Factor presence nexus standards and market-based sourcing: a tough combination for service businesses.

• Author: Britt, Charles

Two trends--factor presence nexus standards and market-based sourcing of services for sales factor purposes--have steadily gained steam in state legislatures.

In general, under factor presence nexus standards, a business is presumed to have nexus with a state if the business has a property, payroll, or sales factor numerator in the state that exceeds a certain threshold. Under the market-based approach to sourcing receipts from sales of services in the sales factor, service businesses are required to include service receipts in the numerator of the sales factor if the market for those services is within the state rather than based upon the traditional income-producing-activity test.

As of this writing, at least nine states had adopted factor presence nexus standards, and of those states, six had adopted market-based sourcing rules for receipts from sales of services. This combination can have a particularly significant impact on multistate service providers.

Factor Presence Nexus Standards

On Oct. 17, 2002, the Multistate Tax Commission (MTC) adopted a model rule, Factor Presence Nexus Standard for Business Activity Taxes, in an effort to promote uniformity among the states and create a simple bright-fine nexus test for business activity taxes in response to the proliferation among the states of a wide variety of economic and attributional nexus schemes. Pursuant to this rule, a taxpayer establishes nexus with a state for business activity tax purposes if the taxpayer exceeds any of the following apportionment factor numerator thresholds in that state during a tax period:

* $50,000 of property;

* $50,000 of payroll;

* $500,000 of sales; or

* 25% of total property, total payroll, or total sales.

Not surprisingly, the true focus for states and taxpayers alike is on the sales factor threshold, as this is a purely economic measurement of activity within the state. The existence of a property factor or payroll factor in a state would indicate that the taxpayer has a physical presence within the state, which is a traditional indicator of nexus for Commerce Clause purposes.

On July 1, 2005, Ohio became the first state to impose a factor presence nexus standard with the enactment of Ohio Rev. Code Section 5751.01(H)(3), which adopted the MTC thresholds for purposes of determining whether a business is subject to the states commercial activity tax (CAT). Since then, factor presence nexus standards have been adopted by Alabama (Ala. Code [section]...