Many states have been slow to change their income tax nexus rules to comply with the more aggressive sales and use tax economic nexus standard, which resulted from the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc. This is not surprising given that the dust has not yet settled for many states’ implementation of their Wayfair-like economic nexus rules on the sales and use tax side. Further, a handful of states have had income tax economic nexus rules (i.e. no in-state physical presence of the taxpayer required) for a number of years based on the position that the physical presence test only applied to sales and use tax.
States that have the clearest rules are those that have adopted economic nexus standards, which are commonly referred to as “factor-presence” or “bright-line” nexus rules. These rules include certain thresholds that, if exceeded, will result in an income tax filing obligation for the business. For example, a taxpayer located in one state can have an income tax filing obligation in another state in which the taxpayer has no presence, based solely on deriving a certain amount of revenue from customers located in that state. Notable states that held these rules prior to the Wayfair decision include California, Colorado, and New York. Still, many states either lack clear guidance or still adhere to applying a physical presence test when it comes to imposing an income tax on multistate businesses.
By Aronson’s count, the trickle of states explicitly applying the Wayfair decision to income tax so far include Hawaii and, most recently, Pennsylvania. As with most state and local tax issues, the two states have taken somewhat different approaches in implementing an economic nexus standard for income tax purposes.
Hawaii’s adoption of an economic nexus standard for income tax purposes is a result of the state’s legislature enacting Senate Bill 495, which went into effect on July 2, 2019 and applies to tax years beginning on or after January 1, 2020. It appears that the new section of Hawaii’s income tax law will be codified into the general provisions portion of the income tax chapter of the state’s statute, which means that the new rule will apply to all business taxpayers, rather than corporate taxpayers only. In terms of the substantive nexus standard, Hawaii is using the same thresholds that it adopted for sales and use tax purposes. Beginning in 2020, a business taxpayer (e.g. C corporation, S corporation, partnership) without a physical presence in Hawaii will have an income tax filing obligation if, during the current or preceding calendar year, the taxpayer either (1) engages in 200 or more business transactions with persons within the state; or has gross income from in-state sources that is equal to or exceeds $100,000.
Pennsylvania’s approach is slightly different. Instead of enacting an economic nexus standard into Pennsylvania law, the Department of Revenue merely issued a tax bulletin on September 30, 2019 explaining the impact of the Wayfair decision on income taxation. Second, the language in the bulletin strongly suggests that the Department will only initially be applying an economic nexus standard to corporate taxpayers. The bulletin provides that “[f]or Pennsylvania Corporate Net Income Tax purposes, the decision in Wayfair has confirmed that out of state corporations are considered to be doing business in this Commonwealth . . . to the extent they are taking advantage of the economic marketplace of the Commonwealth, regardless of whether they are physically present in Pennsylvania.” As a result, the Department will require such taxpayers to begin filing Corporate Tax Reports so long as they meet the minimum thresholds for nexus under the Constitution of the United States. The department has also adopted a higher sales threshold than the Commonwealth’s sales and use tax economic nexus law, which is set at $100,000. For corporate income tax purposes, the department presumes that a corporation without a physical presence in Pennsylvania has a filing requirement if the corporation has $500,000 or more of gross receipts sourced to Pennsylvania during tax year.
At the very least, multistate corporate taxpayers should add Hawaii and Pennsylvania to the list of states imposing a “factor-presence” or “bright-line” nexus rules starting with the 2020 tax year. Further, Hawaii and Pennsylvania will not be the last states to move in this direction. In fact, Texas also has a proposal to amend Rule § 3.586 to include an economic nexus test with respect to the state’s franchise tax. Thus, businesses deriving a material amounts of revenue from customers in multiples states need to monitor development across the country.
If you have questions regarding your businesses state income tax filing obligations, please contact Michael L. Colavito, Jr., or one of our tax advisors at 301.231.6200.