State Insecurity

Faced with alarming budget shortfalls, states are pursuing corporate tax dollars in new and aggressive ways.

State tax officials are reportedly growing more litigious as well. State revenue departments “have moved from seeking the right outcome to using their power to maximize revenue from taxpayers by pushing (or threatening to push) every matter to litigation,” says one survey respondent from a $5 billion communications company.

State courts, for their part, seem quite receptive to aggressive tax collection. In one 2010 decision in which it found against fast-food chain KFC, the Iowa Supreme Court noted that “state supreme courts are inherently more sympathetic to robust taxing powers of states than is the U.S. Supreme Court.” Unfortunately for corporations, the high court has recently showed little interest in hearing such cases.

Nexus Nightmares

No issue involving corporate taxpayers is more contested than the matter of what constitutes nexus. Tax authorities appear to be growing bolder about pursuing companies on the basis of sales, rather than physical presence. New York, California, Massachusetts, New Jersey, and Michigan were ranked by survey respondents as the most aggressive states in terms of “asserting nexus positions for corporate income tax over corporations with only an economic presence in a state.”

To assert so-called economic nexus is in itself an aggressive posture, since until quite recently states limited themselves to collecting sales taxes from companies that had established a physical presence in the state. But the Iowa Supreme Court, in the KFC case, and the Washington Supreme Court, in a case involving Lamtec, a Pennsylvania-based manufacturer of industrial materials, found in two separate recent decisions that there was no such necessity.

“In both cases, out-of-state corporations that had no physical presence in the host [state] were judged to be subject to tax nevertheless. I think that’s a big problem,” says Willens. Connecticut also implemented a broad version of the economic nexus standard in January 2010.

The basis for economic nexus may indeed be growing more tangential. The Iowa high court upheld the finding that KFC should be taxed on the basis that it licensed its trademark to independent franchise restaurants in Iowa and was collecting royalties as a result of its trademark. Most alarmingly, tax attorneys say, KFC will have to pay income taxes in Iowa. That represents a significantly more aggressive stance than previous assertions of nexus, which merely required companies to collect sales taxes from their customers.

This past January, the Washington Supreme Court chimed in on the nexus issue, ruling that Lamtec, which sells its wares via telephone, had nexus in the state. The court ruled that the company would be required to pay the state’s business and occupation tax (a tax on the company’s gross receipts, rather than its profits), interest, and penalties.

The court’s reasoning: about two or three times a year, a few Lamtec sales employees visit customers in Washington to answer questions and provide information about the company’s products. Willens calls such activity “a pretty tenuous connection” for establishing nexus.


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