Evaluate Apportionment And Nexus Issues
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CPA Tax Compliance & Planning (TCP) › Evaluate Apportionment And Nexus Issues
Following the Supreme Court's decision in South Dakota v. Wayfair (2018), economic nexus for sales tax purposes is established when:
A seller's nationwide revenue exceeds $1 million.
A seller exceeds a state's economic nexus threshold, commonly $100,000 in sales or 200 transactions in the state - physical presence is no longer required.
A seller advertises its products in the state through any medium.
A seller has at least one employee physically working in the state.
Explanation
Wayfair eliminated the physical presence requirement for sales tax nexus - economic presence (meeting transaction or revenue thresholds) is sufficient. Answer A is correct. Physical presence (B) is no longer required. National revenue (C) is not the nexus standard. Advertising (D) alone does not establish economic nexus.
A state that uses a single sales factor apportionment formula:
Apportions income equally among all states where the business operates.
Apportions income based solely on the ratio of the taxpayer's sales attributable to the state to the taxpayer's total sales everywhere - this rewards businesses that create jobs and property in the state but sell elsewhere.
Apportions income based solely on the ratio of the taxpayer's payroll in the state to total payroll.
Only taxes businesses that have employees physically located in the state.
Explanation
Single sales factor apportionment uses only the sales ratio, which benefits companies with in-state production (property/payroll) and out-of-state sales by excluding property and payroll from the formula. Answer D is correct. Employee location (A) is a nexus issue. Payroll-only (B) describes a payroll factor formula. Equal allocation (C) ignores the actual formula.
The sales factor in state income tax apportionment is generally calculated as:
The average of the taxpayer's beginning and ending in-state accounts receivable.
The taxpayer's sales sourced to the state divided by the taxpayer's total sales everywhere.
The ratio of in-state customers to total customers.
The taxpayer's in-state sales minus returns and allowances.
Explanation
The sales factor = in-state (state-sourced) sales / total everywhere sales, expressed as a fraction. Answer A is correct. Absolute sales amount (B) is not the factor. AR averages (C) are used in property factor calculations. Customer counts (D) are not the sales factor.
Under the 'market-based sourcing' rule for services, sales are typically sourced to:
The state where the customer received the benefit of the service - regardless of where the service was performed.
The state with the highest income tax rate where the taxpayer has nexus.
The state where the service provider's headquarters are located.
The state where the service provider's employees physically performed the service.
Explanation
Market-based sourcing sources service revenue to where the customer receives the benefit - favoring businesses with out-of-state performance that serve in-state customers. Answer C is correct. Cost-of-performance (A) is the traditional alternative rule. Headquarters (B) is not the sourcing standard. Tax rate (D) is not a sourcing rule.
The 'throwback rule' in state apportionment applies when:
A sale is 'thrown back' to the state of origin (where the goods are shipped from) when the destination state has no jurisdiction to tax the seller - preventing some sales from falling out of all state apportionment formulas.
A taxpayer's property factor exceeds its payroll factor.
A taxpayer's income in a state decreases year over year.
A taxpayer has nexus in every state where it makes sales.
Explanation
The throwback rule prevents 'nowhere income' by assigning sales back to the shipping state when the seller lacks nexus in the destination state. Answer D is correct. Year-over-year changes (A) are irrelevant. Nexus everywhere (B) is the opposite situation where throwback doesn't apply. Factor comparisons (C) don't trigger throwback.
A taxpayer has the following data for State Y: property in State Y = $200,000; total property everywhere = $1,000,000; payroll in State Y = $100,000; total payroll everywhere = $500,000; sales in State Y = $300,000; total sales everywhere = $1,500,000. Using a three-factor equally weighted formula, State Y's apportionment percentage is:
23.3% - calculated as (20% + 20% + 30%) / 3.
25% - calculated as average of (20%, 20%, 30%).
30% - calculated using only the sales factor.
20% - calculated as (20% property + 20% payroll + 20% sales) / 3 = 20%.
Explanation
Property: $200K/$1M = 20%; Payroll: $100K/$500K = 20%; Sales: $300K/$1.5M = 20%. Average = (20+20+20)/3 = 20%. Answer A is correct. The sales factor is 20% ($300K/$1.5M), not 30% (B, C, D are all wrong because sales = 300/1500 = 20%).
Physical presence nexus for income tax purposes can be established by:
Holding a bank account in the state.
Having employees, independent contractors, property, or inventory in the state - any physical connection may create nexus for income tax purposes beyond P.L. 86-272 protections.
Advertising in a state through national publications or broadcast media.
Billing customers located in the state.
Explanation
Physical nexus for income tax can arise from employees, agents, property, or inventory - connections beyond protected solicitation activities under P.L. 86-272. Answer C is correct. Advertising (A), billing customers (B), and bank accounts (D) generally do not create physical nexus.
A state requires combined reporting for unitary businesses. 'Combined reporting' requires:
Only the parent corporation to report all income of subsidiaries.
Each member of a corporate group to file separate state returns reporting only their own income.
Members of a unitary business group to combine their income and factors into a single apportionment calculation - eliminating intercompany transactions and income shifting within the unitary group.
All members of an affiliated group to file one combined state return based on federal consolidated taxable income.
Explanation
Combined reporting eliminates tax avoidance through intercompany transactions by treating the unitary group as a single entity for apportionment purposes. Answer D is correct. Separate filing (A) allows income shifting combined reporting prevents. Combined reporting is based on unitary income, not consolidated federal income (B). Only parent reporting (C) doesn't capture the unitary concept.
Economic nexus standards for state income tax purposes (separate from sales tax Wayfair thresholds) typically arise when:
A business earns at least 10% of its total revenue from in-state customers.
A business exceeds a state's statutory or regulatory economic presence threshold - common thresholds include $50,000 to $500,000 of in-state sales or revenue, even without physical presence.
A business has any customers located in the state.
A business is registered to do business in the state.
Explanation
Many states have enacted economic nexus standards for income tax that set minimum revenue thresholds, creating nexus without physical presence following Wayfair. Answer A is correct. Any customer (B) is too broad. A 10% threshold (C) is not a standard threshold. Business registration (D) creates nexus but is not the economic nexus standard.
A business sells software as a service (SaaS) to customers in multiple states. Under market-based sourcing, the revenue from each SaaS subscription would be sourced to:
The state where the customer uses (receives the benefit of) the software - typically the customer's location.
The state where the company's servers hosting the software are located.
Equally allocated among all states where the company has nexus.
The state where the software was developed.
Explanation
Market-based sourcing assigns SaaS revenue to where the customer accesses and uses the service - the customer's location. Answer B is correct. Server location (A) is the cost-of-performance approach, not market-based. Development state (C) is not the sourcing rule. Equal allocation (D) is not the standard.