Texas Nexus for Franchise Tax No Longer Requires Physical Presence

Up until the beginning of this year, only Texas and Pennsylvania required a physical presence for their “income” taxes. Most states have allowed some form of economic nexus for their income tax for years. This stems from the language the U.S. Supreme Court used when they issued their opinion in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). I am paraphrasing, but the Supreme Court said that at least for sales tax, a physical presence is required. Because of this limiting language, many states and their court systems allowed an economic nexus for taxes other than sales tax. Texas is no longer a holdout as of 12/31/2019 when their new definition of nexus became effective.

Texas Implements Economic Nexus Threshold of $500,000 for Texas Franchise Tax 

Beginning with franchise tax reports due on or after 1/1/2020, any entity without a physical presence in Texas now has nexus if during any federal accounting period in 2019 or later it has gross receipts from Texas of $500,000 or more.

Until recently, any company registering for sales tax was automatically registered for the franchise tax. If you had a physical presence in Texas, there was no way to avoid having to file for the tax. However, if you voluntarily registered for sales tax or registered due to the economic nexus for sales tax, you could get out of having to file the franchise tax as you did not have a physical presence. 

That may no longer be possible. In addition to showing you don’t have a physical presence you also have to show you do not have an economic presence. So companies without a physical presence and sales of less than $500,000 may be able to get out of filing the franchise tax. However, if you have a physical presence that generally includes having inventory in the state, or if you have more than $500,000 in gross sales, you will have to file.

What About PL-86-272? Does it Protect Sellers from States Imposing an Income Tax?

PL 86-272 or the Interstate Income Act of 1959 does provide limited protection from a state’s net income tax. In order to qualify for this protection, a company can only be selling tangible personal property (TPP) in the state. It can not be offering any additional services or intangibles. In addition, all sales must be approved outside the state and all sales must be fulfilled from a point outside the state. If all three conditions are met a state may not impose a net income tax on you. For those who have inventory in a state, the protections of PL 86-272 do not apply but in most states where a company only has an economic nexus, the protections would apply.

However, Texas is not like most states. The franchise tax in Texas is not actually a net income tax, but rather a gross receipts tax. The protections of PL 86-272 only apply to a net income tax and not any other type of tax. Other states with gross receipts taxes include but are not limited to Nevada ($4 million), Ohio ($500), Oregon ($750k), and Washington ($100k). Oregon actually has a net income tax and a gross receipts tax. We expect more states to implement gross receipts taxes over the next couple of years.

If I am not Registered for Sales Tax, Income or Gross Receipts Taxes are Not an Issue

Contrary to popular belief, income tax nexus has nothing to do with sales tax. You could have a responsibility to pay income tax and not sales tax or vice versa. Or you may have a responsibility to pay both. Many clients and potential clients who ask to deregister for sales tax do not realize they may still have a responsibility to pay income tax. For example, many companies that don’t have taxable sales like those that only have sales for resale or now those that only sell through marketplaces fail to recognize they may still owe income tax.

Summary

The exposure for sales tax is generally much greater than the exposure for income tax because sales tax is generally based on sales revenue and income taxes are basically based on profits. Smaller companies generally don’t have enough exposure to be worried. However, larger companies do. My prediction is that at some point in the next two years states will become much more aggressive on the income tax side seeking larger sellers. Large Amazon FBA sellers will not be excluded from this push by states. If you or your clients have questions we have a free webinar where we compare income and sales tax nexus. Here is a link to all our free webinars. If anyone needs help figuring out where they may need to pay income tax, we suggest starting with the free webinar and if you still need help you may contact us at contact@salestaxandmore.com to learn about additional services. 

By: Michael J. Fleming, CMI

This blog is intended for educational purposes and not as tax advice. Tax policies and procedures change frequently, so specific information, such as thresholds, rates, etc. included in this blog may have changed since it was originally published. Please request a consultation for more in-depth information.