The Increasing Compliance Burden of Economic Nexus

By Catherine Shaw Stanton, CPA

Editor: Sarah McGahan, J.D., LL.M.

Years ago, life seemed so much simpler: Taxpayers could more readily use their intuition in determining their state income tax filing requirements, and they were likely correct. Operating a business consisted of hiring employees and using tangible property to manufacture products or perform services. It was clear where these activities occurred, and it was assumed filing obligations must be met in those jurisdictions.

In fact, P.L. 86-2721 was enacted to calm the outcries of the business community in response to the U.S. Supreme Court's decision in Northwestern States Portland Cement Co.2 This decision upheld the imposition of a Minnesota tax on an Iowa corporation that only solicited orders and maintained leased office space for sales representatives in Minnesota. The sales representatives' activity was limited to soliciting orders for the purchase of the company's products; the business accepted those orders at and filled them from Iowa.

Both the business community and Congress had grave concerns over the complexity the Northwestern decision brought to tax compliance, its impact on interstate commerce, and the additional burdens placed on smaller businesses. Congress intended for the federal law to be a stopgap measure and passed it very quickly before any studies were conducted. As stated in 1959 by Sen. Harry F. Byrd of Virginia: "Unless immediate action is taken at this time, it is feared that the states will amend their laws to further encroach upon interstate commerce."3

Those fears have certainly been realized. For many taxpayers the news that P.L. 86-272 prevents states from imposing income taxes when in-state activities are limited to sales solicitation is unexpected relief. In fact, it now even appears odd that sellers of tangible personal property have this special type of relief. But the states narrowly construe this federal law. It only provides protection from income tax for sellers of tangible personal property whose contacts with the state are limited to solicitation. It does not protect a taxpayer that solicits or performs services in the state, and it does not apply to any non-income-based taxes.4

Apart from federal law protection, the states are aggressively pursuing out-of-state businesses as an additional source of revenue. In BNA's most recent state surveys,5 37 states (and the District of Columbia) now impose what is called an "economic nexus" policy. When the four states that do not impose a corporate income tax and the four states that refused to answer the question are added to that list, that leaves only six holdouts.6

For years, much of the practitioner and business community believed the U.S. Supreme Court decision in Quill7 required some form of physical presence to establish the requisite connection with a state for the state to subject a business to tax. Yes, the Geoffrey8 decision encroached on this view, although one could argue that Geoffrey the Giraffe was "present" within the state of South Carolina, since one only had to visit a Toys R Us store to see him happily displayed on the building.

But a much different tax world now exists in the majority of states, a world defined by economic nexus. Washington, Tennessee, and New York are three of the most recent states to enact statutes that impose this emboldened standard. State courts have clearly supported the economic nexus theory, which does not require a business to actually conduct activities within the state to incur an income tax obligation. In fact, one only needs income arising from a source within the state.


P.L. 86-272 never limited the state of Washington since it imposes a business and occupation tax (B&O), which is not an income tax but is based on gross receipts. Only recently has the state begun pursuing sellers of tangible personal property shipping into the state. Most likely Washington is following Ohio's example with its imposition of the commercial activity tax (CAT), which is also based on gross receipts; Ohio was the forerunner in applying economic nexus in imposing non-income-based taxes.9

Effective Sept. 1 of this year, wholesalers selling to customers in Washington are now subject to the B&O tax if receipts exceed $267,000 or, alternatively, either payroll or property apportioned to the state exceeds $53,000.10 However, the period for measurement under the new bright-line standard is the previous calendar year. As mentioned, P.L. 86-272 does not provide protection against these Washington or Ohio taxes, so sellers of tangible personal property into these states need to be aware of these economic presence thresholds.

Economic nexus is not new in Washington for sales of other than tangible personal property. Effective June 1, 2010, the B&O tax already applied to business entities with sales into the state exceeding these thresholds that were not classified as sales of tangible personal property. But this standard is now also being followed for sellers of tangible personal property into the state. In addition, if nexus exists in any tax year, the business is deemed to have a substantial nexus with the state for the following tax year (i.e., "trailing nexus").11

Outside of the Washington and Ohio gross-receipts-based taxes, sellers of tangible personal property can still bask in the sunlight of protection afforded by federal law and enjoy the lack of state encroachment as it relates to income-based taxes if activities within the state do not go beyond solicitation. For service providers, however, there may only be dark clouds looming.


Tennessee's recently enacted Revenue Modernization Act (RMA)12 imposes economic nexus, also measured by bright-line standards. Prior to the RMA, Tennessee was historically one of those states that upheld the physical presence standard for its excise tax.13 As of Jan. 1, 2016, Tennessee now defines the meaning of "substantial nexus in this state" to include any direct or indirect connection of the taxpayer such that the taxpayer can be required under the U.S. Constitution to remit the tax imposed.14

Tennessee now imposes a bright-line test, under which taxpayers with receipts in excess of $500,000 or 25% of total receipts have nexus with the state. Property or payroll in the state in excess of $50,000 or in excess of 25% of the taxpayer's total property or payroll will also create nexus. Tennessee goes on to capture within its definition those taxpayers that systematically and continuously have business activity in Tennessee that produces gross receipts attributable to customers in Tennessee (i.e., regardless of the level of gross receipts).15

New York

Effective Jan. 1, 2015, New York also statutorily adopted an economic nexus standard for the corporate income tax.16 New York chose to use a $1 million threshold in defining the amount of receipts necessary to be considered substantial. Oddly enough, the new standard is contained within the corporate statutes and does not apply to flowthrough entities owned by individuals.

A New Environment

Is this now an environment where states require an income tax return merely because customers are located within the state? The answer: possibly. P.L. 86-272 will still protect those businesses that are only soliciting for sales of tangible personal property, as already mentioned. Constitutional constraints must also be considered. No taxpayer relishes being in a position of having to incur costly litigation to fairly determine its filing requirements. The alternative would be to file a return, potentially increasing compliance and tax costs, possibly unnecessarily. The greatest cost would be to small businesses, whose tax bills will generally not be large enough to justify fighting the states. All those nickels and dimes can accumulate quite nicely in the state coffers.

The U.S. Supreme Court has not taken on an economic nexus case in recent years, although an increase in constitutional challenges can be expected based on the Due Process Clause of the Fourteenth Amendment. The Due Process Clause requires some "minimum contacts," not necessarily physical, with the taxing jurisdiction to create nexus. If a taxpayer does not pursue a market within the state and does not have any other contacts with the state other than having a customer located there (not resulting from the taxpayer's solicitation), states may be hard-pressed to show that a minimum connection exists under the Due Process Clause.

For example, providing a glimmer of hope is the ConAgra case,17 in which the West Virginia Supreme Court of Appeals affirmed a trial court decision that royalty income an out-of-state licensor earned from the nationwide licensing of food industry trademarks and trade names was not subject to West Virginia's net income and business franchise tax based on economic nexus. In this case, the licensor performed no direct solicitation into the state. Affiliated and unrelated licensees of the licensor manufactured all products bearing its trademarks and trade names entirely outside West Virginia and the licensor gave no direction to the licensees regarding how they were to advertise or distribute the products. In addition, licensees did not operate any retail stores in the state and only sold to wholesalers and retailers. The licensor itself had no physical presence and did not sell or distribute products or provide any services within the state. Royalty income in excess of $1 million was received by the licensor, based on the licensees' sales into the state.

The court determined the licensor's activities did not satisfy the "purposeful direction" test under the Due Process Clause, which requires some action to pursue a market within the state. In addition, the court noted that even under the Commerce Clause, economic presence did not exist since there was no "significant economic presence."

With regard to the Commerce Clause, the U.S. Supreme Court has confirmed that interstate commerce is not immune from state taxation. However, limitations apply. A state tax cannot be sustained unless the taxpayer has a substantial nexus with the state, and the tax is fairly apportioned, does not discriminate, and is fairly related to services provided by the state.18 The court in ConAgra determined that "substantial nexus" is not exclusively measured by the amount of receipts coming from sources within a state, and that there must be something more to establish that a company has substantial nexus with a state. This flies in the face of the wave of new state statutes that use a gross-receipts bright-line standard to determine nexus.

So what is a taxpayer to do? That depends on the taxpayer's specific facts and tolerance for risk. But in determining whether economic nexus has been triggered, the taxpayer needs to assess all of its contacts with the given state, not just the presence of sales. And in all cases, now more than ever, the taxpayer and its advisers should thoroughly explore constitutional defenses. Failing to do so and refusing to address the changes in this new era in state taxation could prove very costly.  


1Interstate Income Act of 1959, P.L. 86-272, 73 Stat. 555. The law generally limits states' authority to subject businesses to income tax when the only activity taking place in the state is the solicitation of sales for tangible personal property.

2Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450 (1959).

3Cong. Rec. p. 16354 (Aug. 19, 1959).

4See Multistate Tax Comm'n, Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272 (July 27, 2001) (available at, for additional information on activities that fall within the definition of "solicitation of sales" and the overall applicability of P.L. 86-272.

5Bloomberg BNA, 2015 Survey of State Tax Departments (April 24, 2015).

6Delaware, Louisiana, Rhode Island, Tennessee, Texas, and Vermont. However, out of these six states, Louisiana, Rhode Island, and Vermont indicated they do not follow the physical presence standard of Quill for income taxes. Tennessee will impose economic nexus beginning Jan. 1, 2016.

7Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

8Geoffrey, Inc. v. South Carolina Tax Comm'n, 437 S.E.2d 13 (1993), cert. denied, 510 U.S. 992 (1993).

9Ohio requires a tax return from every business with Ohio receipts of more than $150,000, regardless of physical presence or whether the business is pursuing a market within the state (Ohio Rev. Code §5751.02).

10Wash. Rev. Code §82.04.067; Wash. Dep't of Rev. Excise Tax Advisory 3195.2015 (2/3/15).

11Wash. Rev. Code §§82.04.066, 82.04.067, and 82.04.220.

12Tenn. H.B. 644, known as the Revenue Modernization Act (RMA), enacted on May 20, 2015.

13J.C. Penney Nat'l Bank v. Johnson,19 S.W.3d 831 (Tenn. Ct. App. 1999).

14Tenn. Code. §67-4-2004([52]).


16N.Y. Tax Law §209.1(b).

17Griffith v. ConAgra Brands, Inc., 728 S.E.2d 74 (W. Va. 2012), aff'g Civ. Action No. 10-AA-02 (W. Va. Cir. Ct. 1/13/11), rev'g Admin. Dec. No. S 06-544 N (W. Va. Office of Tax App. 1/6/10), and Admin. Dec. No. S 08-286 W (W. Va. Office of Tax App. 1/8/10).

18Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).



Sarah McGahan is a senior manager, state and local tax, with KPMG LLP in Washington. Catherine Shaw Stanton is a partner and national leader–State & Local Tax with Cherry Bekaert LLP in Tysons Corner, Va. For more information about this column, contact Ms. Stanton at


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