Revised December 22, 2005

By Michael Mazerov

PDF of this report

All Reports by Date

Federal Limits on State Tax Authority

State Fiscal Policy

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

A bill under consideration in the U.S. House of Representatives would strip states of authority they currently have to tax a fair share of the profits of many corporations that are based out of state but do business within their borders.  H.R. 1956, the “Business Activity Tax Simplification Act of 2005,” was introduced in April 2005 by Representatives Bob Goodlatte and Rick Boucher.[i]  The bill was approved (with minor amendments) by the Subcommittee on Administrative and Commercial Law of the Judiciary Committee on December 13, 2005.  The National Governors Association has estimated that states could lose $4.7 billion to $8.0 billion annually if this bill is enacted.[ii]

What the Bill Does

H.R. 1956 would impose what is usually referred to as a federally-mandated “nexus” threshold for state (and local) “business activity taxes” (BATs).[iii]  State taxes on corporate profits are the most widely-levied state business activity taxes.  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 firm’s 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 governing business taxation will set forth the types of activities conducted by a business within the state that obligate the business to pay the tax.  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 on its in-state activities.  Federal statutes can override state nexus laws, however, and H.R. 1956 proposes to do so in four key ways:

Why the Claim of a “Negligible” State Revenue Loss Is False

A previously-issued Center on Budget and Policy Priorities report explains why and how these new restrictions on the authority of states to impose taxes on many out-of-state corporations would directly reduce state BAT revenues and open up broad new opportunities for corporations to avoid paying state taxes on a large share of their profits.  (See: Michael Mazerov, Proposed "Business Activity Tax Nexus" Legislation Would Seriously Undermine State Taxes on Corporate Profits and Harm the Economy, May 9, 2005,  Hereafter referred to as “the Center analysis of H.R. 1956.”)  As noted, the National Governors Association has estimated that the enactment of H.R. 1956 would lead to state revenue losses of between $4.7 billion and $8.0 billion annually. 

Proponents of H.R. 1956 vehemently dispute these analyses.  They claim that H.R. 1956 would not — and is not intended to — reduce the aggregate amount of business activity taxes corporations pay to the 50 states collectively.

Underlying the claim that the enactment of H.R. 1956 would have no more than a “negligible” revenue impact on the states are a number of more specific assertions.  These have been laid out in the greatest detail by the “Coalition for Rational and Fair Taxation” (CRAFT), which has been organized to lobby for the enactment of federal BAT nexus legislation.[v]  These assertions — and their rebuttals— are as follows: 

H.R. 1956 is intended to — and would— block states from taxing the profits of many corporations they are now taxing.  While in theory state laws could be rewritten both to ensure that these no-longer-taxable profits are taxed by other states and to nullify many of the various tax sheltering opportunities the bill would open up, the business community has an excellent track record in stopping state efforts to close corporate tax loopholes.  There is little doubt that the overall effect of H.R. 1956 would be to reduce significantly the aggregate amount of business activity taxes that corporations pay to the states collectively.

End Notes:

[i] No Senate counterpart to H.R. 1956 has been introduced.

[ii] National Governors Association, Impact of H.R. 1956, Business Activity Tax Simplification Act of 2005, On States, September 26, 2005,

[iii] H.R. 1956 applies equally to BATs imposed by local governments.  This paper generally refers to states alone, however, because most of the discussion in it is applicable to corporate income taxes.  Corporate income taxes are not commonly imposed by local governments, with the prominent exceptions of New York City and the District of Columbia.

[iv] One of the amendments adopted in the subcommittee mark-up clarifies that the 21-day limit applies to employees and property combined.  In other words, a corporation that had employees in a state on 15 days and property in the state on an additional 10 days would be outside the 21 day limit; a state would not be barred from asserting nexus over the company.  As discussed in the previously-published Center analysis of H.R. 1956, however, such a provision is largely meaningless because a corporation that wished to have employees in a state for 15 days and property in the state for 10 more without establishing nexus could easily incorporate a separate subsidiary to be the nominal owner of the property.  In that event, neither corporation would exceed the 21-day limit.  The limit applies separately to each separately-incorporated subsidiary in a group of commonly-owned and commonly-controlled corporations.

[v] Letter dated September 27, 2005 from Arthur Rosen on behalf of the Coalition for Rational and Fair Taxation in support of H.R. 1956 to the Chairman of the Subcommittee on Commercial and Administrative Law, House Judiciary Committee.  Hereafter referred to as the “CRAFT Statement.”

[vi] Proponents of H.R. 1956, including CRAFT, frequently characterize the entire bill as doing nothing more than establishing a “physical presence” nexus standard.  That characterization is misleading.  A physical presence nexus standard would mean that if a corporation had no physical presence in a state it would not be taxable there, and if it had a physical presence it would be taxable.  In contrast, H.R. 1956 provides several new “safe harbors” that would allow a corporation to have substantial physical presence in a state without creating nexus, and it also preserves Public Law 86-272, which allows a corporation to have sales and delivery personnel in a state without creating nexus.  Nonetheless, the quoted language is one provision of H.R. 1956, and — operating independently of the rest of the bill — it would establish a “physical presence” standard.  That is why it is referred to in this section as the “true” physical presence threshold in the bill.

[vii] See: Affidavit of Thomas K. Condon, Massachusetts Department of Revenue, in the case of Prime Receivables Corporation v. Alan LeBovidge, dated December 3, 2003.  This document indicates that a number of large multistate banks with customers in Massachusetts but no direct physical presence there dropped their challenges to the state’s bank income tax, which asserts that nexus is established if out-of-state financial institutions have a significant number of Massachusetts-resident customers.  See the longer discussion on pp. 6-7 of this report.

[viii] See: Michael Mazerov, Federal "Business Activity Tax Nexus" Legislation: Half of A Two-Pronged Strategy To Gut State Corporate Income Taxes, Center on Budget and Policy Priorities, Revised November 30, 2005.