States probing boundaries of 'physical presence'.

• Author: Jensen, Jennifer

States are experiencing lackluster revenue growth in 2017, with only modest improvements expected in 2018. In fact, according to the Center on Budget and Policy Priorities, in 2017, 25 states are facing or already have addressed revenue shortfalls. Further, more than half the states lack enough revenue to maintain services at existing levels going into 2018. This means that two-thirds of the states are facing or addressing revenue shortfalls this year, next year, or both. (1) A number of factors contribute to the weakness in state tax collections. One key reason is slower-than-average sales tax collections, which are still below their historic average as consumers have remained cautious after the end of the recession, and untaxed internet sales continue to grow. (2) Slower-than-average sales tax collections present significant concerns for state budget officials because sales taxes represent a substantial revenue source for the states that impose them. According to the Tax Foundation, which used data from the U.S. Census Bureau, sales taxes generated about 31.4% of state tax revenue in fiscal year 2014. (3)

With such a large percentage of state tax revenue coming from sales and gross-receipts taxes, states are considering strategies to raise additional revenue from these sources. Since retailers are required to collect and remit tax only in states where they have a taxable presence, or nexus, one strategy to increase revenues is to enact laws that expand the definition of nexus-creating activities. Though individuals who make purchases upon which sales or use taxes are due are responsible for self-remitting the taxes if the vendor does not collect them, states have found that enforcement at the individual purchaser level is difficult. Thus, the focus has been on the retailers and those entities that facilitate the retail sales (e.g., marketplace providers).

For example, New York state began its nexus expansion movement in 2008 with what is known as a "click-through" nexus law that addresses taxation of sales made over the internet by out-of-state sellers. (4) Since then many states have followed suit with their own click-through laws, as well as other means to expand the definition of nexus-creating activities. This column provides an overview of these state efforts to expand nexus standards and focuses on other recent developments.

Nexus in general

Before gaining an appreciation of what states are doing to expand nexus principles, one must understand the limitations currendy imposed on states through the Constitution as well as case law. In Quill Corp. v. North Dakota, (5) the U.S. Supreme Court held that the Commerce Clause prevents a state from requiring an out-of-state retailer to collect and remit use tax if it does not have a physical presence in, or "substantial nexus" with, the state. States have struggled with the definition of physical presence ever since the Quill decision. Traditionally, a retailer established physical presence if it had in-state property and/or employees, employees visiting the state, or third-party agents working on its behalf in the state. It is the expansion of what constitutes a physical presence beyond these traditional activities that has been the focus of the majority of the nexus expansion laws, and, more recently, some states are even ignoring the physical presence requirement.

Click-through nexus

As mentioned above, in 2008, New York enacted its click-through nexus legislation, which requires out-of-state internet retailers to collect and remit state sales tax on tangible personal property or services sold through links on websites owned by in-state residents, referred to as "affiliates." (6) The law requires out-of-state sellers operating "affiliate programs" in the state to register to collect and remit sales tax. It provides that a "vendor" includes a person making sales of tangible personal property or services to New York customers through an agreement with a New York resident for a commission or other consideration, by which the resident directly or indirectly refers potential customers, by a link on an internet website, to the seller, if the cumulative gross receipts from those sales exceed $10,000 per year.

In other words, potential customers reach the out-of-state retailer's website by clicking on a link on the in-state affiliate's website (thereby creating click-through nexus). The state's position is that the in-state affiliate is operating in the state on behalf of the out-of-state retailer. A seller may rebut the presumption of nexus by providing proof that the resident with whom the seller has an...