Nexus is crucial, complex connection for state tax professionals: after financial crisis, states enacted broader laws to increase revenues.

• Author: Yopp, Mark
• Position: STATE AND LOCAL TAX

Nexus is a wondrous word, replete with meanings. A quick search turns up all kinds of interesting uses. Nexus is a cell phone, it is a type of android from the movie Blade Runner, and it appears in the names of songs, bands, and albums. It is a superhero, the center of the DC Comics universe, and a plot device in a Star Trek movie. The list goes on.

But for tax professionals, particularly state and local tax professionals, a discussion of nexus is really the discussion of one basic question: can a person (or transaction) be subject to tax?

For academics, a discussion of nexus can cover significant and complex theoretical questions about the Due Process Clause, the dormant Commerce Clause, and a state's sovereign authority to impose tax. However, for tax professionals, a discussion of nexus is a practical question: is my client or company exposed to tax in a particular jurisdiction?

It is no secret that states lost significant revenue during and after the 2008 financial crisis. (1) That loss resulted in states enacting broader and broader nexus laws in an effort to increase revenues, particularly with respect to sales and use taxes. Sales and use tax nexus has always been an important issue, but a number of recent developments could represent significant changes in the nexus landscape. (2)

In this article, I will try to answer three simple, practical questions:

1. What is the current state of the law?

2. What should you be worried about?

3. What should you do now?

We will focus primarily on sales and use tax, (3) although there will be some important discussions about the state of income and gross receipts taxes toward the end.

What Is the Current State of the Law?

The dormant Commerce Clause requires a person (or transaction) to have "substantial" nexus with a state before the state may impose a tax on the person or transaction. (4) Despite many states' efforts to impose a different standard, for sales and use tax nexus, substantial nexus requires physical presence.

A retailer has physical presence either directly, by having property or employees (5) in a state, or indirectly, through a third party that has a physical presence in the state and engages in activities that establish and maintain a market for the retailer. (6) This has been the rule since 1992, when a case commonly referred to as Quill was decided. Since Quill, there have been various attempts to expand the definition of nexus and what constitutes physical presence. Currently, several efforts are underway to address the physical presence rule. Although many other issues exist, we will focus on four primary ones:

* economic nexus provisions;

* reporting and notification requirements;

* marketplace nexus bills; and

* federal legislation.

Economic Nexus Provisions

States have long wanted to use an economic nexus standard, rather than a physical presence standard, to establish substantial nexus for sales and use tax. However, until recently few states had such statutes on the books, (7) and the precedential power of Quill was likely considered so strong that few states would try.

Within the last year, however, states have started to explicitly push back on Quill. States are passing economic nexus statutes or adopting administrative positions under which an out-of-state retailer is required to collect sales and use tax if the retailer's sales into the state exceed a threshold amount. As of this writing, at least five states (South Dakota, Wyoming, Alabama, Tennessee, and Massachusetts) have passed or adopted economic nexus statutes or administrative actions, (8) and many more are considering similar legislation. (9) All of these approaches are being challenged by trade groups or taxpayers as being unconstitutional under Quill. Of the five states, South Dakota's challenge is the furthest along, so I will focus on that.

The bill enacted by South Dakota was designed to move a challenge to Quill in front of the U.S. Supreme Court as quickly as possible. The South Dakota statute provides that an out-of-state retailer that makes more than $100,000 of sales into South Dakota has substantial nexus and is required to collect and remit sales and use tax. The statute has an anti-retroactivity feature that prohibits the state from enforcing a collection requirement while the statute is being challenged, as well as a provision allowing a challenge to be filed directly in court without having to go through the standard audit and assessment process. Pursuant to these provisions, the state filed suit against four out-of-state retailers (one of which settled) in a South Dakota district court. The retailers attempted to remove the case to federal district court, but the federal district court remanded the case back to state court. On March 6, the state district court granted the retailers' motion for summary judgment. (10) The case now moves forward to the South Dakota Supreme Court as South Dakota v. Wayfair, Inc. et al.

This case will move quickly and should be tracked closely. Assuming the South Dakota Supreme Court affirms the lower court and the U.S. Supreme Court then grants certiorari, if South Dakota's approach is approved by the U.S. Supreme Court, then it is expected that virtually every state with a sales and use tax will pass some version of the South Dakota statute relatively quickly. In response, there may be a renewed effort by online retailers to get legislation passed at the federal level (discussed further below) to provide some protections for businesses.

If the approach is not...