By Vito A. Cosmo Jr., CPA, CGMA | Grant Thornton LLP

Your company just received a “nexus questionnaire” from the state of California. What should you do? And what exactly is “nexus” anyway?

First, by all means, do not let your sales department handle the inquiry! You will understand why after reading this article. Nexus is a fancy word that means that you have a definite link or a minimum connection to a state, which gives that state the jurisdiction to subject your company to one or more of its taxes. Why would a state make this claim? Because states maintain that sales made into a state are assured by that state providing a stable marketplace. For example, if you send employees into the state to solicit business, the state provides police and fire protection and a safe infrastructure for your trucks. These, and other, services need funding. It just so happens that it has become politically expedient to tax a company from out of state that does not vote.

For decades a “physical presence,” such as employees entering the state to meet with customers or company trucks making deliveries, was required before a state could impose taxes such as sales and use tax and corporation income tax.

In recent years, states have begun asserting nexus merely if a company makes sales in the state. Known as “economic nexus,” this theory takes into account that an economic benefit was derived from within the state.

As a result, several states assert that a physical presence is still required for the collection of sales and use tax but not for income tax. The last U.S. Supreme Court decision on the matter, they say, was the Quill case, which was specifically a sales tax case. However, many state and local tax scholars say that nexus is not a tax concept, but rather a jurisdiction concept that cannot be bifurcated along tax types.

Many have asked Congress to address this bifurcation because it has the power to do so under the commerce clause of the U.S. Constitution. In fact, Congress exercised its commerce clause powers in 1959 to pass Public Law 86-272. This law provides companies with an exemption from income tax, and only income tax, if their activities are limited to the solicitation or orders for sales of tangible personal property if those orders are not approved in state and the property is filled, shipped, or delivered from a location outside the state.

With this knowledge, let’s look again at that nexus questionnaire. It must be carefully and thoughtfully addressed. Full knowledge of your activities in California is essential. Read each question very carefully. Answer them succinctly and honestly. Do not elaborate or provide information not requested. Be cognizant that some states write these questionnaires to serve as a type of trap. Therefore, it is imperative that a knowledgeable CPA is consulted. For instance, you may indeed have facts that fit within the Public Law 86-272 immunity. The sales department won’t understand that nuance. As good, performance-driven professionals, they will assert that the company has done everything under the sun in California, including saving its water crisis! Don’t go there.

Vito A. Cosmo Jr., CPA, CGMA, is a managing director, state and local taxes, at Grant Thornton LLP in Philadelphia. He can be reached at vito.cosmo@us.gt.com.