Determining sufficient nexus in a state.

• Author: Wood, Rita
• Position: Degree of business presence measured by activity

Nexus is the degree of business activity a taxpayer must have before a state can impose taxes. Each state writes its own laws on what constitutes nexus. A business may be able to avoid unnecessary tax payments by understanding how nexus defines its tax liability (or lack of liability).

Generally, state taxable income is apportioned using the average of three ratios, the numerator of which is the "within state" amount and the denominator, the "everywhere" amount. The first step in determining whether it is necessary to file an income tax return is to evaluate three basic factors: property, payroll and sales.

Different factors apply to each particular business situation. The property factor includes buildings, land, machinery, furniture, equipment, autos and inventory. If a business rents or leases a building or equipment, the expense is generally multiplied by eight and added to the two-year average of the property, plant and equipment. The sales factor includes sales generated in the ordinary course of business and from the sale of fixed assets located within the state. Income such as interest, dividends, royalties, etc., is considered nonbusiness income; while some states use nonbusiness income in their calculation of Federal taxable income multiplied by the allocation factor, most states do not. The payroll factor includes all compensation paid to officers and employees.

The total everywhere amount for each factor should agree with the books of the business. For example, total payroll should agree with the Form W-3 if the company is a calendar-year taxpayer or to the total payroll expense in the books. If there are several states involved, it...