How Wayfair Affects Income Tax Nexus

The 2018 Supreme Court decision in South Dakota v. Wayfair is widely known for revolutionizing sales tax obligations for remote sellers. Its influence did not stop there. The core legal principle of the case, allowing a state to tax a business based on its economic connection rather than its physical location, is now being extended by states to corporate income tax. This creates new tax responsibilities for companies with a significant online presence or a customer base spread across many states. For businesses that have long operated assuming they only need to pay income tax where they have offices or employees, this shift is a fundamental change. The principles from a sales tax case are now creating novel income tax liabilities.

The Shift to Economic Nexus for Income Tax

For decades, the standard for whether a state could impose an income tax on a business was based on “physical presence.” This meant a company had to have a tangible footprint within a state’s borders, such as offices, warehouses, or employees, to establish the necessary connection, or “nexus.” If a company had no property or personnel in a state, it did not have an income tax filing requirement there.

The Wayfair decision dismantled this traditional standard for sales tax purposes. The Supreme Court ruled that a business could have a substantial connection with a state based purely on its economic activity, even without a single office or employee there. This concept, known as “economic nexus,” links a tax obligation to a specific level of economic engagement, such as generating a certain amount of sales revenue or conducting a high volume of transactions within a state.

Following this ruling, many states began applying the same logic to corporate income tax. State revenue departments argue that if a company systematically exploits a state’s market to generate revenue, it has established a sufficient economic connection to be subject to that state’s income tax. This interpretation means a business could owe income tax in another state simply by selling its products or services to customers there, provided its sales exceed certain thresholds.

This change has profound implications, especially for e-commerce companies, software-as-a-service (SaaS) providers, and other businesses that serve a national customer base remotely. Previously, these businesses might have only filed income tax returns in their home state. Now, they face potential income tax liabilities in every state where they have a significant economic connection, forcing a complete re-evaluation of their tax posture and compliance processes.

Federal Protections and Their Limits

A federal law, Public Law 86-272, has historically shielded some businesses from state income taxes. Enacted in 1959, this law prohibits a state from imposing a net income tax on a business if its only activity within that state is the solicitation of orders for tangible personal property. For this protection to apply, the solicited orders must be sent outside the state for approval, and if approved, the goods must be filled by shipment from a point outside the state. Any activity that exceeds this “mere solicitation” standard, such as performing in-state repairs or maintaining an office, can break this federal immunity.

The limitations of this federal law are significant in the context of economic nexus. P.L. 86-272 offers no protection to businesses that sell services or intangible property, such as digital downloads or software subscriptions. Furthermore, the law only applies to net income taxes; it does not prevent states from imposing other types of taxes, such as franchise or gross receipts taxes. A major area of contention today is how P.L. 86-272 applies to modern internet-based activities. Some states argue that online interactions like placing tracking cookies, offering extensive pre-sale assistance through a website’s chat function, or providing post-sale support through an online portal could be interpreted as in-state business activities that nullify the law’s protections.

State-Specific Income Tax Nexus Thresholds

In the wake of the Wayfair decision, numerous states have formally adopted economic nexus standards for corporate income tax, each with specific thresholds. These thresholds are typically based on the volume of a company’s economic activity within the state during a tax year. A common model has emerged, often mirroring the sales tax nexus standard of $100,000 in sales or 200 separate transactions.

Several states have established bright-line factor-presence nexus standards that include specific thresholds for property, payroll, and sales. For example, a state might assert nexus if a company has more than $50,000 of property, $50,000 of payroll, or $500,000 of sales within its borders. In many of these states, exceeding just one of these thresholds is sufficient to create an income tax obligation.

Other states have adopted a sales-only threshold, creating a more direct link to the Wayfair precedent. In these jurisdictions, a remote company may trigger income tax nexus if its gross receipts from in-state customers exceed a set amount, such as $100,000 or $250,000. This approach simplifies the nexus determination but expands the reach of the state’s taxing power.

Determining and Managing Your Income Tax Nexus

Information Gathering and Analysis

The first step in managing economic nexus for income tax is to conduct a thorough internal analysis, often called a nexus study. This process begins with gathering detailed, state-by-state financial data, showing gross sales revenue and the total number of transactions in each jurisdiction. This data is the foundation for comparing the company’s activities against the specific economic thresholds established by each state.

Beyond sales and transaction counts, a company needs to create a comprehensive inventory of all its business activities on a state-by-state basis. This includes documenting any property, whether owned or leased, and tracking the location of all employees, including remote workers. For businesses with a significant online presence, this review must include an assessment of web-based interactions, such as the use of cookies or customer support chat logs, as these can be interpreted as in-state activities by some tax authorities.

Compliance Actions

After determining that income tax nexus exists in one or more new states, a business must take specific procedural steps to become compliant. The immediate action is to register with the appropriate state agency, typically the Department of Revenue. This process usually involves completing an online application to obtain a state tax identification number and formally establish the business as a taxpayer.

With nexus established, the company must then understand how to calculate its tax liability in each state. This involves apportionment, which is the method used to divide the company’s total taxable income among the states where it has nexus. Most states have shifted to a single-sales factor apportionment formula. The business must then prepare and file the required state corporate income tax returns by the specified deadlines and address any potential back-tax liabilities for prior years.