Ohio’s CAT law and other similar laws and drafting their own version.

The takeaway from this Ohio case is that if you do significant business in another state where you have no “physical presence” you may still be liable for state tax if your revenue from that state exceeds a certain threshold.

This area of tax law is very complicated so please consult your tax advisor if you think this situation may apply to you.