Revised November 30, 2005


By By Michael Mazerov

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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:

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:

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.

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