Navigating Nexus

Multistate business operations face a wide variety of state taxes.

Nexus can be a hidden danger for a company with a multistate presence. Certain activities might cause nexus for sales and use tax, income tax, franchise tax or other business taxes. One key to successfully navigating these widely varying provisions is for tax professionals to review the statutes and rulings of each state in which a business client might be considered as doing business. The connection might not be obvious, particularly for sales and use tax. And some states levy types of taxes that might not be familiar to business owners and managers, such as those on gross receipts or business activity.


Another, less well-known key is familiarity with states’ provisions for voluntary disclosure and amnesty. Businesses might need a CPA experienced in negotiating with the state or states in question to use these tax controversy resolution tools, especially if they didn’t think they had nexus for an earlier period but belatedly determine that they did.



Sales tax. Federal law requires a state to have “substantial nexus” to a seller to require that seller to collect sales and use tax. The definition of “substantial nexus” has always been a subject of contentious debate between states and businesses. Generally, however, it means having a physical presence in the state , whether by salesperson, contractor, location or a number of different events (see Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967)). Owning or leasing tangible personal property or real property in the state is usually considered to establish sales-and-use-tax nexus. Depending on the state, some other common activities that can result in nexus are listed in the sidebar, “Nexus Study Overview and Checklist,” below.


Income, franchise and other business taxes. Having nexus for sales tax purposes does not necessarily mean a taxpayer will have nexus for income tax purposes, as a higher level of business activity may be required. Historically, state income tax nexus has been created when an out-of-state company derives income from sources within the state, owns or leases property in the state, or employs personnel who engage in activities that go beyond those “protected” under federal interstate commerce laws. Under 15 USC § 381 (commonly referred to by its 1959 enacting legislation, PL 86-272) states imposing a tax based on or measured by net income may not impose that tax on out-of-state taxpayers whose only connection with the state is the solicitation of orders for sales of tangible personal property when such orders are approved and shipped from outside the state. Since PL 86-272 applies only where the in-state activities are the solicitation of orders for sales of tangible personal property, it has no applicability where the solicitation is for the sale of intangible property, real estate or services.


Although PL 86-272 offers protection from income tax, it does not offer protection from a state’s franchise tax, which is imposed for the privilege of doing business in the state and generally based on an apportioned capital, net worth or another non-income base. Currently, about half the states impose a franchise tax, either in conjunction with, or in lieu of, an income tax. In general, a taxpayer with sales tax nexus will be subject to the state’s franchise tax.


Additionally, in recent years several states replaced their income tax with non-income-based taxes. These include the Michigan business tax (MBT), the Texas margin tax (TMT), and the Ohio commercial activities tax (CAT). Like the Washington state business and occupation (B&O) tax and the Delaware gross receipts tax, the MBT, TMT and CAT are not based on or measured by income, but are imposed on gross receipts generated from the sale of products or services, the value of a business’s transactions or some other modified base.


Gross receipts taxes are imposed on the seller and are similar to a privilege tax. It should be noted that taxes based on gross receipts are not sales taxes, even if the same sales receipt impacts both the seller’s gross receipts tax liability and the purchaser’s sales or use tax liability. The MBT, TMT and CAT also require “affiliated” taxpayers engaged in unitary business operations to report their income on a combined basis, thus further expanding their reach. Because gross-receipts and other business taxes are not based on or measured by net income, they are not subject to the protection of PL 86-272. Thus, a taxpayer with even minimal activity within a state could likely find itself subject to one of these taxes.


Not only are states enacting non-income-based taxes, adopting mandatory combined reporting and aggressively broadening the concept of nexus, they also are seeking to capture a larger proportion of the taxable income of multistate businesses by replacing the traditional, equally weighted payroll, property and sales apportionment with formulas based predominantly or solely on the percentage of sales to customers in the state.



Physical presence is the most obvious and traditional nexus standard, especially, as noted earlier, for sales and use tax. A number of states, however, are reaching beyond the traditional view of nexus toward an “economic nexus” standard in which physical presence is not required as long as there is an “economic” connection to the state. For example, in the income tax arena, the exploitation of a trademark, where a fee is paid to use the trademark, has been held to be enough to create nexus for the owner of the trademark. See, for example, Geoffrey Inc. v. Commissioner of Revenue, 899 N.E.2d 87 (Mass. 2009), and Lanco Inc. v. Director, Div. of Taxation, 188 N.J. 380 (2006). Substantial economic nexus has also been successfully asserted with respect to banking and financial services and products directed into a state. See, for example, Capital One Bank v. Commissioner of Revenue, 899 N.E.2d 76 (Mass. 2009), and West Virginia Tax Commissioner v. MBNA America Bank, N.A., 220 W.Va. 163 (2006).


Activities that can create a link between a company and state through the use of subsidiaries or agents will result in agency or affiliate nexus. Such activity might be an entity accepting returns for its online affiliate, as in Borders Online LLC v. State Board of Equalization, 29 Cal. Rptr.3d 176 (Cal. Ct. App. 2005), or even, in some cases, teachers handing out book order forms (see, for example, Scholastic Book Clubs v. State Board of Equalization, 255 Cal. Rptr. 77 (Cal. Ct. App. 1989)). Unless there is a clear separation of the relationship between the out-of-state seller and the in-state activities, a case can be made for nexus. Almost like the game “six degrees of separation,” the seller needs to be aware of any activities of related entities.


Currently, the hottest controversy in affiliate nexus is the New York “Amazon law” fallout (see JofA coverage: “Amazon Loses Round in N.Y. Nexus Fight,” April 2009, page 72; and “Online Retailers Battle N.Y. Nexus,” Oct. 2008, page 96). To date, New York has successfully created a connection through’s New York “affiliates,” state residents to whom the company paid commissions when purchasers “clicked through” their websites to its site. Amazon is appealing the 2009 New York state trial court decision siding with the state. Some states followed suit by introducing similar legislation. Colorado, North Carolina and Rhode Island enacted some version of the “Amazon” nexus presumption law. After Colorado introduced its new law, Amazon pulled its affiliates program there, even though the Colorado law does not specifically identify referral programs for online retailers as creating nexus. Most recently, Connecticut and Minnesota have introduced similar legislation, and additional states will probably introduce or reintroduce this type of legislation over the next year. It is important for the taxpayer to understand its relationships with other vendors, contractors or even partner programs.


Many states would like to require remote sellers to collect their tax even absent physical presence. This would be easier if sales tax laws were made simpler and more uniform, which is the purpose of the Streamlined Sales and Use Tax Agreement (SSUTA).


To date, 23 states have passed conforming legislation, and there are 20 full member states, which agree to comply with uniform sourcing rules and to simplify exemptions. The SSUTA generally makes it easier for small businesses to determine what rate of tax to charge and provides a centralized registration system that uses a single application to register a filer in all participating states. The SSUTA could also make it easier for the federal government to play a role in unifying the state systems. On July 1, 2010, HB 5660, the “Main Street Fairness Act” was introduced in Congress and referred to the House Judiciary Committee. It proposes to overturn the physical presence requirement for sales-and-use-tax collection, allowing SSUTA member states to require out-of-state sellers to collect their tax.



Ideally, the time to assess nexus is before a multistate business starts or expands its operations. But at any stage, companies should periodically perform a diagnostic “checkup” for their sales-and-use-tax-related processes. This checkup (see sidebar, “Sales-and-Use-Tax Diagnostic Checkup”) is a holistic exercise designed to look at other risk areas often associated with sales-and-use-tax processes. Companies suspecting their activities in various states may have created sales tax nexus—subjecting them to sales and/or use tax collection responsibilities—should consider performing a nexus study, which may be performed before or in conjunction with the diagnostic checkup. The study can be completed by a company’s internal tax professionals, or through a qualified CPA or tax consultant who understands the various state nexus requirements. The goal of a nexus study is to obtain a thorough understanding of a company’s potential nexus-creating activities in the various states, and evaluate these activities in light of each state’s laws, administrative guidance, recent court decisions and other rulings to determine a company’s nexus profile (for example, whether nexus is certain, probable or unlikely). See sidebar, “Nexus Study Overview and Checklist,” below.



Companies that discover as a result of a nexus study that they have nexus exposure of which they were unaware may wish to consider the following options.


Voluntary disclosure agreements. As stated earlier, taxpayers may realize only after the fact that they had nexus and thus a state tax delinquency. One option in such instances is to enter into a voluntary disclosure agreement (VDA), an agreement between a state and eligible taxpayer in which the taxpayer comes forward voluntarily and agrees to submit the delinquent returns and associated tax payments as specified in the VDA. In exchange for the taxpayer’s voluntary disclosure, the state grants the taxpayer certain benefits and protections, including the opportunity to resolve the taxpayer’s outstanding tax liabilities fully and completely.


Although the exact benefits offered vary from state to state and taxpayer to taxpayer (and all differ from the federal program by the same name), the most significant benefits include a limited lookback period and a waiver of all applicable penalties. The lookback period refers to the number of prior years or periods a taxpayer will be required to report and pay tax on, with 36 to 48 months being common for sales tax VDAs. Taxpayers are relieved from filing and paying the associated tax for all years prior to the beginning of the lookback period.


As most states allow a request to enter into a VDA to be made anonymously through a taxpayer representative, another significant benefit is the opportunity to review the conditions of the VDA and negotiate preferred terms before disclosing the taxpayer’s identity.


Although entering into a VDA can be beneficial, there are several issues to consider. One reason states offer voluntary disclosure—in addition to collecting tax liabilities that they might otherwise obtain only through extensive collection efforts—is that the program brings new taxpayers onto the state’s tax rolls. A typical VDA eligibility requirement is that the taxpayer not already be registered for the tax involved in the VDA. In addition, a state may require that the taxpayer come forward for all taxes for which the taxpayer has nexus, or that the taxpayer make an affirmative statement that no other nexus exists. However, a taxpayer may not realize that its activities in a state have created nexus for other taxes. The state also may require completion of additional documents, such as a nexus questionnaire. The taxpayer’s responses on the nexus questionnaire could lead the state to determine that the taxpayer has nexus for other taxes, thereby creating a situation where the taxpayer would have to file these other taxes outside of the protection offered through a VDA.


Once a taxpayer has been accepted into the program, the phases of the process must also be completed within the state’s strict deadlines. For instance, once taxpayers have come forward, been accepted into the program, and disclosed their identity, they may have only 30 or 60 days to prepare and file all delinquent returns and pay all money owed to the state. Care should be taken to fulfill a VDA’s requirements and time frames, as failure to do so could mean losing the benefits and protections offered.


Amnesty programs. Similar to a voluntary disclosure program, a tax amnesty program allows a delinquent taxpayer to come forward voluntarily and pay delinquent taxes. As an enticement, states will typically offer an abatement of all applicable penalties and may offer an abatement of all or a portion of the applicable interest.


Unlike state voluntary disclosure programs, tax amnesty programs must be approved by the legislature, occur only periodically and run for a limited time. In addition, a tax amnesty program typically does not offer the benefit of a limited lookback period or the opportunity to negotiate preferred terms. A taxpayer wishing to obtain the benefits of filing during a tax amnesty period must file and pay all delinquent taxes as far back as the liability extends. If a taxpayer with nexus has never filed in the state, the statute of limitations never begins to run. As a result, the state has the authority to go back and assess tax for as many years as the state determines the taxpayer should have been filing.


To assess the feasibility of a VDA or amnesty, companies can take the following steps:


Prepare an exposure analysis. This analysis will capture the anticipated exposure estimates by state for the entire period of the liability. In addition to providing an estimate for increasing amounts booked to reserves, the analysis also can be used to prioritize liabilities by their level of urgency and materiality.


Prepare a VDA or amnesty analysis. With the prioritized liabilities identified in the exposure analysis, try estimating a proposed VDA exposure or probable amnesty outcome for the states. Consider the different eligibility requirements and, for a VDA, the different lookback periods, as well as whether the state has announced or is anticipated to announce an amnesty program. It is important to also capture a position on other tax-type nexus and exposure at this part of the process.


Proceed with a VDA request or tax amnesty filing and prepare to negotiate with the state(s). After deciding to move forward with a VDA request, identify an appropriate advocate to negotiate optimal terms with the states having exposure. Many CPAs and consulting firms offer this service; be sure to use resources with experience in the state in question, both in terms of the state’s nexus requirements and with representing clients in the VDA process. Also, when engaging a CPA firm to serve as tax advocate, consider that the AICPA, SEC and PCAOB independence rules limit the types of activities that a tax advocate can perform without impairing independence.


While many states have similar procedures, the states will expect the negotiator to adhere to all policies and procedures of the VDA program. Negotiation is not generally part of filing within a tax amnesty, so the taxpayer advocate should also be experienced in dealing with tax amnesties. The filing of delinquent returns and payment of outstanding liabilities must be performed within the tax amnesty’s limited time frame to obtain the amnesty benefits. Also consider that filing within an amnesty period may mean waiving any right to claim a refund, protest or initiate any administrative proceeding that challenges any assessment.


Register as a sales tax vendor and begin collections and filings with the state(s). Registration for new taxpayers is often handled as part of the voluntary disclosure process. In some cases, the taxpayer may need to complete this step before negotiation. Whether the registration is handled during the voluntary disclosure process by the taxpayer advocate or by internal resources, this step should be performed in accordance with the state’s policies and procedures.


Maintain good standard procedures to minimize future exposure and liability. If business processes need to be changed, be sure to have a plan to facilitate accurate accounting and reporting.



States are looking for new revenue sources, and companies are looking for ways to help their bottom lines. Thus it’s more important than ever to take preventive action to anticipate nexus issues and smart remedial action once it is unexpectedly discovered.



Sales-and-Use-Tax Diagnostic Checkup

Periodically performing a holistic review of sales-and-use-tax processes is a useful exercise for a company with multistate presence. A “checkup” can help identify areas of tax exposure risk or even areas for refund opportunities. Changes made to procedures as a result of the findings will minimize or eliminate surprises under audit and allow for accurate reporting of tax reserves. While the purpose of the checkup is to identify areas of exposure or weakness, it is also a good opportunity to identify areas where internal controls should exist.


The following is a list of some typical activities associated with the sales-and-use-tax checkup:


Analysis areas


 Nexus analysis

  • Identify activities that may be creating nexus.
  • Determine which states consider the activities a sufficient connection.
  • Prepare exposure analysis for uncollected tax in states where nexus exists.



  • What automated solutions are used?
  • Do amounts such as gross sales reconcile between accounting systems and the tax solution? If not, why? There may be valid reasons for differences, but they should be documented.
  • Does the tax collected reconcile to the tax remitted?


 Tax data

  • Are the rates accurate for all jurisdictions?
  • What sourcing rules are used to determine the rates?
  • How are taxability decisions maintained?
  • Are customer exemption certificates verified, catalogued and maintained?
  • Are exemption certificates issued to vendors logged and tracked?
  • Does the tax department or does an automated solution verify the taxes charged and paid on invoices received from vendors?
  • Review exemptions by state to determine if any refund opportunity may exist based on the use of any goods purchased. A good example may be pollution management equipment.



  • Is there an up-to-date tax filing calendar identifying returns, due dates and responsible resources?
  • Are the logins and passwords for state websites maintained in a secure manner with more than one resource?
  • Are bank account or tax payment procedures documented?
  • Are sales and use tax general ledger accounts reconciled, taking into consideration vendor collection discounts?



  • Review any audit findings for the last five years. Were procedures put in place to remediate any issues previously identified?


Once the checkup is performed, all of the findings are captured in a report with a recommendation for remediation of any issues. Any refund opportunities should be highlighted while any exposure amounts are identified and the liability added to the company’s tax reserves account.


Nexus Study Overview and Checklist
In addition to a sales-and-use-tax diagnostic “checkup,” a business should consider a nexus study either in conjunction with or following the diagnostic checkup. While the focus of the checkup is to identify areas of tax exposure risk, internal control weaknesses and refund opportunities, the goal of a nexus study is to gain an understanding of a business’s potential nexus-creating activities in the various states, and determine a company’s nexus profile. The following is a checklist of activities a CPA or tax consultant should perform when completing a nexus study:

 Complete a nexus questionnaire. This document will likely contain many of the typical questions that might be found in a state-issued nexus questionnaire, and should focus on activities that indicate nexus, such as whether a company does any of the following in other states:

  • Owns or leases real property (store, warehouse, office) or personal property (machinery or equipment).
  • Maintains inventory, whether consigned, in a warehouse or carried by sales representatives.
  • Delivers its products to customers using company-owned vehicles.
  • Advertises in the local media (for example, local phone directories) or through an unrelated telemarketing firm physically located in the state.
  • Sends employees into the state to attend trade shows or conduct training or seminars.
  • Actively solicits orders for sales of tangible personal property, through employees, agents or independent representatives (sales tax nexus).
  • Performs activities that exceed those protected by PL 86-272, including the solicitation of orders for services, real estate or intangibles (income tax nexus).
  • Provides installation, warranty repair, maintenance or other similar services to customers either through its employees or third-party subcontractors.
  • Allows an unrelated third party with an in-state physical presence to accept merchandise returns, approve sales orders, resolve warranty issues or receive payments on the company’s behalf.
  • Sells products or services over the Internet and contracts with “affiliates” who post Web links from their in-state website to the company’s out-of-state website (sales tax nexus).
  • Charges a license, royalty or other similar fee for the use of its intangibles (trademarks, trade names) to related or unrelated entities (income tax nexus).


As these are only a sample of typical questions, additional questions are likely to be included, particularly where a company engages in a unique business activity or is in a special industry.


 Conduct in-depth interviews with company management and other personnel whose job responsibilities could impact a company’s state nexus profile. Such interviews:

  • Should not be limited to accounting, finance and tax personnel.
  • Should corroborate the questionnaire responses.
  • Should uncover how the sales process is completed, to reveal how sales activities impact nexus (“solicitation” involves providing on-site engineering, inventory is being sold during “solicitation,” services or “affiliate” contracts are being solicited).
  • May uncover other functional areas that should be interviewed, for example, engineering, training and warranty departments.


 Once a company’s multistate activity is thoroughly comprehended, analyze this information in conjunction with state law, administrative guidance, court decisions and other pronouncements that help to interpret a state’s position on certain activities, to opine on a company’s nexus profile.


 Calculate an estimate of nexus exposure. For sales tax, this might be based on factors such as the number of periods since nexus was established, the amount of taxable sales and sales tax rate in effect for each period, and the applicable interest and penalty for those periods.





  Because state business taxes differ in type and standards, multistate enterprises need to assess their nexus with respect to each state in which they do business. If they belatedly discover nexus exists, they also need to know about amnesty and voluntary disclosure programs available in most states.


  Businesses generally have nexus for sales and use taxes when they have a physical presence in a state. Owning or leasing real or personal property in a state can establish physical presence, but less obvious nexus-creating activities can include providing services and making deliveries other than by mail or common carrier.


  Nexus for state income taxes generally requires that income be derived from sources within a state or via activities in the state beyond soliciting orders for sales of tangible personal property that is shipped from outside the state. However, a number of states levy franchise taxes for the privilege of doing business in those states and variants of gross-receipts taxes, for which nexus is similar to that for sales taxes. Also, some states have asserted “economic nexus” based on an economic connection to the state independent of any physical presence.


  Activities of an agent or affiliate can create nexus. New York and an increasing number of states have asserted nexus where state residents act as affiliates of an online retailer by posting on their own websites hyperlinks to the retailer’s site.


  In a voluntary disclosure agreement, a business comes forward and agrees to submit delinquent returns and tax payments, in exchange for the state taxing authority’s limiting the “lookback” period and waiving penalties.


  Penalties also are commonly abated, and sometimes interest, in tax amnesty programs, which are offered only periodically, are typically available for a limited time, and generally do not limit the lookback period.


Diana DiBello ( is director of product development for SpeedTax, a provider of sales and use tax compliance software solutions. Sylvia Dion ( is a tax executive, state and local tax consultant, and writer.


To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at or 919-402-4434.







Use to find past JofA articles. In the search box, click “Open Advanced Search” and then search by title.


CPE self-study

  • Multistate Income Tax: Simplifying the Complexities (#732466)
  • Sales and Use Tax: Guide to Doing It Right (#730067)



Tax Strategies for the High-Income Individual, May 5–6, 2011, Las Vegas


For more information or to make a purchase or register, go to or call the Institute at 888-777-7077.


On-Site Training

  • Sales and Use Tax: Guide to Doing It Right (#CT-GST)
  • Multistate Income Tax: Simplifying the Complexities (#MIT)
  • Introduction to Multi-State Income and Sales & Use Taxes (#MSSU—available May 15, 2011)


To access courses, go to and click on “On-Site Training,” then search by “Acronym Index.” If you need assistance, please contact a training representative at 800-634-6780 (option 1).






The Tax Adviser and Tax Section

The Tax Adviser is available at a reduced subscription price to members of the Tax Section, which provides tools, technologies and peer interaction to CPAs with tax practices. More than 23,000 CPAs are Tax Section members. The Section keeps members up to date on tax legislative and regulatory developments. Visit the Tax Center at The current issue of The Tax Adviser is available at


More from the JofA:


 Find us on Facebook      Follow us on Twitter


Where to find June’s flipbook issue

The Journal of Accountancy is now completely digital. 





Leases standard: Tackling implementation — and beyond

The new accounting standard provides greater transparency but requires wide-ranging data gathering. Learn more by downloading this comprehensive report.