State tax developments & trends: what to watch for in 2015: Nexus, market-sourcing, intercompany transactions, single-sales-factor apportionment expected to dominate state tax discussions this year.

• Author: Levin-Epstein, Michael

Will the Republican Congress take up legislative measures of tremendous concern to TEI state tax law professionals, such as the Internet Tax Freedom Act and Mobile Workforce Act? It's too early to tell, but it bears watching.

Will the Republican domination of state legislatures lead to a panoply of business tax cut measures and other reforms (see box, page 30)? It's too early to know that answer as well, but what is clear is that, regardless of politics, at least four major, hot-button issues will be front and center in the state tax regulation landscape this year: nexus, market-sourcing, intercompany transaction, and single-sales-factor apportionment.

The "Nexus" Issue

One of the most important state tax developments and trends to monitor in 2015 involves the thorny issue of nexus: whether a state can tax the income of an out-of-state business person who makes sales to customers in the state and whether a state can impose a sales tax on other transaction-based taxes when the seller does not have a physical presence in the state.

While the issue of nexus is not new, this development will be increasingly significant this year as we continue to move at an almost breakneck speed to a more digitally based economy in which goods and services can be purchased remotely over the Internet.

As Jamie Fenwick, senior director of tax policy at Time Warner Cable explains, from both an income tax and sales tax perspective, states cannot tax certain companies and transactions based on traditional physical-presence nexus standards. In an attempt to tax these companies and transactions, lawmakers and tax administrators have developed alternative nexus standards--such as economic nexus, affiliate nexus, "click-through" nexus, and dollar-threshold nexus--to effectuate what might not be possible through traditional physical nexus, she notes. "It is still unclear whether or not these alternative nexus standards are permissible and whether the use of these alternative standards will likely create significant controversy or litigation in the future," Fenwick says.

States are struggling to figure out how to treat pass-through entities, agrees Steven N. J. Wlodychak, principal at Ernst & Young. For federal tax purposes, he notes, the "check the box" regulations simplified the process. Most states complied with the federal mandate, he explains. However, he adds, the complexity of withholding (nonresident withholding, how to treat corporate members, levying direct entity level taxes), apportionment (when should a corporation apportion partnership income at the partnership level, or when does it succeed to its distributive share of factors?), and non-income tax separate filing obligations for DREs come into play to make the lives of corporate tax directors exceedingly difficult.

In addition, Wlodychak notes, some states, such as Kansas and Ohio, view pass-throughs primarily as small businesses and want to continue growth through tax incentives. Kansas eliminated personal income tax on Sub K income entirely, he explains, while Ohio provides a special deduction.

States are becoming much more focused with respect to nexus issues, asserts Tov Haueisen, principal with PricewaterhouseCoopers LLP. "Whether it is...