What is Income Tax Nexus?

What is Income Tax Nexus?

Nexus is a word which means connection.  In the realm of income tax, nexus refers to the concept that a business will owe income tax to a state if it has a sufficient connection to that state.

Although each state writes its own laws, many states say that a business has income tax nexus if it has substantial economic activity there.  Most states don’t require that the business have a physical presence in the state, like a store or a warehouse, in order to qualify as having substantial economic activity.  Some states have a factor-based nexus standard that creates nexus if a business exceeds certain thresholds during the year for sales in the state, the value of property in the state, or payroll in the state.

The Interstate Income Act of 1959 provides relief for some businesses.  This law says that states cannot impose income tax on a business that merely solicits orders for tangible personal property in the state, as long as the orders are approved and filled from outside the state.  Think of the old-fashioned traveling salesman.  If I make a product at a manufacturing facility in New Jersey, but I send a salesman to Chicago to speak to potential customers, that alone does not create nexus in Illinois for me.  Since this law applies only to tangible personal property, it offers no protection for businesses that sell intangibles or perform services.  Also, since this federal law was enacted long before the existence of the internet, the Multistate Tax Commission (MTC) has written opinions that the Interstate Income Act does not protect businesses who conduct transactions through their websites.  As states continue to reform their laws in response to interstate activity, businesses need to keep up with the latest regulations.

When a business evaluates whether it has nexus with each state, some of the general considerations are

1. Ownership, lease or use of property
2. Business registration and authorization        
3. Employee activities
4. Services provided
5. Advertising
6. Transportation of goods and products
7. Financial activities and transactions

It is important to note that income tax nexus isn’t necessarily the same as sales tax nexus.  A business may be required to collect and remit sales taxes in a state but not need to file an income tax return in that state. 

Knowing the rules for all the states in which you have customers is important.  Most states offer voluntary disclosure programs to encourage taxpayers to come forward and get into compliance if they have past tax liabilities.