State Tax Nexus - a Changing Environment

1. State Tax Nexus - a Changing Environment May 7, 2012

2. Who We Are CliftonLarsonAllen is a professional services firm that provides over 100 audits annually for our higher education clients. We have been serving the higher education industry for 35 years and have a dedicated staff of over 60 professionals nationwide serving higher education clients. Our services include: Audit and Attestation Tax Preparation, Planning, and Consulting Internal Audit Accounting Outsourcing Pension Plan Compliance and Auditing Financial Advisory Services Other Consulting Services

3. Learning Objectives At the end of this learning session, you will be able to: Understand some of the complexities related to State and Local Tax Nexus Understand the implications of economic nexus for providers of higher education - bright line standards - nuances in the application of these rules Be aware of the latest developments related to nexus

4. Nexus and Expanded Powers of the State Nexus is the amount and degree of business activity that must be present before a state can tax an entity’s income

5. Nexus and Expanded Powers of the State Nexus standards vary by tax type Sales tax – Physical presence Income tax – Physical presence or economic presence Franchise tax – Physical presence States are testing the waters and expanding their nexus provisions to subject companies selling into their states to tax

6. What is Economic Nexus? Economic Nexus generally is created by the purposeful direction at a market with significant sales or benefits derived by these activities

7. What is Economic Nexus? Originated from tax planning that shifted profits to tax havens using intangible holding companies Does not require physical presence in the state Each state’s definition varies Standards generally include broad language but to date have only been tested for very specific types of activities such as financial related activities or licensing of intangibles Today the majority of states do include some type of economic nexus language in their nexus or “doing business” statute

8. Economic Nexus Only 3 states require physical presence for income tax nexus Only 7 states do not include some type of “economic presence standard” in their statutory definition of income tax nexus 7 states have factor based or bright line nexus standards Example: Nexus created if; In state sales > $X, or in state sales > X% of total sales, In state property > $X, or in state property > X% of total property, and/or In state payroll > $X, or in state payroll > X% of total payroll States include: California, Colorado, Connecticut, Michigan, Ohio, Oklahoma (franchise tax only) and Virginia (Washington B&O also has bright line rules for service providers only) States moving toward a nexus standard that is easier to identify. Easier to make connection sufficient to allow a state to tax income of businessStates moving toward a nexus standard that is easier to identify. Easier to make connection sufficient to allow a state to tax income of business

9. California Economic Nexus Standard Beginning 1/1/11 a taxpayer is considered ”doing business” in California if any of the following conditions are satisfied: Taxpayer is actively engaging in any transaction in California for the purpose of financial or pecuniary gain or profit It is organized or commercially domiciled in California Its sales in California exceed the lesser of $500,000 (based on market sourcing) or 25% of the taxpayer’s total sales or Its real property and tangible personal property in California exceed the lesser of $50,000 or 25% of the taxpayer's total real property and tangible personal property Its California payroll exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer

10. Colorado Economic Nexus Standard

11. Connecticut Economic Nexus Standard Beginning on or after 1/1/10 any corporation, partnership or S corporation deriving income from Connecticut sources or that has substantial economic presence in the state, without regard to physical presence, will be liable for Connecticut income taxes Economic presence is evidenced by the purposeful direction of busness toward Connecticut, examined with regard to the frequency, quantity and systematic nature of the company’s economic contacts with the state

12. Connecticut – Economic Nexus A bright line test was established to determine if the frequency, quantity and systematic nature of the contacts results in nexus. Test consists of the following: If receipts from Connecticut sources are less than $500,000 then Company will be deemed to not have nexus with the State Income arriving from passive investment activity will not create economic nexus Licensing of intangible property if the licensor derives receipts in excess of $500,000 under the license agreement with the licensee corporation will result in nexus. Transactions with related members (other than licensing activity) will not create nexus. Public Law 86-272 will still provide protection to businesses that have economic nexus

13. Michigan Nexus Guidance – Corporate Income Tax Effective January 1, 2012 Michigan Business Tax will be replaced by a Corporate Income Tax (on C-Corporations only). The Corporate Income Tax is imposed on taxpayers with business activity within Michigan or that have an ownership interest or beneficial interest in a flow-through entity that has business activity in Michigan. Public Law 86-272 protection applies if applicable. Business activity means the transfer of legal or equitable title to or rental of property, whether real, personal, or mixed, tangible or intangible, or the performance of services, or a combination thereof, made or engaged in, or caused to be made or engaged in, whether in intrastate, interstate, or foreign commerce, with the object of gain, benefit, or advantage, whether direct or indirect, to the taxpayer or to others.

14. Michigan Nexus Guidance – Corporate Income Tax – Bright Line Test Substantial Nexus – A taxpayer has substantial nexus in Michigan and is subject to the Corporate Income Tax if the taxpayer: Has physical presence in the State for a period of more than one day during the tax year. If the taxpayer actively solicits sales in Michigan Has gross receipts of $350,000 or more sourced to Michigan or If the taxpayer has an ownership interest or a beneficial interest in a flow-through entity, directly, or indirectly through one or more other flow-through entities, that have substantial nexus in Michigan.

15. Ohio Nexus Guidance – Commercial Activities Tax – Bright Line Test A taxpayer has “bright-line” presence in Ohio if the taxpayer has any of the following: property in the state with a value of at least $50,000; payroll in Ohio of at least $50,000; taxable gross receipts of at least $500,000; at least 25 percent of its total property, payroll or gross receipts in the state; or is domiciled in Ohio

16. Virginia Nexus Guidance – Corporate Income Tax – Bright Line Test Virginia Code § 58.1-400 imposes an income tax “on the Virginia taxable income for each taxable year of every corporation organized under the laws of the Commonwealth and every foreign corporation having income from Virginia sources.” Generally, a corporation will have income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the applicable apportionment factors positive. The existence of positive Virginia apportionment factors clearly establishes income from Virginia sources.

17. Practical Considerations State sourcing rules will vary with 2 general approaches: Cost of performance or Market Generally holding an ownership interest in an entity doing business in a state creates nexus. Factors may flow through for factor presence (“bright line”) tests Being registered with the secretary of state or other licensing agency within a state often is considered “doing business” and will require a filing Review answers to nexus questionnaires carefully before responding What entities are impacted by these expanded nexus provisions?

18. Amazon Law and Impact on E-Commerce Originated in New York. Internet retailers are considered vendors if the seller enters into agreements with New York residents for a commission or other consideration under which they directly or indirectly refer potential customers (“click thru nexus”) As of October, 2011 - 7 states had enacted Amazon laws

19. Amazon Responds Amazon, Overstock and other online sellers severed relationships with affiliate online sellers located in states that enacted expanded nexus provisions Most recently Amazon has negotiated deals with California and other states to defer effective date of legislation to allow for federal legislation SALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers' Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contractSALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers' Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contract

20. Federal Legislation Federal Proposals The Main Street Fairness Act (H.R.2701 and S.1452 (112th Congress) The Marketplace Equity Act of 2011 (H.R.3179) (112th Congress) The Marketplace Fairness Act (S.1832)(112th Congress) (supported by Amazon and California) Resolutions on Small Business (S.Res.309)(H.Res.95) SALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers's Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contractSALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers's Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contract

21. What Impact Does this Have on Income Tax? States have broad nexus statutes already in place that are not being enforced States will be empowered Focus will no longer be on sales tax Budgetary shortfalls are expected to continue Additional information will be available as to who is selling into the state and the volume of sales SALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers's Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contractSALES AND USE TAX—"Amazon" law creates nexus safe harbor. L. 2011, S36, effective 06/08/2011, provides that owning or using a distribution facility in South Carolina will not be used to determine whether a person has a physical presence in South Carolina sufficient to establish nexus for sales and use tax purposes. Owning or using a facility includes leasing, or utilizing a distribution facility, including a distribution facility of a third party. “Distribution facility” means an establishment where shipments of tangible personal property are stored and processed for delivery to customers and no retail sales of the property are made. The provision only applies to either a person who, or a person who has an affiliate who: (1) places a distribution facility in service after December 31, 2010, and before January 1, 2013; (2) makes, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013; and (3) creates at least 2,000 full-time jobs and with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013. In addition, after meeting the above requirements, the person or affiliate, must maintain at least 1,500 full-time jobs with a comprehensive health plan for those employees until January 1, 2016. The nexus safe harbor expires January 1, 2016, or when the business fails to meet the above requirements noted above, whichever occurs earlier, or on the effective date of a law passed by the U.S. Congress allowing states to require that its sales tax be collected and remitted even if the taxpayer does not have substantial nexus with that state. In addition, the owner of the facility that makes a retail sale through an Internet website must notify a purchaser in a confirmation email that the purchaser may owe South Carolina use tax and include an Internet link to the Department of Revenue's website allowing the purchaser to pay the use tax. Furthermore, by February 1 of every year, the retailer must provide to each purchaser who had goods delivered in South Carolina, a statement of the total sales made to the purchaser during the preceding calendar year. The purchaser must also be notified that use tax is imposed on its sales of tangible personal property stored, used, or consumed in South Carolina. Notification must also be provided on a retailers's Internet website and catalog. The new law also phases out the sales and use tax on durable medical equipment by reducing the rate, beginning July 1, 2011, from 5.5% to 3.5% until July 1, 2012, when it further decreases to 1.75%. On January 1, 2013, the tax will be eliminated such items are exempt. Furthermore, beginning September 1, 2011, the law exempts the sale or renewal of a warranty or service maintenance contract for tangible personal property regardless of whether it is purchased alone or as part of a sale of the tangible personal property covered by the contract

22. Other Federal Legislation - Business Activity Tax Nexus Bill or “BATSA” Creates a physical presence requirement before a state could assert jurisdiction and impose a tax on a business Expands upon PL 86-272 by applying the solicitation exemption to companies performing services and dealing in intangibles. There are a number of nexus “safe harbors” such as an unlimited amount of employees and property in a state without creating nexus, so long as neither is present in the state for more than 21 days within a particular year Provides clarity for companies State administrators are opposed due to loss of revenue

23. Where does this leave your business? Nexus is an evolving area and must be continually monitored Stay on top the changing rules and how this applies to your company If contemplating a sale of the business be aware that past exposures can impact sales negotiations Information sharing and ability to evaluate information electronically heightens the need to be proactive Past exposures can be mitigated As state licensing requirements change there may be a need to revisit your tax filing obligations

24. Questions? Ellen McCabe (612) 376-4807 Ellen.mccabe@cliftonlarsonallen.com Wendi Boddy (407) 244-9324 Wendi.boddy@cliftonlarsonallen.com