December 15, 2006

Why Large Corporations Can Do Business in Your State Tax-Free – The “Substantial Nexus” Test


The holiday season is in full swing — and chances are you’re buying gifts on the Internet or over the phone, from people you will never meet and companies that will never set foot in your state. These companies are clearly benefitting from services provided by your state government. They could not conduct their business without the roads used for deliveries and the state courts that stand ready to enforce contracts or the telephone lines that are regulated by the state. You might think it would be perfectly reasonable for these companies to pay state corporate income taxes and collect state sales taxes, to pay their share for the services they enjoy. You might then be dismayed to learn that court rulings and federal legislation restrict such state taxes and sometimes let these companies off scotfree.

The problem stems from court rulings and from Congress. The U.S. Supreme Court has found that the Constitution bars a state from requiring companies that are not “physically present” in the state to collect sales taxes from its in-state customers. The corporate income of these same companies is shielded from state taxes in some, but not all, situations under an obscure law passed by Congress decades ago. These problems can be fixed through a mixture of federal and state legislation, but some powerful interests want to move in the opposite direction. Attempts in Congress and in the courts to extend such restrictions could cost the states billions — meaning your state has less to pay for the roads and services that facilitate business as well as the schools and services that residents depend on.

Read the Full Report (PDF)