Mary Bernard
Mary Bernard
Nexus Update

There was a point in time when nexus might have been considered a good thing in state tax planning. The last 10 years may have changed that impression.

July 29, 2010
by Mary Bernard, CPA

Before the onset of e-commerce, many businesses operated only within their state of domicile. They commonly paid state income taxes only in one state. In some cases, it was advantageous to establish nexus in another state, preferably a lower tax-rate state, to obtain the opportunity to apportion income between states. In some fortunate cases, a company might be in a position to have “nowhere sales” that are not taxed by either state.

With the expansion of Internet use in businesses, it is now extremely uncommon for a business to incur an income tax liability in only one state. With the increase of service industries, state boundaries are blurring in the pursuit of business opportunities. With state budgets in precarious positions, legislators are casting a wider net to include more taxpayers in their jurisdiction.

Economic Nexus

Although the concept of economic nexus originated in 1993 with the original Geoffrey (PDF) case in South Carolina, not much happened after that until 2006. That year, two states, West Virginia and New Jersey, decided cases establishing the current trend towards economic nexus. These two cases, MBNA and Lanco (PDF), provided the impetus to the wave of legislation that continues to pick up speed.

The concept of economic nexus is that a state may exercise its taxing authority over an out-of-state business that has no physical presence at all in the state. States are now deciding that the Quill physical presence test requirement only applies in cases of sales-and-use taxes and therefore an economic presence is sufficient to assess an income tax on companies without physical presence in their state. One by one, state courts are invoking this position on unsuspecting out-of-state companies.

Joining West Virginia and New Jersey, New Hampshire immediately embraced the concept of economic nexus before the ink was dry on MBNA and Lanco. Several other court cases subsequently followed the rationale of economic nexus. Now, legislators are passing laws to codify the concept to aid in balancing troubled budgets.


For tax years beginning on or after January 1, 2009, Wisconsin adopted the economic nexus standard in budget adjustment legislation. The definition of doing business in the state has been expanded to include “regularly soliciting business from potential customers in Wisconsin,” with no requirement for physical presence in the state.


Effective January 1, 2010, Connecticut’s budget bill provides that an out-of-state corporation with “substantial economic presence” in Connecticut is subject to the corporation business tax, regardless of physical presence. A “substantial economic presence” in Connecticut means purposely directing business towards the state. This “purpose” is determined by frequency, quantity and systematic nature of economic contacts with the state.

Multistate Tax Commission (MTC) Factor Presence Standard

The “factor presence nexus standard” first appeared in Ohio where nexus for the Commercial Activity Tax was defined in quantitative terms with no physical presence required. The MTC has defined a “substantial nexus” standard as one where a company has $50,000 of property or payroll in a state or more than $500,000 in sales in the state. Alternatively, nexus would exist if at least 25 percent of a company’s payroll, property or sales are in the state. This standard has yet to be challenged by a court but is controversial due to the statutory threshold of sales triggering nexus without any physical presence.


For the first time, the factor-presence standard is being applied to a traditional corporate income or franchise tax. It has formerly been incorporated in only non-income based taxes, such as gross-receipts taxes. For tax years beginning on or after January 1, 2011, California defines “doing business” for purposes of income and franchise tax based on a factor presence standard modeled directly on the MTC statute. Companies with property or payroll of $50,000 or sales in excess of $500,000 to California customers will now be determined to be doing business in the state. If more than 25 percent of a company’s sales are in the state, including sales made by independent contractors or agents, the company will be subject to income and franchise tax, regardless of whether or not physical presence has been established.


Effective April 30, 2010, Colorado issued regulations adopting the MTC’s factor presence test for nexus for purposes of the corporate income tax. A corporation is doing business in Colorado if it exceeds the activities protected by PL 86-272 and it has substantial nexus within the state as defined by the MTC standard. The substantial nexus thresholds are the same as the MTC regulation.


Economic nexus is gaining in popularity through legislation and court cases. The concept is based on the conclusion that the physical presence requirement of Quill only applies to sales and use tax cases, opening the door to a different interpretation for income and franchise tax purposes. This trend will likely continue in states unless and until the issue is successfully challenged in the courts.

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Mary F. Bernard
, CPA, is director — income/franchise tax, at the Dallas, Texas-headquartered tax services firm of Ryan. Bernard formerly worked as principal, director of State & Local Tax Services, at Providence, RI-based Kahn, Litwin, Renza & Co., Ltd.