The reporting requirements of
FASB Interpretation no. 48 have exacerbated an
already vexing matter for many CPAs and
taxpayers—the uncertainty surrounding the tax
issue of nexus. Much of that uncertainty derives
from inconsistent adjudication of nexus issues by
state courts and the absence of recent guidance
from the U.S. Supreme Court or Congress.
PHYSICAL PRESENCE VS. ECONOMIC PRESENCE
When the Supreme Court last
reviewed state nexus in Quill Corp. v. North
Dakota , 504 U.S. 298 (1992), it said a
state could impose sales and use taxes only on a
taxpayer that was physically present in the state.
Subsequently, states have searched for ways to
circumvent this limitation by adopting a variety
of “economic presence” standards. For example, in
1993, South Carolina crafted an economic presence
standard to assess income tax on a corporation
that was not physically present in the state.
Since then, courts and legislatures in New Mexico,
North Carolina, Minnesota, Arkansas and, more
recently, West Virginia and New Jersey have
successfully applied economic nexus to impose
income taxes on non-physically present companies.
The Supreme Court has failed to provide
needed guidance in this area and recently declined
to review the New Jersey and West Virginia cases.
In Lanco , a case involving a trademark
holding company, the New Jersey Supreme Court in
2006 used “affiliate nexus” to impose income taxes
on an out-of-state seller that had affiliated
companies operating in the state. In MBNA
, a case involving a pure economic nexus
issue, a West Virginia court imposed income taxes
on an out-of-state credit card company that had no
in-state affiliates. Similarly, the Massachusetts
tax board recently ruled that the state could
assess income tax on an out-of-state bank that had
no physical presence in the state.
ENTER FIN 48
FIN 48 imposes
a new recognition and measurement standard that
requires taxpayers to analyze all outstanding
income tax positions (that is, federal, state,
local and international) with the expectation that
each position would be reviewed in an audit.
Taxpayers must determine whether the position is
“more likely than not” to withstand challenge by
the taxing authority.
taxpayers and their advisers must carefully and
continuously review the precedential value of
state court decisions, statutes and administrative
practices pertaining to nexus to make a realistic
and reasonable judgment when applying the
more-likely-than-not recognition standard and when
estimating and measuring a tax benefit. The FIN 48
determination must be supported by well-documented
and auditable evidence including a detailed
analysis supporting the recognition and
measurement requirements and a disclosure of open
periods of assessment for unfiled returns.
Furthermore, FIN 48 compels taxpayers that may be
ensnared by economic or affiliated nexus to review
their decision not to file a return—a decision
previously overlooked as a tax position.
TO FILE OR NOT?
more-likely-than-not standard is not met on the
decision not to file, taxpayers are required to
record an unrecognized tax benefit for the
potential tax liability, which cumulatively can be
a significant amount, since taxpayers who have
never filed are not protected by a statute of
limitations in most states. Alternatively,
taxpayers and their advisers could seek ways to
limit exposure for unfiled years by participating
in state amnesty programs and entering into
voluntary compliance and disclosure agreements.
Alternately, taxpayers may simply avoid doing
business in a state.
greater disclosure raises the question of how work
papers will be used by state taxing authorities.
Will disclosure trigger “fishing expeditions”? The
IRS has said it will apply its usual policy of
restraint to FIN 48-related tax-accrual work
papers, but states could choose to treat them
Just weeks after the Supreme
Court declined to review Lanco and
MBNA, Congress reintroduced legislation
that would codify a physical presence standard and
expand that standard into the income tax area (see
“ Tax Matters,” page 84). Until Congress or the
Supreme Court creates a uniform definition of
nexus, taxpayers will continue to operate in a
state of uncertainty in this area as they try to
comply with the recognition and measurement
requirements of FIN 48.
Lanco Inc. v. Dir., N.J. Div. of
Taxation, U.S. No. 06-1236, cert. denied
(6/18/07), and FIA Card Services, N.A., fka
MBNA Am. Bank, N.A. v. Tax Comm’r of the State
of W.Va., U.S. No. 06-1228, cert. denied
By Jean T. Wells, CPA, J.D.,
assistant professor of accounting and KPMG
Professor in Residence, Howard University,
Washington, D.C., and Gwendolyn
McFadden-Wade, CPA, J.D., LL.M,
associate professor of accounting, North
Carolina A&T State University, Greensboro.