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Posted by Tarra Curran on Mon, Jun 13, 2011 @ 02:45 PM

The CBIZ Tofias client base tends to include many medium to large businesses that sell products and services across state lines, and many of these businesses reach their customers through the internet.  Selling over the internet tends to mean that these businesses only establish a "physical presence"[1] in one or two states, even though they may have customers in all 50 states.  Increasingly, our New England offices are fielding calls from clients who are surprised to discover that they are subject to income tax in states where they have "economic nexus" but no physical presence.

A (Very) Brief History of Economic Nexus

Beginning with the South Carolina Supreme Court decision in Geoffrey, Inc. v. South Carolina. 437 S.E.2d 13 (1992), courts across the nation have distinguished nexus for state sales taxes (physical presence required) from nexus for all other state taxes.  Geoffrey and similar cases in Massachusetts, North Carolina, and New Jersey focused on the in-state use of intangible property to establish nexus.  Subsequent cases have taken the concept a step further to conclude that merely directing economic activity towards a state's market may be enough to establish nexus.

Critics of Geoffrey and the other subsequent cases that created the concept of economic nexus have long claimed that such a vague and nebulous definition of nexus would create a great burden on taxpayers to determine whether state income tax returns needed to be filed.  Instead, opponents of Geoffrey and its progeny advocated for a bright-line physical presence test the same as is used for state sales taxes.[2]

As the economy deteriorated into the recent recession, states appear to have become receptive to the idea of a bright-line nexus standard.  Unfortunately, the result is not a physical presence standard of the type long advocated by the critics of economic nexus.  Rather, in the face of diminishing tax coffers, state legislatures are coming up with ways to increase their tax base instead of committing the politically detrimental measure of increasing tax rates.  One measure gaining popularity is attributing nexus through "factor presence."

Factor Presence

Factor presence is dictated by the amount of property, payroll, or sales a business has within a state.  Savvy readers will no doubt deduce that having a certain amount of property or payroll in a state is not the controversial part of factor presence.  After all, any amount of property or payroll in a state gives a business a physical presence, which constitutes a taxable presence for all state taxes.  The controversy with factor presence is the notion that a certain dollar amount of sales made in a state, even if there is no physical presence, creates nexus.

Despite its growing popularity, factor presence is not a new concept. The Multistate Tax Commission ("MTC") first developed the idea of factor presence in 2002.[3]  The standard was meant to be a simple, certain and equitable standard for the collection of taxes.  In the MTC's version of factor presence, substantial nexus is established if any of the following thresholds is exceeded during the tax period: $50,000 of property; $50,000 of payroll; or $500,000 of sales.[4] This standard allows for substantial nexus in situations where there is no physical presence as long as sales during the tax period are greater than $500,000.  In spite of questions concerning its constitutional validity, several states have incorporated these standards into their statutory nexus standards.

States Currently Incorporating Factor Presence

Ohio was the first state to incorporate factor presence.  Upon its adoption of the Commercial Activity Tax, Ohio incorporated the MTC's factor presence standards into its statutory nexus requirements.[5] As justification for imposing a nexus standard that does not require any physical presence, the Ohio Department of Revenue interpreted the Quill decision as only imposing a physical presence requirement on sales and use taxes.[6]

Michigan was another state that incorporated factor presence principles into the nexus standards of the Michigan Business Tax ("MBT").  A taxpayer has substantial nexus in Michigan and is subject to the MBT if the taxpayer has a physical presence in Michigan for a period of more than one day during the tax year or if the taxpayer actively solicits sales in Michigan and has gross receipts of $350,000 or more sourced to Michigan.[7] The Michigan Department of Revenue also relegated the Quill physical presence test to only sales and use tax, relying on persuasive authority from the Geoffrey decision and its progeny.  In particular, the Department noted that its ruling was consistent with the West Virginia Supreme Court's ruling in MBNA America Bank v. Tax Comm'r of West Virginia ("MBNA" -- discussed below).  That being said, Michigan is reverting to a more traditional income tax in 2012, and it remains to be seen how the nexus standard for this tax will be interpreted. 

In the face of weakening economic conditions, some states have resorted to factor presence as a means of trying to increase tax revenue. In 2009, California was the first state with a traditional corporate income tax scheme to adopt factor presence principles into its nexus standards for tax years beginning on or after January 1, 2011.[8] Colorado followed suit in April of 2010 by finalizing regulations that adopted factor-presence nexus standards for its corporate income tax.[9] Most recently, the Connecticut Department of Revenue issued guidance adopting the MTC factor presence standards to clarify what would constitute economic nexus in that state.[10]  It should also be noted that the Oklahoma Business Activity Tax and Washington Business & Occupation Tax have adopted factor presence standards similar to those of the MTC.[11]

The Courts and Factor Presence

Due to the relative novelty of factor presence among states, state courts have not had much opportunity to weigh in on the validity of these measures. In the case In re: L.L. Bean, Ohio Department of Taxation (08/10/2010), L.L. Bean challenged the constitutional validity of the factor-presence nexus standards of the Commercial Activity Tax.  However, L.L. Bean's claim was based on nexus for sales tax purposes rather than income tax purposes.  The ruling that may provide the most insight as to how various state courts may rule is the Supreme Court of West Virginia's decision in MBNA.

In the MBNA case, the court applied a significant economic presence test as a better indicator of whether substantial nexus existed for Commerce Clause purposes, while limiting the physical presence standard of Quill to only sales and use tax.  The court held that this standard involved an examination of both the quality and quantity of a company's economic presence, which better meets the requirements of the Due Process and Commerce Clauses.  The court was particularly moved by the amount of gross receipts in the state (over $8 million) to justify a determination that the taxpayer had a frequent and systematic presence in the state sufficient to establish substantial nexus.  However, the court did not establish any bright-line threshold of receipts or sales that would create substantial nexus.

The U.S. Supreme Court has yet to affirmatively weigh in on any issues of economic nexus.  Despite repeated attempts in multiple jurisdictions to reserve the bright-line physical presence test for state sales taxes, the Court seems content to refuse appeals to hear such cases, instead relying on lower courts' rulings, which tend to favor the concept of economic nexus and the use of factor presence.


While factor presence has become the law in only a few states, its recent emergence coupled with tight state budgets raises the potential for it to become a growing trend.  Particularly indicative of the rise of factor presence may be its adoption in California, a typically influential state with a traditional income tax scheme.  Therefore, taxpayers should be aware that the reach of economic nexus is expanding outside of related party intangible holding companies to include companies with no physical presence in their affiliated group.  As a result, amassing receipts over some objective benchmark such as $500,000 may create nexus despite the lack of any physical presence.

For more information on the impact of factor presence and other nexus trends on your business, please contact us.


[1]“Physical presence” is generally defined as owning or leasing real or tangible personal property in a state or having employees in a state.  However, it should be noted that a physical presence can be established through the use of manufacturers’ representatives, independent contractors, or other such third parties.
[2]The physical presence test for sales tax nexus is described in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). 
[3]MTC Policy Statement 02-02, Ensuring the Equity, Integrity and Viability of State Income Tax Systems, approved on October 17, 2002. 
[4]In addition, if 25% of total property, total payroll, or total sales is in the state, then the substantial nexus threshold is presumed to be met.
[5]Ohio Rev. Code Ann. § 5751.01(I). 
[6]Ohio Tax Information No. CAT 2005-02 (9/1/2005).
[7]Mich. Comp. Laws Ann. § 208.1200(1). 
[8]See Cal. Rev. & Tax. Code § 2310. 
[9]See Colo. Code Regs.  §39-22-301.1(2)(b). 
[10]See Conn. Gen. Stat.  §12-216a.  Conn. Info. Pub. 2010(29.1) (12/28/2010). 
[11]See 2010 Okla. Sess. Laws  S.B. 6143.


CurranTarra is a Managing Director in the Tax Group and leader of the New England State and Local Tax Practice. She can be reached at 401.626.3240 or






Tags: Tarra Curran, Sales Tax, state and local tax (SALT), corproate nexus, nexus, tax nexus, new england state and local tax

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