The Evolution of State Level Business Taxes

In 1992, the US Supreme Court ruled in Quill Corp. v. North Dakota that states may not collect sales tax from retailers that do not maintain a physical presence within the state (in other words, companies without a nexus in that state). The decision involved mail-order catalog sales but would soon be applied to the rapidly rising amount of business conducted on the internet.

While consumers and online retailers have benefited from the decision, states haven’t fared as well. According to the National Conference of State Legislatures, the loss of sales tax revenue for states hovers around $23 billion annually, a massive hit for state budgets.

In direct defiance of the new federal ruling, states slowly adopted new nexus rules. Instead of looking to a company’s physical presence, states construed a new “economic nexus” and legislated a slew of new taxes.

Corporate Income Taxes in the Digital Age

States took their cue from a paper published in the National Tax Journal by Stanford University professor, Charles E. McLure, Jr. titled “Implementing State Corporate Income Taxes in the Digital Age.”

While McLure argued that state income taxes upon businesses could not be conceptually justified, they were not going “to go away.” Diverging from the Supreme Court decision in Quill, McLure reasoned that taxpayers engaging in significant economic activity that would normally create tax liabilities ought remit taxes, whether or not they maintained a physical presence in the state.

Working from this framework, the Multistate Tax Commission formed a model statute: Factor Presence Nexus Standard for Business Activity Taxes in 2002. The statute advocated that an economic nexus is created if any of the following are exceeded during a specific tax period:

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

This framework offered states a new justification for assessing business taxes in spite of the clear federal ruling made in Quill.

Rise of New State Business Taxes

In the wake of MTC model statute, states around the country began adopting new business taxes.

In 2005, Ohio became the first state to roll out a new tax—the Commercial Activity Tax—using economic nexus standards. In 2008, Michigan followed suit. In 2010, so did Washington, Connecticut, Oklahoma, and Colorado, with California doing so in 2011.

As of 2017, there are 37 states (and the District of Columbia) with what are officially known as “factor presence nexus” taxes. These go by a wide range of names:

  • Business Franchise Tax
  • Business Privilege Tax
  • Business and Occupation Tax
  • Commercial Activity Tax

The Future of State Business Tax

Currently, state level taxation is up in the air. The decisions of state governments to impose taxes based upon an economic nexus run directly against the ruling in Quill. It remains to be seen if a new nexus case will come before the Supreme Court. If it does, it will be the first nexus case the Court has heard in the modern digital era.

Another possibility is the Marketplace Fairness Act, introduced in the Senate in 2015, which would effectively allow states to impose sales taxes upon any retailers with an economic nexus. Should the Marketplace Fairness Act pass Congress, it is uncertain whether or not states with economic nexus taxes would revise their tax code or simply keep their current laws in place.