Peer Review Report
State Nexus
Wills and Trust documents
Privacy Policy
- To Our Business Clients - November 21, 2006
Several of our business clients have recently received nexus questionnaires from states and have been surprised to learn that their business is subject to that state’s sales / use tax or income tax and, in some cases, both. The purpose of this letter is to provide you with a general understanding of what constitutes nexus for (1) state sales and use tax purposes and (2) state income tax purposes.
Historically, states have asserted that virtually any type of in-state business activity creates nexus for an out-of-state business. This assertion reflects the political reality that it is more appealing to tax out-of-state businesses than it is to raise taxes on in-state business interests, the owners and employees of which vote. The desire of state lawmakers and tax officials to, in effect, export the local tax burden has been counterbalanced by the Due Process Clause and Commerce Clause of the U.S. Constitution.
The Due Process Clause states that no state shall “deprive any person of life, liberty or property, without due process of law”. The U.S. Supreme Court has interpreted this clause as prohibiting a state from taxing an out-of-state corporation unless there is a “minimal connection” between the company’s interstate activities and the taxing state.
The Commerce Clause expressly authorizes Congress to “regulate commerce with foreign nations, and among the several states”. The U.S. Supreme Court has interpreted the Commerce Clause as prohibiting a state from taxing an out-of-state business unless that business has a “substantial nexus” with the state.
Under Public Law 86-272, taxpayers may engage in certain protected activities without triggering the imposition of state income tax. Generally, these activities involve the solicitation of sales of tangible personal property that are accepted out of state and fulfilled with stocks located outside the state. Hence, an out-of state business can send a non-resident salesman, or independent agent, into a state to solicit sales without being subject to that state’s income tax if the orders are accepted out of state and filled with shipments of inventory from stocks outside of that state. However, if the salesman’s duties include any functions other than “mere solicitation,” for example handling customer complaints, following up on delinquent accounts receivable from the customer, installing the product, etc., the protection afforded by Public Law 86-272 may be lost.
Nexus in a state is generally determined by the presence of three factors, i.e. sales, payroll and property. In-state sales coupled with one or more of the other factors will always be sufficient for a state to assert nexus. The presence of destination sales to an out of state customer is not sufficient to establish income tax nexus if the level of the company’s activities in the state do not rise above the “mere solicitation” level. However, the presence of either one of the other two factors, i.e. payroll (a resident employee) or property (company provided automobile, cell phone or computer to the resident salesman or inventory in an in-state warehouse) will result in nexus with or without in-state sales.
The discussion so far has been restricted to nexus for state income tax purposes. For sales / use tax purposes, states can assert nexus at a lower level of in-state activity. This is because the protection afforded by Public Law 86-272 applies only to state income taxes. It is a fairly common misconception that Public Law 86-272 offers protection from state sales / use tax liability. Public Law 86-272 does not apply to taxes measured by gross receipts or sales.
An out-of-state business may avoid having nexus for a state’s income tax, but may be held liable to collect that state’s sales / use tax. The above example in which a business’ non-resident salesman regularly solicits sales in another state is generally sufficient activity for the state to successfully assert nexus for sale / use tax purposes whether or not the salesman’s activity rises above “mere solicitation.” A few of our business clients recently have been subjected to out-of-state sales / use tax liability as a result of this situation.
It is important to note that each state’s rules are different. In one or two states, the mere mailing of a business’ advertising catalog to an in-state consumer is sufficient to establish sales and use tax nexus (the out-of-state business has sent its property into the state).
States are constantly becoming more sophisticated in their search for additional tax revenue. Many states, as an audit tool, compare business payroll tax filings with business income tax filers to verify that all businesses filing payroll tax returns are also filing business income tax returns. Also, many states obtain lists from operators of public warehouses of the owners of property stored in the warehouse. More and more, it appears that state revenue departments are sending out nexus questionnaires to out-of-state suppliers of in-state businesses, i.e. your customers.
The consequences of not being in compliance with state income tax and sales / use tax requirements can be costly. There is no statute of limitations that can expire when no returns are filed. Therefore, a state can insist on a long look-back period. Penalties and interest are calculated from the due date of the delinquent tax returns. On the other hand, overpaid “home” state taxes can be recovered only for prior years not yet closed under the statute of limitations period.
Many states offer formal or informal “voluntary disclosure programs” to encourage businesses to voluntarily get into compliance. Usually a three or four-year look-back period is required and the state will waive penalties, but usually not interest. Occasionally a state may designate a relatively short “amnesty period” within which a business may file delinquent tax returns and agree to future compliance in return for relief from penalties and, in some cases, a portion of interest. Announcement of an upcoming amnesty period is often coupled with an increase in post-amnesty period penalty rates.
If you have any questions or concerns regarding state tax matters, we would be happy to discuss them with you.
Sincerely,
CHARLES J. GRIES & COMPANY L.L.P.
Certified Public Accountants
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- To Our Clients and Friends - October 29, 2003
Several of our business clients have recently received nexus questionnaires from states and have been surprised to learn that their business is subject to that state’s sales / use tax or income tax and, in some cases, both. The purpose of this letter is to provide you with a general understanding of what constitutes nexus for (1) state sales and use tax purposes and (2) state income tax purposes.
Historically, states have asserted that virtually any type of in-state business activity creates nexus for an out-of-state business. This assertion reflects the political reality that it is more appealing to tax out-of-state businesses than it is to raise taxes on in-state business interests, the owners and employees of which vote. The desire of state lawmakers and tax officials to, in effect, export the local tax burden has been counterbalanced by the Due Process Clause and Commerce Clause of the U.S. Constitution.
The Due Process Clause states that no state shall “deprive any person of life, liberty or property, without due process of law”. The U.S. Supreme Court has interpreted this clause as prohibiting a state from taxing an out-of-state corporation unless there is a “minimal connection” between the company’s interstate activities and the taxing state.
The Commerce Clause expressly authorizes Congress to “regulate commerce with foreign nations, and among the several states”. The U.S. Supreme Court has interpreted the Commerce Clause as prohibiting a state from taxing an out-of-state business unless that business has a “substantial nexus” with the state.
We are writing to suggest that it may be a good time for you to review your Wills, Trusts and other estate planning documents to be sure they will still accomplish what you want them to accomplish given the current federal estate tax law and future scheduled phase-in changes in the law.
Most of the Wills and Trust documents that we have reviewed for our clients provide for the estate of a first-to-die spouse to be divided into a Family Trust and a Marital Trust. The Family Trust is funded with an amount equal to the unused portion of the unified credit exemption equivalent (presently $1 million) and the balance of the estate is used to fund the Marital Trust. This strategy is designed to produce a zero estate tax liability on the estate of the first spouse to die and to assure that the amount in the Family Trust is not taxed in the surviving spouse's estate. The surviving spouse has the right to all of the income and the principal of the Marital Trust.
As many of you are aware, the unified credit exemption equivalent is scheduled to increase to $1.5 million in 2004, $2.0 million in 2006 and to $3.5 million in 2009. The estate tax is repealed in 2010, and is reinstated in 2011 and future years with a $1.0 million exemption equivalent. With the Republican Party recent success in the Congressional Elections, there is now talk of accelerating the above changes and of making permanent the repeal of the federal estate tax. With two Presidential Elections before 2010, all we can say with certainty is that there will be more changes ahead.
The current law scheduled changes in the exemption equivalent amount can have an unintended financial impact on a surviving spouse. This is because most estate planning documents require the Family Trust to be funded with the maximum amount available for the exemption equivalent, with the balance of the estate to be placed in the Marital Trust. Example 1, assume a first-to-die spouse passes away in 2003 with an estate of $2.0 million. The estate will use $1.0 million to fund the Family Trust and the other $1.0 million will fund the Marital Trust. The surviving spouse will generally be entitled to the income from both trusts for his or her lifetime and will also be entitled to the principal of the Marital Trust. Example 2, assume the same facts as above except the first-to-die spouse passes away in 2006, the entire $2.0 million will fund the Family Trust and there will be no assets available for the Marital
Trust. The surviving spouse will likely be entitled to the income of the Family Trust, but will not have the same access to principal that he or she would have had to assets in a Marital Trust. Even if the surviving spouse and the beneficiaries and Trustee of the Family Trust (who usually are the spouse's children) get along, the surviving spouse in the second example may not feel as financially secure as the surviving spouse in the first example. Of course, if the surviving spouse has considerable assets of his or her own, the above result may not be a problem.
We would be pleased to meet with you or your attorney to discuss this matter.
Sincerely,
CHARLES J. GRIES & COMPANY L.L.P.
Certified Public Accountants
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CHARLES J. GRIES & COMPANY L.L.P.
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