Watson CPA Group - Knowledgebase


Physical and Economic Presence, Nexus Attached

Article ID: 378
Last updated: 23 Nov, 2018
Revision: 1
print  Print
share  Share
comment  Add comment
Views: 0
Comments: 0

By Jason Watson ()
Posted November 23, 2018

In a 1992 U.S. Supreme Court case docketed as Quill Corporation v. North Dakota, the court established a physical presence test for sales tax nexus. The court did not address income tax, and since this decision states have varied quite a bit on attaching nexus to taxes other than sales and use tax.

Several appellate courts have limited the Quill case to sales and use tax nexus, and have deferred income tax nexus to economic presence rather than physical presence. According to Bloomberg’s Multi State Survey from 2015, only 7 states applied the physical presence test in determine an income tax nexus leaving 43 states to apply an economic presence test for income tax nexus. That was 2015 and prior to the Wayfair case.

Let’s consider California’s economic presence rules. A business is considered doing business in California under Revenue and Taxation Code Section 23101 (enacted in 2011) if it meets any of the following conditions-

  • They have sales in California, in the amount of $500,000 or 25% of total sales, whichever is less.

  • They have property in California, with a value of $50,000 or 25% of total property, whichever is less.

  • They have payroll in California, in the amount of $50,000 or 25% of total payroll, whichever is less.

California’s numbers above are a bit out dated since they are annually adjusted for inflation. According to their website as of this writing, they state, “For taxable years beginning on or after 1/1/2016, the amounts are $547,711, $54,771 and $54,771, respectively.”

These hard numbers are called bright-line nexus. You simply meet a numeric threshold, and you magically have nexus in that state. Several states have a preponderance of the evidence set of rules using phrases such as “businesses earning significant income.” Really!? Sounds like fun trying to defend that.

More bad news. Your business might not have income associated with California but be deemed as doing business in California. Seriously! And, in this case you would be subjected to the $800 minimum franchise tax regardless. Yuck.

Here is the direct language from California’s Franchise Tax Board website-

An out-of-state taxpayer that has less than the threshold amounts of property, payroll, and sales in California may still be considered doing business in California if the taxpayer actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California.

Partnership A, an out-of-state partnership, has employees who work out of their homes in California. The employees sell and provide warranty work to California customers. Partnership A's property, payroll, and sales in California fall below the threshold amounts. Is Partnership A considered to be doing business in California?

Yes. Partnership A is considered doing business in California even if the property, payroll, and sales in California fall below the threshold amounts. Partnership A is considered doing business in California through its employees because those employees are actively engaging in transactions for profit on behalf of Partnership A.

Corporation B, an out-of-state corporation, has $100,000 in total property, $200,000 in total payroll, $1,000,000 in total sales, of which $400,000 was sales to California customers. Corporation B has no property or payroll in California. Is Corporation B doing business in California?

Yes. Although Corporation B's California sales is less than the $500,000 threshold, Corporation B's California sales is 40 percent of its total sales which exceeds 25 percent of the corporation's total sales ($400,000 ÷ 1,000,000 = 40%.)

And to make matters worse, your business might be protected by Public Law 86-272 if you are simply soliciting orders for tangible personal property in California. But if you are selling services in California, even with independent contractors, there is no protection and the income will be taxed if you meet one of the three criteria above.

More direct language from California's FTB Publication 1050-

PL 86-272 still applies to sellers of tangible personal property. As a result, if a taxpayer's activities in California stay within the protections of PL 86-272, a taxpayer also remains protected from the imposition of those taxes that are computed based on net income, namely, the California franchise and income tax. Nevertheless, if a taxpayer is considered doing business in California either under R&TC Section 23101(a) or (b), it still has a filing requirement and will be subject to the minimum tax, because that tax is not computed based on net income and therefore is not subject to the protections of PL 86-272.

Corporation C, an out-of-state corporation, is a seller of tangible goods over the internet and qualifies for protection under PL 86-272. For taxable year 2011, Corporation C has $1,000,000 of sales but no property or payroll in California. Is Corporation C considered doing business in California?

Yes. Corporation C is considered doing business in California because it has sales of $1,000,000 in California. Therefore, Corporation C must file a California return to pay the minimum tax. However, since Corporation C is protected under PL 86-272, it will not be subject to California franchise tax.

Corporation D, an out-of-state corporation with no property or payroll in California, is a service provider that has sales of $2,000,000 to purchasers who receive the benefit of Corporation D’s services in California. Those services are from income-producing activity that is performed outside of California and Corporation D uses the four-factor formula (property, payroll, and double-weighted sales) to apportion its income to California. As a result, none of Corporation D's income is apportioned to California. Is Corporation D considered doing business in California?

Yes. Sales of services and intangibles are sourced under R&TC 25136(b) for purposes of applying the doing business test of R&TC 23101(b) regardless of whether those sales are sourced under R&TC 25136(a) for income apportionment purposes (that is, regardless of whether taxpayer elects single sales factor apportionment). Accordingly, Corporation D is considered doing business in California because it has sales of services here of $2,000,000. Although Corporation D has no California source income, it is still liable for the minimum tax because it is doing business here. PL 86-272 does not protect the taxpayer, because it does not apply to service providers, nor does it protect against the minimum tax (because that tax is not income-based).

California is a fun state to research since they are usually on the forefront of legislative changes and updates, and there is so much economic activity. The following link is California’s FTB1050 (updated 2017) where they outline in plain language a list of protected activities and unprotected activities as they relate to Public Law 86-272 (tangible personal property).


There are 50 other examples aside from California (including Washington DC and New York City). Please do the homework!

Some more fodder for your consideration. In two U.S. Supreme Court cases, Scripto v. Carson (1960) and Tyler Pipe v. Washington Department of Revenue (1987), the court affirmed that a third-party can create nexus. The court specifically stated what matters

“is whether the activities performed in the state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for the sales.”

This third-party connection is detrimental to Amazon and eBay retailers (and the like) and discussed in more detail later.

Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition
This KB article is an excerpt from our book which is available in paperback from Amazon, as an eBook for Kindle and as a PDF from ClickBank. We used to publish with iTunes and Nook, but keeping up with two different formats was brutal. You can cruise through these KB articles, click on the fancy buttons below or visit our webpage which provides more information at-

$24.95 $17.95 $12.95


This article was:   Helpful | Not helpful Report an issue

Prev     Next
Sales and Use Tax, Income Tax       Wayfair Case Part 2