As more businesses enter the online marketplace to sell goods across borders, states are creating laws to capture sales tax for online transactions. Recently, both Connecticut and Mississippi have enacted new tax laws targeting out-of-state e-commerce sellers. Check out the following articles to learn more:
When conducting business across state lines, it is crucial to have a thorough understanding of nexus laws.
While the word “Nexus” has a variety of meanings, when it comes to taxation, “nexus” refers to whether or not a person or transaction can be subject to tax in a particular jurisdiction. Sales and use tax nexus is one of the most common considerations for businesses, and the current law requires “substantial” nexus to be had in a state before said state can move to collect any tax. However, the definition of “substantial” when it comes to establishing nexus is not exactly cut and dry and varies state by state; jurisdiction by jurisdiction. Nexus used to be established by physical presence; however, the prevalence of online sales have made it necessary for states to consider an alternative to the physical presence test. The new nexus test is fashioned more on an economic nexus standard. However, the newly defined economic nexus standard has been questioned by various courts. The states are hoping the courts will reverse their position on these new economic nexus standards, thereby allowing their use. In allowing the use of the new economic nexus standard, the courts would need to recognize that many of the sales and use tax laws were created and interpreted before the development of readily available sales tax software and before the eCommerce marketplace exploded. As you can see, nexus can be tricky to navigate!
Retailers and service providers are especially affected by nexus rules, but buyers of property and taxable services should have a good understanding as well. A recent Tax Executive article provides a thorough look into the current state of nexus law, as well as explains what businesses need to consider and do to remain in compliance.
Just as several times before in United State Supreme Court jurisprudence, a brief and simple statement can garner a great deal of analysis and debate. Recently, as part of his concurring opinion in Direct Marketing Association v. Brohl, Justice Kennedy commented that the Court’s 1992 Quill v. North Dakota, 504 U.S. 298 decision is ripe for reevaluation. As evidenced by its newest Rule (Ala. Admin. Code 810-6-2-.90.03), it appears Alabama has grown impatient. The Rule, in short, disregards Quill’s physical presence nexus standard for sales and use tax purposes. Effective for transactions occurring after 1/1/2016, the new Rule will require out-of-state sellers to register, collect and remit sales tax if:
- The seller’s retail sales of tangible personal property sold into Alabama exceed $250,000 per year based on the previous calendar year’s sales; and
- The seller conducts one or more of the activities described in Ala. Code § 40-23-68 (which sets out a series of wide reaching in-state activities involving ownership of property, the presence of representatives, the qualification/authorization to do business, direct advertising, or franchising/licensing activities).
The above Rule establishes an economic nexus presence standard for sales tax. Clearly, Alabama is attacking Quill’s physical nexus presence standard head on (even though Quill is still, technically, good law)! Only time will tell how this will play out in the courts. In the meantime, out-of-state sellers should evaluate their Alabama-destined sales, be prepared to comply with the Rule, and consider filing protective refund claims.
The Rule can be found here: https%3A%2F%2Frevenue.alabama.gov%2Frules%2F810-6-2-.90.03.pdf&usg=AFQjCNE0uDNQY6K4e2Fi8ODHGB0Fpj-6yQ
As not-for-profit organizations expand their reach, many are unaware that they may be creating nexus in states where they have previously had a limited presence. Here’s what they need to know.
By Andrew Gray, CPA
August 18, 2015
State nexus and compliance for public charities and private foundations has been a long-standing issue, and as these not-for-profit organizations are able to expand their reach through technology and other means, state requirements for not-for-profits are also increasing. Many not-for-profits do not know that the states in which they conduct business have many rules that may apply to them.
State and local governments are actively interested in the charities that operate within their borders to ensure that the organizations’ assets are used for their intended charitable purposes and to protect their residents from being fraudulently solicited for donations. These governments are also interested in the financial gain from regulating charities. They may impose fees on the not-for-profit organizations based on their size (or other factors). In addition, if a not-for-profit organization has income from business unrelated to its exempt purpose, both the federal and state taxing authorities want to make sure they receive their share of any taxes on that income.
Not-for-profit organizations should consider the following factors before beginning any business activity within a state, to address the increased scrutiny of state and local authorities.
1. Interested parties: The organization’s audience
Becoming compliant with the laws of state and local jurisdictions is increasingly important because of the accessibility of information to the general public. Several interested parties could be actively seeking information about the not-for-profit’s status with various states, including:
- The IRS;
- Foundations and donors;
- Researchers and watchdog groups;
- News media; and
- State agencies and other federal agencies.
While the searching activities for the above groups are unknown, the information is available to them. In their efforts to increase revenue and protect their residents, it is probable that they would use what is readily available. In addition, the IRS and many states are sharing information about not-for-profits. Further, potential donors often use information from their state to ensure the organization is in compliance with state laws and not a fraudulent enterprise.
2. Federal tax law requires compliance with states
Regs. Secs. 1.6033-3(c)(1) and -2(a)(2)(iv) require private foundations to furnish a copy of their annual Form 990-PF, Return of Private Foundation, to the attorney general of the following places:
- Where the organization’s principal office is located;
- Where the organization was created or incorporated;
- Any state the organization reports to concerning its organization, assets, or activities; and
- Any state where the organization has registered (or otherwise notified the state) that it intends to be (or is) a charitable organization or holder of property devoted to a charitable purpose.
While this federal requirement does not explicitly apply to public charities, if the state requires a copy of the Form 990, Return of Organization Exempt From Income Tax, the organization must comply. In fact, Form 990 contains a list of states in which the form is required to be filed.
Public charities should be careful to send only the public disclosure copy of Form 990 to the states to ensure that donor information (contained on Schedule B, Schedule of Contributors) and other sensitive information are not released to the public. States often publish the Forms 990 on a website or send copies to those who request them. Generally they do not check to be sure that a public disclosure copy was sent.
In a recent case (Center for Competitive Politics v. Harris, No. 14-15978 (9th Cir. 5/1/15)), the Ninth Circuit upheld a California regulation requiring charities that are registered to solicit contributions in the state to file a nonredacted copy of Form 990, Schedule B. California maintains it does not make Schedule B available to the public, but, even so, organizations should be aware of the potential exposure in California and the need to provide only the required copy to any other state that requests it.
3. Regulating solicitation and annual compliance requirements
A solicitation is defined as any request for a contribution, through any medium, i.e., asking for a gift or selling goods or services. If the organization is soliciting or conducting business, it may need to register with one or more offices within a particular state. Conducting business could mean a variety of things—including solicitation, having property or employees in the state, or selling goods or services in the state. The organization will also need to renew its status annually, which might include a simple postcard filing, a tax return filing, or filing an online form describing the organization’s activities and financial information.
Some organizations may be exempt from filing with a particular state. Although the exceptions vary from state to state, exemptions often apply to religious organizations and organizations that have raised less than certain amounts in the state.
As part of the requirements to register to solicit donations, states such as North Carolina require specific disclosures on their solicitations, written acknowledgments, receipts, and advertisements. Most state disclosures let the donor know where to find financial and registration information about the organization. Note that many states also regulate fundraising professionals (professional solicitors); the rules vary by state.
It is important, once an organization registers with the state, that it maintain its annual compliance. Many states are issuing severe penalties for noncompliance. And these states are hesitant to provide relief from penalties, even to small organizations (and are sometimes prohibited from doing so by law).
4. Sales and use tax
Tax-exempt organizations must comply with each state’s sales and use tax rules much as for-profit businesses do. The analysis to determine whether an organization has sufficient nexus to be required to collect and pay over sales taxes is the same for a not-for-profit organization as it is for a commercial business entity. In general, not-for-profit organizations collect and remit sales tax for taxable sales. For example, if an organization sells T-shirts with its logo on it, this is usually a taxable sale, and sales tax must be collected and remitted to the state where the sale takes place.
The good news is that some states provide sales tax exemptions to not-for-profits for purchases, which is a valuable tax benefit when organizations purchase supplies or other items or services. This often overlooked benefit could save qualifying organizations 5% to 9% on purchases.
5. Unrelated business taxable income (UBTI)
According to the IRS, more than 45,000 Forms 990-T, Exempt Organization Business Income Tax Return, were filed for the 2011 tax year (IRS, Statistics of Income Division, Tax Exempt Organizations, Unrelated Business Income (October 2014)). Many not-for-profit organizations have income from activities unrelated to their exempt purpose (UBTI) or are considering engaging in those activities for additional revenue. Having income from business unrelated to an organization’s exempt purpose comes with additional state income tax compliance issues. In fact, most states conform to the federal income tax definition of UBTI and impose corporate income tax or state unrelated business income tax on state-sourced UBTI.
It is important for a not-for-profit to know whether it needs to file in a particular state. If the organization is not otherwise doing business in the state by soliciting contributions, then it should analyze whether it has income/franchise tax nexus in the state from specifically generating UBTI. If an organization is already registered with the state to solicit contributions, then it would need to apply the appropriate apportionment of UBTI to that particular state, if any, to determine whether it must file a return in that state. However, not-for-profits often have unrelated business losses, so it may be prudent to file in a particular state to preserve a loss that may be carried forward against future income. Note that even when an organization does not have UBTI, it may need to apply for exemption from certain state income and franchise taxes (e.g., North Carolina and California).
It is noteworthy to mention the complex matter of alternative investments (such as limited partnerships, real estate funds, and private-equity funds), which not-for-profits frequently use hoping for higher returns. (For a discussion of this issue, see Evans and Hall, “Are Alternative Investments Worth Their SALT for Tax-Exempt Organizations?” 46 The Tax Adviser 416 (June 2015).)
The bottom line
States are increasingly looking for more revenue and to protect their residents from fraudulent organizations by stepping up their regulation of not-for-profits. This increased attention gives not-for-profits an opportunity to further their mission through transparency while maintaining balance to provide only what is required of them. Preventive action is crucial when reviewing multistate activities and related compliance requirements. Not-for-profit organizations are well-advised to review their activities with their CPA and legal counsel to determine the requirements they must meet in each stat
by Denis Del Bene, JD, LL.M. (RIA)
Alabama has enacted legislation establishing a factor presence nexus standard for business activity for purposes of the income tax, the business privilege tax, and the financial institution excises tax. (L. 2015, H49 (Act 505), effective for tax years beginning after 12/31/2014.)
Substantial nexus. Individuals who are residents or domiciliaries of Alabama and business entities that are organized or commercially domiciled in Alabama have substantial nexus with Alabama. Nonresident individuals and business entities organized outside of Alabama that are doing business in Alabama have substantial nexus and are subject to the income tax, the business privilege tax, and the financial institution excises taxes, when in any tax period, the property, payroll, or sales of the individual or business in Alabama exceeds certain thresholds.
Thresholds for substantial nexus. Substantial nexus is established if any of the following thresholds are exceeded during the tax period: (1) a dollar amount of $50,000 of property; (2) a dollar amount of $50,000 of payroll; (3) a dollar amount of $500,000 of sales; or (4) 25% of total property, total payroll, or total sales. At the end of each year, the Department will review the cumulative percentage change in the Consumer Price Index (CPI) and adjust the thresholds if the CPI has changed by 5% or more since January 1, 2015 or since the date that the thresholds were last adjusted. The adjusted thresholds will be rounded to the nearest $1,000. The CPI means the CPI for All Urban Consumers (CPI-U).
Pass-through entities. Pass-through entities, including, but not limited to, partnerships, limited liability companies, S corporations, and trusts must determine threshold amounts at the entity level. If property, payroll, or sales of an entity in Alabama exceeds the nexus threshold, members, partners, owners, shareholders, or beneficiaries of that pass-through entity are subject to tax on the portion of income earned in Alabama and passed through to them.
Property, payroll, and sales for purposes of the threshold. Property: Property counting toward the threshold is the average value of the taxpayer’s real property and tangible personal property owned or rented and used in Alabama during the tax period. Property owned by the taxpayer is valued at its original cost basis. Property rented by the taxpayer is valued at eight times the net annual rental rate. Net annual rental rate is the annual rental rate paid by the taxpayer less any annual rental rate received by the taxpayer from sub-rentals. The average value of property will be determined by averaging the values at the beginning and ending of the tax period but the tax administrator may require the averaging of monthly values during the tax period if reasonably required to reflect properly the average value of the taxpayer’s property.
Payroll: Payroll counting toward the threshold is the total amount paid by the taxpayer for compensation in Alabama during the tax period. Compensation means wages, salaries, commissions, and any other form of remuneration paid to employees and defined as gross income under IRC §61.
Compensation is paid in Alabama if: (1) the individual’s service is performed entirely within Alabama; (2) the individual’s service is performed both inside and outside Alabama, but the service performed outside the state is incidental to the individual’s service inside the state; (3) some of the service is performed in Alabama and: (a) the base of operations or, if there is no base of operations, the place from which the service is directed or controlled is in Alabama, or (b) the base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the individual’s residence is in Alabama.
Sales: Sales counting toward the threshold include the total dollar value of the taxpayer’s gross receipts from transactions in the current period, from: (1) the sale, lease, or license of real property located in Alabama; (2) the lease or license of tangible personal property located in Alabama; (3) the sale of tangible personal property received in Alabama as indicated by receipt at a business location of the seller in Alabama or by instructions, known to the seller, for delivery or shipment to a purchaser, or to another at the direction of the purchaser, in Alabama; and (4) the sale, lease, or license of services, intangibles, and digital products for primary use by a purchaser known to the seller to be in Alabama.
If the seller knows that a service, intangible, or digital product will be used in multiple states because of separate charges levied for, or measured by, the use at different locations, because of other contractual provisions measuring use, or because of other information provided to the seller, the seller must apportion the receipts according to usage in each state. If the seller does not know where a service, intangible, or digital product will be used or where a tangible will be received, the receipts will count toward the threshold of the state indicated by an address for the purchaser that is available from the business records of the seller maintained in the ordinary course of business. If that is not known, then the receipts will count toward the threshold of the state indicated by an address for the purchaser that is obtained during the consummation of the sale, including the address of the purchaser’s payment instrument, if no other address is available.
Taxpayers subject to special apportionment methods: For a taxpayer subject to special apportionment methods, the property, payroll, and sales for measuring against the nexus thresholds will be defined as they are for apportionment purposes under those special apportionment methods and associated regulations.
Financial institutions: Financial institutions subject to an apportioned income tax must determine property, payroll, and sales for nexus threshold purposes the same as for apportionment purposes under Chapter 16 (Financial Institutions Excise Tax) of Title 40 of the Alabama Code.
Interaction with Federal Interstate Income Law (Public Law 86-272). The legislation provides that a state without jurisdiction to impose tax on or measured by net income on a particular taxpayer because that taxpayer comes within the protection of Public Law 86-272, 15 11 U.S.C. § 381, does not gain jurisdiction to impose such a tax even if the taxpayer’s property, payroll, or sales in the state exceeds a threshold. Public Law 86-272 preempts the state’s authority to tax and will therefore cause sales of each protected taxpayer to customers in the state to be thrown back to those sending states that require throwback.
The corporations at issue were established as bankruptcy-remote special purpose entities (SPEs) and were engaged in securing loans for their parent and affiliated corporations that conducted business in California. As a preliminary matter, the court found that an entity with a California presence was an agent of the SPEs. The court then concluded that the activities conducted by the in-state agent created California nexus for the SPEs that satisfied both Due Process and Commerce Clause requirements.
The Due Process Clause requires some “minimum connection” between the state and the person it seeks to tax, and is concerned with the fairness of the governmental activity. Accordingly, a Due Process Clause analysis focuses on “notice” and “fair warning,” and the Due Process nexus requirement will be satisfied if an out-of-state company has purposefully directed its activities at the taxing state. In Harley-Davidson, the SPEs purpose was to generate liquidity for the in-state entity in a cost-effective manner so that it could make loans to Harley-Davidson dealers, including dealers in California. Additionally, the SPEs’ loan pools contained more loans from California than from any other state, and the in-state entity oversaw collection activities, including repossessions and sales of motorcycles, at California locations on behalf of the SPEs. As a result, the court concluded that “traditional notions of fair play and substantial justice” were satisfied.
The Commerce Clause requires a “substantial nexus” between the person being taxed and the state. The Supreme Court of the United States has addressed this substantial nexus requirement, holding that a seller must have a physical presence in the taxing state to satisfy the substantial nexus requirement for sales-and-use tax purposes. In Tyler Pipe Industries v. Washington State Department of Revenue, 483 U.S. 232 (1987), the Supreme Court stated that, “the crucial factor governing [Commerce Clause] nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for the sales.” While Harley-Davidson argued that the activities of the in-state agent could not create nexus for the SPEs, as such activities were not sales-related activities, the California court rejected this argument stating that “this argument fails from the outset, however, because the third-party’s in state conduct need not be sales-related; it need only be an integral and crucial aspect of the businesses” (internal citations omitted). The court observed that participating in actions to repossess motorcycles “maintain[ed] the value of the security interests underlying the securitization pools” and was “integral and crucial” to the SPE’s securitization business, thus, creating nexus for the SPEs.
Since Tyler Pipe, no case has expanded the “purposeful availment” or “substantial nexus” standards to encompass attribution of activities not relating to an out-of-state company’s ability to establish and maintain an in-state market. Although, some have argued that Tyler Pipe has left this door open. In contrast, other activities that do not directly generate income—such as purchases from in-state suppliers—have been found to be non-nexus creating. The court’s decision in Harley-Davidson blurs the “market-enhancement” bright line by asserting that a broader range of activities conducted by in-state “agents” could satisfy Commerce Clause requirements if the activities are deemed “integral and crucial” to an out-of-state entity’s business. Interestingly, the court cites to a California Supreme Court decision, involving two foreign insurance companies and nexus under the Due Process Clause, to presumably support its Commerce Clause conclusion.
Since “integral and crucial” is a fairly amorphous standard, would an out-of-state business that retains a California law firm or a California management consulting firm to provide general advice (i.e., not specifically related to California) become subject to California taxation? After conversations with Franchise Tax Board (Board) employees, we understand the Board is encouraged that this decision reflects a broader view of the activities of an in-state person that can be attributed to an out-of-state business for nexus purposes. While this seems to be the superficial conclusion in Harley-Davidson, a closer review of the court’s rationale reveals that the court may have been confusing the “representative” and “alter ego” sub-categories of attributional nexus—or possibly, confusing unitary facts (which relate merely to apportionment concepts) with jurisdictional requirements. Perhaps the factors on which the court relied should have resulted in merely the conclusion that the two SPEs are properly includable in a combined California return, and not that such SPEs are taxpayers themselves.