Revised November 30, 2005
FEDERAL "BUSINESS ACTIVITY TAX NEXUS" LEGISLATION:
HALF OF A TWO-PRONGED STRATEGY TO GUT STATE CORPORATE INCOME TAXES
By
By Michael Mazerov
|
PDF of full report Categories: |
| If you cannot access the files through the links, right-click on the underlined text, click "Save Link As," download to your directory, and open the document in Adobe Acrobat Reader. |
Background and Summary
Major multistate corporations are engaged in a two-pronged strategy aimed at substantially increasing the share of their nationwide profit that is not taxed by any state. The strategy involves the enactment of complementary state and federal legislation. The state legislation — which corporations have already succeeded in enacting in 14 states and are actively seeking in close to a dozen more — is aimed at lowering the corporate taxes of in-state corporations and shifting these taxes onto out-of-state corporations. The federal legislation, which corporations have been seeking since 2000, would make it much more difficult for states to require many out-of-state corporations to pay any income tax. Together, the two changes in tax law would create a “heads I win, tails you lose” system of state corporate income taxation — with corporations the winners and state treasuries the losers.
The latest version of the federal legislation is H.R. 1956, the “Business Activity Tax Simplification Act of 2005.” Its lead sponsors are representatives Bob Goodlatte and Rick Boucher. Like its predecessors, H.R. 1956 would impose what is usually referred to as a federally-mandated “nexus” threshold for state (and local) “business activity taxes” (BATs). State taxes on corporate profits collected by 45 states and the District of Columbia are the most widely-levied state business activity taxes and are the focus of this report. (The term also encompasses such broad-based business taxes as the Michigan Single Business Tax — a form of value-added tax — and the Washington Business and Occupations Tax — a state tax on a business’ gross sales.) The “nexus” threshold is the minimum amount of activity a business must conduct in a particular state to become subject to taxation in that state.
Nexus thresholds are defined in the first instance by state law. State laws levying a tax on a business will set forth the types of activities conducted by a business within the state that obligate the business to pay some tax (which usually is proportional to the level of activity in the state). If a business engages in any of those activities within the state it is said to have “created” or “established” nexus with the state, and it therefore must pay the tax. Federal statutes can override state nexus laws, however, and H.R. 1956 proposes to do so in four key ways:
H.R. 1956 declares that a business must have a “physical presence” within a state before that jurisdiction may impose a BAT on the business. This provision would nullify many state laws that assert that a non-physically-present business establishes nexus with the state when it makes economically-significant sales to the state’s resident individuals and/or businesses. In establishing this true, “physical presence” nexus threshold, H.R. 1956 would resolve in favor of business a lingering question as to whether state laws declaring nexus to be created by sales alone are valid under the U.S. Constitution.
Under H.R. 1956, however, some businesses could have a physical presence in a state without creating nexus. The bill would create a number of nexus “safe harbors.” These are categories and quantities of clear physical presence that a corporation or other business could have in a state that nonetheless would be deemed no longer sufficient to create BAT nexus for the business. For example, the bill allows a corporation to have an unlimited amount of employees and property in a state without creating nexus, so long as neither are present in the state on more than 21 days within a particular year.
H.R. 1956 substantially expands an existing nexus “safe harbor,” federal Public Law 86-272. P.L. 86-272 provides that a corporation cannot be subjected to a state corporate income tax if its only activity within a state is “solicitation of orders” of tangible goods, followed by delivery of the goods from an out-of-state origination point. The protected “solicitation” may be conducted by advertising alone or through the use of traveling salespeople. H.R. 1956 would expand the coverage of P.L. 86-272 to the entire service sector of the economy and apply it to all types of BATs, not just income taxes.
H.R. 1956 would impose new restrictions on the ability of a state to assert BAT nexus over an out-of-state corporation based on activities conducted within its borders by a (non-employee) individual or other business acting on behalf of the out-of-state business.
In short, H.R. 1956 is intended to substantially raise the nexus threshold for corporate income taxes and other BATs — that is, to make it much more difficult for states to levy these taxes on out-of-state corporations.
The fact that state corporate income tax nexus thresholds would be raised by H.R. 1956 means that the profits of particular corporations would no longer be subject to tax in particular states. While that may raise equity concerns, it does not inherently mean that the states as a group would lose corporate income tax revenue. In fact, however, many of the same corporations pushing for the enactment of legislation like H.R. 1956 at the federal level are lobbying at the state level for complementary changes in state corporate income tax laws. These state laws would ensure that the enactment of legislation like H.R. 1956 would result in a substantial corporate tax revenue loss for states in the aggregate:
Multistate corporations are lobbying in numerous states for a switch to a so-called single sales factor apportionment formula. (They have already obtained enactment of the single sales factor formula in 14 states.) Apportionment formulas embedded in each state’s corporate income tax law determine how much of a multistate corporation’s nationwide profit is subject to tax in a state in which it does have nexus. If a corporation makes 10 percent of its sales to customers in a single sales factor state, then 10 percent of its nationwide profit will be subject to tax in that state.
Under a single sales factor formula, a corporation that produces all of its goods in a state but has all of its customers in other states will have no corporate income tax liability to the state in which it does its production. However, if this same corporation did not have nexus in its customers’ states, because the activities it conducted in those states would be deemed no longer nexus-creating under H.R. 1956, then all of this corporation’s profit would become “nowhere income” — profit not subject to tax by any state.
In reality, of course, most corporations do have at least some customers in the states in which they produce their goods and services, and even under legislation like H.R. 1956 they would often have nexus in some of the other states in which their customers are located. So most multistate corporations would continue to pay some state corporate income taxes even if legislation like H.R. 1956 were to be enacted.
Nonetheless, if the state corporate income tax nexus threshold were raised sharply by new federal legislation, and if multistate corporations continue to make progress in their campaign to get large industrial states to switch to a single sales factor formula, the two policies would interact in a way that would vastly expand the share of total nationwide corporate profit that escapes taxation entirely.
The creation of more “nowhere income” is a major goal of the multistate corporate community in seeking the enactment of bills like H.R. 1956, notwithstanding claims that the legislation is only intended to regulate which states can tax a corporation and not to affect the aggregate taxation of corporate income. The evisceration of state corporate income taxes — the source of $28 billion in annual revenue — would harm states already struggling to provide adequate education, health, and homeland security-related services.
It is not at all clear that congressional action to clarify and harmonize state BAT nexus thresholds is warranted, but if Congress is determined to act, viable alternatives to bills like H.R. 1956 are available that would do less damage to state finances. Congress could implement a proposed model nexus threshold carefully crafted by the Multistate Tax Commission, which would base the existence of BAT nexus on relatively objective measures of the amount of a corporation’s property, payroll, or sales present in a state.