Corporate Close-Up: Alabama Adopts MTC’s Factor-Presence Nexus Standard; Questions Remain for Future of Controversial Bright-Line Threshold

As first reported by Chris Marr in the Daily Tax Report, Alabama adopted a factor-presence nexus standard on August 11th. For tax years beginning after Dec. 31, 2014, out-of-state taxpayers doing business in the state will be considered to have substantial nexus in Alabama if they exceed any of the dollar thresholds: $50,000 of property, payroll or $500,000 of sales in the state or where the value of property, payroll or sales in Alabama exceeds 25% of the total.

The legislation adopts the MTC model, virtually in its entirety, including detailed rules for determining the value of in-state sales and property for purposes of calculating the threshold amount. Though many of these rules appear to mirror Alabama’s general sourcing provisions, taxpayers should be aware of the differences in the sourcing rules for services and intangibles. 

Alabama’s factor presence legislation effectively employs cascading, market-based sourcing rules for determining whether receipts from services and intangibles count towards the $500,000 threshold. A receipt will count if is for the sale, lease or license of a service, intangible or digital product for primary use by a purchaser known by the taxpayer to be in Alabama. 

If the taxpayer does not know where the purchaser will use or receive the service or intangible, then the receipt must be assigned to the customer’s address reflected in the taxpayer’s business records. If that is not known by the taxpayer, then the receipt is sourced to the state of the customer’s billing address or address used in the consummation of the purchase.

In contrast, and as reported by Andrew Ballard in the Daily Tax Report, Tennessee adopted factor presence nexus in May as part of a larger package of tax reforms that included market-based sourcing and triple-weighted sales factor. Apart from the $500,000 and $50,000 dollar thresholds, Tennessee’s factor presence legislation was not based on the MTC model statute. 

It is interesting to note that it has been these two Southern, separate filing states that have had legislatures who enacted factor presence. In Alabama, factor presence nexus was passed largely in the alternative to mandatory unitary combined reporting. 

The need for revenue raisers to plug significant budget gaps in the last legislative cycles was met by strong opposition to combined reporting from the business community in both states. Bruce Ely, quoted in Chris Marr’s August 17th article on Alabama’s factor presence legislation, stated that the business community was “…far more concerned about the combined reporting bill this year.”

In general, factor presence nexus was never as widely adopted as states and some practitioners anticipated. Following the promulgation of the MTC model statute in 2002 and prior to Alabama and Tennessee’s recent legislation, only five states (California, Colorado, New York, Ohio and Washington) have, even partially, adopted factor presence nexus.

However, with California’s adoption in 2011 and New York’s receipts threshold adopted in 2014, expect more states to move towards a bright-line test in the coming legislative cycles. Amongst the reasons that adoption of the standard has been slow are lingering concerns about the constitutionality of factor presence. 

As noted in the Bloomberg BNA 2015 Survey of State Tax Departments, taxpayers and states are monitoring litigation in Ohio on the constitutionality of factor presence nexus in two cases before the Supreme Court of Ohio: Newegg and Crutchfield. It may be that factor-presence does not significantly expand until there is a ruling or denial of cert from the Supreme Court on the issue.

Either way, in a legislative environment in which adoption of combined reporting is combatted fiercely by corporate taxpayers, factor-presence nexus may be a manageable fix for legislatures desperate to pull in more corporate tax revenue.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: does Alabama and Tennessee’s recent adoption of factor presence nexus signal a new era for nexus standards or will factor presence eventually be found unconstitutional? 

Additional discussion of nexus standards for corporate income taxes can be found in Bloomberg BNA's State Tax Portfolios: 1400-2nd T.M., Federal Constitutional Limitations on State Taxation and 1410-2nd T.M., Limitations on States’ Jurisdiction to Impose Net Income Based Taxes.

by Christopher Bailey