Nexus for non-net-income-based taxes.

• Author: Young, Helen

Tax advisers should be aware that the level of clients' multistate business activities may be such that a client is not protected from being taxed in those states that have non-net-income-based taxes other than sales/use taxes (such as a franchise tax, capital tax, license tax, gross receipts tax or net worth tax). States have implicit jurisdiction to tax, subject to three principal limitations--those imposed by the U.S. Constitution, P.L. 86-272 and those that states voluntarily impose on themselves.

Most practitioners are aware that P.L. 86-272 allows a company to have certain minimal activity within a state without establishing sufficient nexus requiring a tax return to be filed. Specifically, this minimal activity level is limited to the physical presence of a salesperson (whether an employee or independent contractor) in a state (either living in the state or merely traveling to it), as long as the salesperson's activities are limited to the solicitation of orders of tangible personal property. It is important to note that P.L. 86-272 does not protect the sale of services. In addition, the law only protects taxpayers from taxes measured by net income, not taxes measured by some other factor (such as book income, retained earnings, capital stock, etc.).

Taxes Not Measured By Net Income

States that impose tax based on a measurement other than net income are not subject to P.L. 86-272. These states can develop their own nexus standards (within the restrictions of the Commerce and Due Process clauses of the U.S. Constitution), which tend to be more restrictive than P.L. 86-272. Several states have enacted legislation providing for a non-net-income-based tax in addition to a tax based on net income. In those states, even having a salesperson or an independent contractor in the state will likely create nexus for purposes of that state's non-net-income-based tax.

Following are some of the states that impose a tax based on a non-net-income measurement or in addition to a net-income-based tax. The list is not all-inclusive, and the summary is intended only to introduce the nature of taxes not based on net income. There are a number of other states that have a non-net-income-based tax (see Exhibit 1 on pp. 240-241). Practitioners should take a proactive approach with their clients to make them aware that strict adherence to the traditional tenets of P.L. 86-272 is not sufficient to completely insulate clients from many states' taxing authority. In today's environment, most companies engage in multistate activities; there are numerous tax traps for the uninformed. Taxpayers' potential exposure for back taxes, penalties and interest can be substantial.

Exhibit 1: Corporate tax base--Franchise v. net income by state Corporate tax assessed: State Method Alabama Net Income Based Franchise Based On Employed Capital Alaska Net Income Based Arizona Net Income Based Arkansas Net Income Based Small annual franchise tax California Franchise Tax Based Upon Net Income ($800 min.) Colorado Net Income Based Connecticut Net Income Based Delaware Net Income Based plus Franchise tax based upon shares o/s D.C. Franchise Tax Based Upon Net Income ($100 min.) Florida Franchise Tax Based Upon Net Income Georgia Net Income Based plus Franchise tax based on net worth Hawaii Net Income Based Financial Institutions subject to Franchise tax based on Net Income Idaho Franchise Tax Based Upon Net Income ($20 min.)...