Even Amid Legal Challenges

States Ramp Up Standards for Collecting Tax

Peter A. DeMarco

Crain's Cleveland Business

If companies can operate in the digital era with no real boundaries around where they can do business, then tax authorities, it seems, can become just as unbounded.

In fact, Ohio tax authorities have led the way with an evolving standard for how to tax commercial activity, and it’s catching on in other states. The method is under assault in appeals courts, but it stands for now as the chosen method by which state tax authorities are claiming their share of tax on business transactions that have perhaps only a cyber tie to their state’s economy.

 

The trend is for states to adopt “factor presence nexus standards” that make it easier than ever for states to claim that some portion of a company’s commercial activities cross into a given state’s borders, even if only digitally. “Nexus” is a term in tax law to describe some connection between a commercial transaction and a state giving the state authority to impose tax on it.

Before the World Wide Web transformed the way business is conducted, a company had to have some kind of physical presence in a given state to claim nexus over that company’s activities. If the company made or sold products in a given state, it was easy to establish nexus, even perhaps if the company only solicited business in the state by sending sales representatives across the border now and then to look for customers.

In the digital era, however, it’s easy for a company to sell products into a given state in a much more passive way. Virtually any company or entrepreneur these days can simply operate a website where customers can place orders and have products shipped to their doorstep or loading dock, in any state, or even in any part of the world, for that matter.

The “factor presence nexus standard” that states are increasingly adopting says a company’s business activities will become taxable if a company’s property, payroll or sales in the state achieve a given portion of their total property, payroll or sales. That casts a much wider net on a company’s commercial activity compared with a nexus standard pinned to a company’s physical presence.

Ohio adopted such a standard in 2005 when it developed and imposed the present-day “commercial activity tax,” a low-rate, broad-based tax meant to target a much larger pool of taxpayers with a small additional tax amount. The idea behind the tax was to spread the taxpaying burden among a larger number of taxpayers, minimizing the pain for any individual or group.

Other states have taken notice and begun following suit. Since early 2010, five more states have jumped on the bandwagon, and more are expected to follow.

L.L. Bean is leading the charge to fight the factor presence approach to establishing nexus, and it’s challenging the tax in Ohio. L.L. Bean argued it had no stores, employees, or other physical presence in Ohio, so it should not be taxed for clothing and other wares it sold to Ohio customers. The Ohio Department of Taxation ruled against L.L. Bean in August.

L.L. Bean has filed notice that it plans to appeal the ruling to the Ohio Board of Tax Appeals, but ultimately it will have to press on to the Ohio Supreme Court or the U.S. Supreme Court to argue the tax on the basis of its constitutionality. Meanwhile, the tax practice is established and growing.

Even the Multistate Tax Commission is onboard with the method. The MTC is a body that is working to bring some kind of cohesiveness to the collection, remittance, and administration of state taxes across state borders to make it easier for companies to understand and comply with their tax obligations. It recommended thresholds for states to consider as they adopted their standards.

Companies that do business across state borders, even if only digitally, need to be aware of just how taxable their transactions really are and assure they comply. 

Please contact Pete DeMarco at (216) 928-5345 or pdemarco@meadenmoore.com with any questions.