Beyond the Physical: Economic Nexus Developments

by Veronica A. Caputo, CPA, Vito A. Cosmo Jr., CPA, CGMA, Matthew D. Melinson, CPA, and Patrick K. Skeehan, JD | Dec 20, 2019

Pennsylvania CPA JournalWith the advent of economic nexus, out-of-state businesses may now be subject to a state’s taxing jurisdiction merely by selling a threshold amount of goods or services into a state, with or without a physical presence in that state.

The U.S. Supreme Court pronounced in Complete Auto Transit v. Brady that the commerce clause of the U.S. Constitution prohibits states from imposing tax on an out-of-state business unless the business has “substantial nexus” with the taxing state.1 In National Bellas Hess v. Illinois, and reaffirmed in Quill v. North Dakota,2 physical presence was required to establish substantial nexus with a taxing state with regard to sales and use taxes. Many practitioners, however, believe that the physical presence standard of Quill extends to other taxes, including state income and franchise taxes; many state courts, though, have since limited the Quill decision to just sales and use tax nexus. The South Carolina Supreme Court was among the first to do so in Geoffrey Inc. v. South Carolina,3 where it held that South Carolina could impose income tax on an out-of-state corporation with no physical presence in-state but whose trademarks were used in-state by a licensee. Since Geoffrey, other states have found that substantial nexus exists for income tax purposes where a taxpayer merely directs economic activity toward a state’s market.4

Factor Presence Nexus

A handful of states have instituted a so-called “bright-line” or “factor presence” standard, whereby an out-of-state taxpayer has nexus with a state when its receipts exceed a certain monetary threshold. In 2002, the Multistate Tax Commission (MTC) initially promulgated a model factor presence nexus statute that uses $500,000 in sales as a threshold to trigger substantial nexus. (The model statute provides for other bright-line factors, including property and payroll.) Ohio was the first to adopt a form of the statute in 2005 when it enacted the commercial activity tax (CAT), a tax based on gross receipts and not subject to the protections of Public Law 86-272.5 Ohio law provides that a nonresident has a “bright-line presence” in the state if it has $500,000 or more in Ohio gross receipts during the tax year.6 Other states have followed suit by adopting their own factor presence nexus standards, including Alabama, California, Colorado, Connecticut, Michigan, New York, Tennessee, and Washington.

State courts have had little opportunity to consider the validity of factor presence nexus until now. The Ohio Supreme Court recently heard oral arguments regarding CAT assessments sustained against three retailers who had no physical presence, agents, or representatives in the state.7 The taxpayers challenged Ohio’s factor presence nexus standard on the grounds of the commerce and due process clauses.

Substantial Nexus Redefined

Even though states have attempted to find a way around Quill’s requirement of physical presence, factor presence nexus raises significant constitutional questions. Using objective threshold amounts for substantial nexus may conflict with the concept of determining nexus on a case-by-case basis. When nexus is established merely by exceeding a sales threshold, out-of-state taxpayers are deprived of a nexus analysis that includes other factors. Further, if states eliminate an in-state activity requirement under a revised substantial nexus standard, what remains is a minimum contacts standard, which only requires that the taxpayer purposefully direct its activities toward a state’s market. The Supreme Court clearly stated in Quill that the substantial nexus requirement of the commerce clause is different from, and more exacting than, a minimum contacts analysis. A bright-line statutory standard may not fully rise to the level of substantial nexus for some.

Factor presence nexus could be challenged on due process grounds because it is an arbitrary and capricious standard. Supreme Court case law has established that de minimis taxpayer activity in a state does not trigger substantial nexus.8 But de minimis activities are not easily defined and are highly dependent on the facts and circumstances of each case. Taxpayers could potentially be subject to tax in states where they have no physical presence and a very small economic presence.

Factor presence standards may also violate the equal protection clause of the Constitution and state uniformity clauses. Often, uniformity clauses place stringent limitations on a state’s authority to classify the objects of taxation. Pennsylvania’s uniformity clause has been interpreted broadly by the Pennsylvania Supreme Court.9 State factor presence schemes provide threshold amounts, such as $500,000 of in-state sales, but if a taxpayer has $499,999 in sales, they would miss the threshold. Just one dollar separates otherwise similarly situated taxpayers.

Sales and Use Tax Nexus

As prescribed in Quill, physical presence remains the nexus standard for sales and use taxes. But it seems that some states – often without the political will for new or increased taxes – are stretching as far as possible to assert nexus. As a complement to sales tax, state use tax laws require customers to report and pay use tax on out-of-state purchases. However, states have generally done a poor job enforcing these laws, and greatly desire sales tax collection at the source by the seller as opposed to requiring use tax compliance by individual consumers. States and other groups have pressed Congress to pass a law that would override Quill and enable states to force retailers without physical presence to collect sales taxes, but Congress has failed to do so.10 Accordingly, states are trying to enact laws or policies to capture the sales tax revenues directly from remote sellers.

Many states have enacted “click-through” nexus statutes, better known as “Amazon laws,” that require out-of-state vendors to collect sales tax if an in-state affiliate refers potential customers to the vendor’s website by clicking on an Internet link. An extension of the physical presence standard, such laws were enacted to bring remote online retailers under the states’ taxing jurisdictions.

Other states have enacted laws requiring remote sellers to provide notice to their customers that use tax may be due on purchases made through the seller. For example, a Colorado law requires out-of-state sellers who do not collect sales tax from Colorado customers to notify those customers of their potential use tax liability and to file an annual customer information report with the Colorado Department of Revenue – which would essentially create a targeted audit list.11 In Direct Marketing Association v. Brohl,12 (DMA) the 10th Circuit Court of Appeals upheld the law, finding that the four-part test of Complete Auto for dormant commerce clause challenges did not apply because the facts involved a reporting requirement and not a tax. The court also determined that the scope of Quill did not extend beyond sales tax collection.

The U.S. Supreme Court weighed in on DMA before remanding to the 10th Circuit.13 Justice Anthony Kennedy indicated in a concurrence that the court may be willing to reconsider Quill should the legal system find an appropriate case. Alabama, in a clear violation of the Supreme Court’s holding in Quill, accepted this invitation by promulgating a regulation establishing economic nexus for out-of-state sellers lacking physical presence but making retail sales of tangible personal property into Alabama exceeding $250,000.14 South Dakota followed by enacting a sales tax collection and remittance requirement for any entity, including remote sellers, exceeding an annual sales threshold of $100,000 or 200 separate transactions in the state.15 Such legislation contradicts the physical presence requirement of Quill, but both Alabama and South Dakota are ready for a challenge in court. In fact, South Dakota has already filed suit to enforce the law, while opponents of the law have sued to block it. At least 13 states have introduced sales and use tax legislation capturing remote sellers so far in 2016, and 18 bills remain active in 11 states.16

Deciding whether to collect and remit sales tax can be a critical business decision, and may not be limited to a pure tax technical analysis. If businesses choose not to collect and remit tax, they run the risk of inheriting the tax liability of their customers. Conversely, should they choose to comply with constitutionally questionable laws, they risk losing business based on potential pricing disadvantages to noncomplying competitors who do not charge sales tax.


The future of economic nexus is far from certain in the areas of income/franchise tax and sales/use tax. Constitutional challenges are making their way through the courts, and more litigation is anticipated. Pennsylvania and local jurisdictions within Pennsylvania have not yet adopted an economic nexus approach for business taxes, but it is conceivable that this could eventually occur as the trend evolves. As other states enact economic nexus standards, Pennsylvania-based businesses with multistate operations should closely monitor sales activity into states where they may have nexus without having any physical presence and decide on a policy. This can be a complex process and requires not only tax technical analysis but also business, risk management, and accounting considerations.

1 430 U.S. 274 (1977).
2 386 U.S. 753 (1967) and 504 U.S. 298 (1992), respectively.
3 437 S.E.2d 13 (S.C. 1993).
4 See
Lanco Inc. v. Director, N.J. Div. of Taxation, 188 N.J. 380 (2006); Capital One Bank v. Mass. Comm. of Revenue, 899 N.E.2d 76 (Mass. 2009); and W. Va. Tax Comm. v. MBNA America Bank NA, 220 W. Va. 163 (2006).
5 P.L. 86-272 provides that a remote seller will not have nexus for state net income tax purposes if its only activity in the taxing state is the solicitation of sales of tangible personal property that are approved and fulfilled from outside the state.
6 Ohio Rev. Code Ann. Section 5751.01(I).
Crutchfield Inc. v. Testa, Ohio S. Ct., No. 2015-0386; Newegg Inc. v. Testa, Ohio S. Ct., No. 2015-0483; Mason Companies v. Testa, Ohio S. Ct., , April 20, 2015 No. 2015-0794; oral arguments May 3, 2016.
8 See
Wisconsin Dept. of Revenue v. Wrigley Co., 505 U.S. 214 (1992); Quill, 504 U.S. 298 (1992).
9 See Vito A. Cosmo Jr., Matthew D. Melinson, and Patrick K. Skeehan, “The Power Behind Pennsylvania’s Uniformity Clause,”
Pennsylvania CPA Journal, fall 2015, pgs. 8-9.
10 The U.S. Senate passed the Marketplace Fairness Act in 2013, but the bill has stalled in the House for years. Similar remote-seller bills have been introduced in the House, including the Online Sales Simplification Act and the Remote Transactions Parity Act, but they have not passed.
11 Colo. Rev. Stat. Section 39-21-112(3.5).
Direct Marketing Association v. Brohl, No. 12-1175 (10th Cir. Feb. 22, 2016).
13 Ibid., 135 S. Ct. 1124 (2015).
14 Ala. Admin. Code r. 810-6-2-.90.03.
15 S.B. 106, Laws 2016.
16 Richard Rubin, “States Set up Fight over Web Sales Tax,”
The Wall Street Journal, Feb. 23, 2016.

Veronica A. Caputo, CPA, is a state and local tax senior manager with Grant Thornton LLP in Philadelphia. She can be reached at

Vito A. Cosmo Jr., CPA, CGMA, is a managing director, state and local taxes, at Grant Thornton. He can be reached at

Matthew D. Melinson, CPA, is a partner, state and local taxes, at Grant Thornton and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at

Patrick K. Skeehan, JD, is a state and local tax senior associate with Grant Thornton. He can be reached at
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