The increasing compliance burden of economic nexus.

• Author: Stanton, Catherine Shaw

Years ago, life seemed so much simpler: Taxpayers could more readily use their intuition in determining their state income tax filing requirements, and they were likely correct. Operating a business consisted of hiring employees and using tangible property to manufacture products or perform services. It was clear where these activities occurred, and it was assumed filing obligations must be met in those jurisdictions.

In fact, P.L. 86-272 (1) was enacted to calm the outcries of the business community in response to the U.S. Supreme Court's decision in Northwestern States Portland Cement Co. (2) This decision upheld the imposition of a Minnesota tax on an Iowa corporation that only solicited orders and maintained leased office space for sales representatives in Minnesota. The sales representatives' activity was limited to soliciting orders for the purchase of the company's products; the business accepted those orders at and filled them from Iowa.

Both the business community and Congress had grave concerns over the complexity the Northwestern decision brought to tax compliance, its impact on interstate commerce, and the additional burdens placed on smaller businesses. Congress intended for the federal law to be a stopgap measure and passed it very quickly before any studies were conducted. As stated in 1959 by Sen. Harry F. Byrd of Virginia: "Unless immediate action is taken at this time, it is feared that the states will amend their laws to further encroach upon interstate commerce." (3)

Those fears have certainly been realized. For many taxpayers the news that P.L. 86-272 prevents states from imposing income taxes when in-state activities are limited to sales solicitation is unexpected relief. In fact, it now even appears odd that sellers of tangible personal property have this special type of relief. But the states narrowly construe this federal law. It only provides protection from income tax for sellers of tangible personal property whose contacts with the state are limited to solicitation. It does not protect a taxpayer that solicits or performs services in the state, and it does not apply to any non-income-based taxes. (4)

Apart from federal law protection, the states are aggressively pursuing out-of-state businesses as an additional source of revenue. In BNA's most recent state surveys, (5) 37 states (and the District of Columbia) now impose what is called an "economic nexus" policy. When the four states that do not impose a corporate income tax and the four states that refused to answer the question are added to that list, that leaves only six holdouts. (6)

For years, much of the practitioner and business community believed the U.S. Supreme Court decision in Quill (7) required some form of physical presence to establish the requisite connection with a state for the state to subject a business to tax. Yes, the Geoffrey (8) decision encroached on this view, although one could argue that Geoffrey the Giraffe was "present" within the...