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The Complexities of Multistate Taxation

The Complexities of Multistate Taxation
by James Richmond

One of the more complex challenges facing a company today is to identify those states where it is subject to a tax, whether it is a gross income tax, net income tax, franchise tax measured by net income, franchise tax measured by capital, excise tax, gross receipts tax, value-added tax, business activities tax or other business tax.

To better comprehend the multistate taxation rules, you must understand some basic concepts. Once you understand them separately and piece them together, you will better understand the rules behind multistate taxation.

The Due Process Clause

The Due Process Clause essentially requires some definite link or some minimum connection between the state and person, property or transaction it seeks to tax. The most minimal connections will satisfy this requirement. The connection need not include physical presence in the state. Due Process also requires that the income attributed to a taxing jurisdiction for tax purposes must be rationally related to values connected with the taxing state.

The Commerce Clause

The Commerce Clause is the second federal constitutional doctrine involved in nexus determinations. The Commerce Clause prohibits state taxes that interfere with commerce between the states.

Nexus (Public Law 86-272)

Public Law 86-272 (P.L. 86-272) restricts a state from imposing a net income tax on an entity if the only business activity of the company within the state consists of the solicitation of orders for sales of tangible personal property, which are sent outside the state for acceptance and shipped from a point outside the state.

P.L. 86-272 only applies to net income taxes or franchise taxes measured by net income.

Pending Federal Legislation

On June 28, 2006, The House Judiciary Committee agreed to report H.R. 1956, The Business Activity Tax Simplification Act. This bill would prohibit states from imposing a net income tax or other business activities tax on an entity without physical presence in the state.

States Imposing Taxes

Every state except Michigan, Nevada, South Dakota, Texas, Washington and Wyoming impose a net income tax. The District of Columbia also imposes a net income tax.

Michigan imposes a Single Business Tax. This tax is a Value-Added Tax and not an income tax.

Nevada imposes a business license tax, which is imposed on most businesses. The current cost is $100.00 and is renewable annually.

South Dakota does not impose a corporate income tax.

Texas imposes a franchise tax.

Washington imposes a Business and Occupation (B&O) tax on both the retail and wholesale transactions of tangible personal property and services.

Wyoming does not impose a corporate income tax.

States Currently Asserting Nexus

Michigan

The state imposes a Single Business Tax (SBT). The SBT is a Value-Added Tax (VAT) levied on the "Services Consumed" or "Benefits Received" principle.

All entities engaged in a "business activity" in the state are subject to the SBT. The state's nexus standards are set forth in Revenue Administrative Bulletin 1998-1.

The state has notified many companies in this industry that they are subject to this tax, and requested that the companies complete and submit a nexus questionnaire and voluntary disclosure request. Upon receipt, the state is notifying the companies that they must submit and pay any tax due and applicable interest for the past three or four years and file in all future years.

Missouri

The state has taken the position that all direct selling companies having independent sellers in their state have nexus for income tax.

Ohio

The state imposes a Commercial Activities Tax (CAT).

The Commercial Activities Tax became law on July 1, 2005. This tax is measured by gross receipts on business activities in the state. The state's position is that this tax is not a net income tax, and therefore P.L. 86-272 does not apply. Therefore, all direct selling companies that have independent sellers in the state are subject to this tax. For additional information see the state's Web site.

Pennsylvania

Pennsylvania imposes a corporate income tax and capital stock/foreign franchise tax.

The state is asserting nexus for their capital stock/foreign franchise tax on all direct selling companies, even if the company is not a domestic corporation and has no property or employees in the state. The state's position is that if the company has independent sellers in the state, it has nexus for this tax.

Texas

The state imposes a franchise tax. The franchise tax is a privilege tax. Corporations pay the greater of the tax on their net taxable capital or net taxable earned surplus.

The state has consistently held that all direct selling companies having one or more independent sellers in their state have nexus and must file and pay their franchise tax.

Washington

The state imposes a Business and Occupation (B&O) tax on both the retail and wholesale transactions of tangible personal property and services.

The state provides a specific exemption from the B&O tax for direct selling companies under Rule WAC 458-20-246.

A company owning, renting or leasing any property, having employees or inventory or performing services of any nature by an employee or compensated third party in the state is subject to the B&O tax.

The state is currently contacting various companies in this industry requesting that the company complete and return a "Business Activities Questionnaire." The purpose of this questionnaire is to determine if the company has nexus in the state.

Wisconsin

The state recently notified two direct selling companies that they have nexus for its income/franchise tax. The state demanded that the companies file and pay these taxes for the past seven years.

The state's position is based on its opinion that the companies have "control" over their independent sellers, based on its rules and procedures as set forth in its distributor manual.

In both cases, the only contacts with the state were that the companies had independent sellers in the state and held a voluntary sales and use tax collection agreement to administer sales taxes on behalf of the independent sellers.

Both companies are appealing.

States to Monitor

• Connecticut-Amended §12-213(a) (20), which defines "carrying on or doing business" for all taxable years commencing on or after Jan. 1, 2005.
• Kentucky-Amended KRS 141.010(25), the nexus standard for their corporate income tax from a physical presence standard to a "doing business" standard. This change is effective for tax periods beginning on or after Jan. 1, 2005.
• New Jersey-In a unanimous decision handed down by the New Jersey Appellate Court on Aug. 24, 2005, out-of-state companies with no physical presence in the state can be taxed on their licensed goods. It is too soon to tell whether New Jersey, as well as other states, will attempt to apply this standard to direct selling companies.
• New Mexico-Based on the Dart decision, the state will impose its income tax and franchise tax on direct selling companies that have the same or similar facts to this case.
• Tennessee-Imposes both an excise tax (based on net income) and a franchise tax (based on net worth). The state attorney general issued an opinion that Public Law 86-272 applies only to the state excise tax and does not create a safe harbor for the franchise tax. Whether the state asserts nexus to direct selling companies having independent sellers in the state is not known at this time.
• Vermont-In Steager v. MBNA America Bank, N.A., the court concluded that the lack of physical presence was not determinative. The court found that MBNA had substantial nexus based on the substantial revenue that MBNA generated from citizens of the state; the extension of credit to citizens of the state; who provided payment; and that the state extended substantial benefits to MBNA by providing banking and consumer credit laws as well as access to its courts, which supported the generation of income to MBNA.

Based on these factors, the court held that there was substantial nexus for the imposition of corporate net income and business franchise taxes despite the lack of physical presence.

Voluntary Disclosures

Each state has a voluntary-disclosure program that allows taxpayers to resolve potential tax liabilities.

Companies may approach the states directly or anonymously through a third party to propose the filing and payment of the prior year's taxes.

Amnesty Programs

From time to time, some states offer an amnesty program. Generally, these programs offer another opportunity to file and pay prior years' returns and taxes. These programs generally waive penalties and limit the look-back period.

Nexus Questionnaires

Many states systematically mail nexus questionnaires. Do not ignore the questionnaire. But do not fill it out. Instead, read and review the state's law and regulations on nexus and any pertinent rulings and court decisions. Based on your review, draft a form letter that will be used to respond to nexus questionnaires. This letter should contain all the appropriate facts regarding the company and clearly state the reasons your company does not have nexus in that state based on its nexus standards.

Respond in a timely manner. Do not lie; you are answering the questions under penalties of perjury.

Summary

The issue of nexus for state and local gross income taxes, net income taxes, franchise taxes, excise taxes, gross receipt taxes, value-added taxes, business activities taxes and other business taxes is a complex one.

The states are very aggressive about tax collection.

Companies must carefully monitor court cases, rulings and law changes to develop the appropriate action plan to minimize their overall state and local tax burden.

James (Jim) Richmond has more than 30 years of tax experience, including 19 years with Amway Corporation (Alticor Inc.) as Supervisor of Sales, Use & Excise Tax. He is recognized as an expert in state and local taxes. He is President of Professional Tax Services Inc., working with direct selling companies in the area of multistate taxes. He can be reached at   taxman_jr@yahoo.com.