The Emergence of Factor Presence Nexus Standards

By Joe Neff, J.D., Michael Williams, CPA, and Mike Draper, CPA, MSA

Editor: Neal A. Weber, CPA

State & Local Taxes

In this era of electronic commerce and record state budget deficits, several states—in an effort to increase tax revenues—have replaced traditional nexus standards with “factor presence nexus standards” to trigger taxes based upon gross receipts and income. The term “nexus” when used in connection with state taxation refers to the due process requirement that there must be some definite link, some minimum connection, between a state and the person, property, or transaction it seeks to tax. Nexus is the contact that must be established with a taxing jurisdiction before it can impose a tax (Miller Bros. Co. v. Maryland, 347 U.S. 340 (1954)).

Statutory apportionment factors imposed by states are typically used to apportion income among states where the company has nexus. Apportionment of income is required to avoid double taxation by states. Typically, the company’s in-state property, payroll, and sales compared with its total property, payroll, and sales are factors that states use for apportionment of income. The methodologies vary among states. Under a factor presence nexus standard, a company’s business activities or income will be subject to tax in a particular state if one of the company’s apportionment factors (property, payroll, or sales) exceeds the state’s statutory threshold. Since January 1, 2010, five states have instituted these nexus standards based on the company’s level of sales, property, or payroll. With this recent wave of new standards, it is likely that other states will impose similar nexus standards as well.

The most controversial aspect of these new standards is that companies deriving revenue from sources within a state will be treated as having nexus with the state and thus will be subject to tax, even though they have no physical presence in the state. The recent tax determination ruling by the Ohio Tax Commission in In re L.L. Bean (discussed below) demonstrates the impact of these nexus standards on companies lacking a physical presence within a state. L.L. Bean’s circumstances were such that the Interstate Tax Limitations Act, P.L. 86-272 (codified in 15 U.S.C. §§381–384), did not apply. P.L. 86-272 provides that a state cannot impose a net income tax if a seller’s only business activity within the state is the solicitation of orders for sales of tangible personal property. Since Ohio imposes a gross receipts tax and not an income-based tax, P.L. 86-272 was not available to exempt L.L. Bean from taxation.

Origin of Factor Presence Nexus

In an effort to promote uniformity among states and create a bright-line nexus test for business activity taxes, the Multistate Tax Commission (MTC) adopted a model statute, Factor Presence Nexus Standard for Business Activity Taxes, on October 17, 2002. The statute calls for nexus to be established if any of the following thresholds are exceeded during a tax period:

  • $50,000 of property;
  • $50,000 of payroll;
  • $500,000 of sales; or
  • 25% of total property, total payroll, or total sales.

The concept originated with Charles McLure in his article “Implementing State Corporate Income Taxes in the Digital Age” (53 Nat’l Tax J. 1287 (December 2000)). McLure reasoned that potential taxpayers should be found to have nexus with a state where they engage in significant amounts of activities that would create tax liabilities if that taxpayer were profitable. Under McLure’s analysis, nexus rules and apportionment rules should be intimately related and not tied to the potential taxpayer’s degree of physical presence in the state, especially in an age of increased electronic commerce. The factor presence nexus standard is also based on the theory that a company’s ability to exploit a market is a source of income and provides states with the entitlement to tax. Factor presence nexus standards are now in effect in seven states.

Business Activity Taxes

Ohio: Effective July 1, 2005, Ohio became the first state to impose a factor presence nexus standard, adopting MTC thresholds for purposes of determining commercial activity tax (CAT) nexus (OH Rev. Code §§5751.01(H) and (I)).

Washington: Effective June 1, 2010, Washington adopted a factor presence nexus standard for the business and occupation tax (WA SB 6143, Laws 2010). Taxpayers engaged in apportionable activities are deemed to have substantial nexus if (1) property in Washington exceeds $50,000; (2) payroll in Washington exceeds $50,000; (3) Washington receipts exceed $250,000; or (4) at least 25% of the taxpayer’s total property, payroll, or receipts are in Washington. The state defines the term “apportionable activities” to include several types of service activities. Taxpayers who engage in business activities that do not fall within that definition must use a physical presence standard to determine nexus.

In addition, for all Washington taxpayers subject to the business and occupation tax, tax returns must be filed for as long as the taxpayer meets the nexus requirements, plus one year.

Oklahoma: Effective January 1, 2010, Oklahoma adopted the MTC’s factor presence nexus thresholds for the state’s new business activity tax (OK SJR 61, Laws 2010).


The Michigan business tax (MBT), which became effective January 1, 2008, is a tax on both modified gross receipts and net income (MI Comp. Laws §§208.1201 and 208.1203). Substantial nexus for Michigan’s purposes occurs when (1) a taxpayer has physical presence in Michigan for more than one day or (2) a taxpayer activity solicits sales in Michigan and has $350,000 or more of gross receipts attributable to Michigan (MI Comp. Laws §208.1200).

Income-Based Taxes

Connecticut: Effective January 1, 2010, as part of the state’s economic nexus standard, Connecticut imposed nexus on any taxpayer with receipts from Connecticut-sourced business activities that exceed the bright-line test of $500,000 (CT Gen. Stat. §12-216a).

Colorado: Effective April 30, 2010, Colorado adopted the MTC’s factor presence nexus thresholds for the state’s income tax (CO Code Regs. §39-22-301.1).

California: Effective January 1, 2011, California adopted the MTC’s factor presence nexus thresholds for the state’s income and franchise tax (CA SBX3 15, Laws 2009).

Questions of Constitutionality

With Ohio as the first state to implement a factor presence nexus standard, it is not surprising that the first challenge to the constitutionality of these standards comes from Ohio as well. On August 10, 2010, the Ohio Department of Taxation issued a final determination ruling that L.L. Bean, Inc. had nexus for commercial activity tax purposes. L.L. Bean sells various apparel and consumer goods through orders received via telephone, mail, and the internet. The company made sales to customers located in Ohio exceeding $500,000 but had no stores, employees, or other physical presence in the state.

L.L. Bean argued the constitutionality of the tax, stating that it was in violation of the Commerce Clause of the U.S. Constitution since the company did not possess the bright-line physical presence in Ohio required by National Bellas Hess, Inc. v. Illinois Dept of Rev., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In National Bellas Hess and as reaffirmed in Quill, the U.S. Supreme Court ruled that substantial nexus exists only if a corporation has physical presence in a state for sales and use tax purposes. The Court has not ruled on whether the physical presence requirement applied to taxes other than sales and use taxes. However, the highest courts in many states, including the Ohio Supreme Court in Couchot v. State Lottery Commn, 74 Ohio St. 3d 417 (1996), have ruled that the physical presence requirement in Quill applies only to sales and use taxes. On the other hand, other states have held that the physical presence requirement applies to other taxes as well, not just sales and use taxes.

The Ohio Department of Taxation does not have jurisdiction to rule on the issue of constitutionality and thus concluded that nexus was present since L.L. Bean had sales to customers in Ohio exceeding $500,000. On October 8, 2010, L.L. Bean filed a notice of appeal to the Ohio Board of Tax Appeals. While that board also does not have jurisdiction to rule on issues of constitutionality, as a matter of state procedure L.L. Bean was not able to circumvent this step. The challenge will ultimately need to go before the Ohio Supreme Court or the U.S. Supreme Court. Therefore, a significant amount of time is likely to pass before there is more certainty on this issue.

As an increasing number of states codify factor presence nexus standards, it is very likely that taxpayers will challenge the constitutionality of these standards in other states as well. Ultimately, until the U.S. Supreme Court decides to rule on the issue, uncertainty will remain.


Neal Weber is managing director-in-charge, Washington National Tax, with RSM McGladrey, Inc., in Washington, DC.

For additional information about these items, contact Mr. Weber at (202) 370-8213 or

Unless otherwise noted, contributors are members of or associated with RSM McGladrey, Inc.

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