Section of Taxation Publications

VOL. 61
NO. 4

Contents | TTL Home


Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.

Economic Nexus and Nonresident Corporate Taxpayers: How Far Will it Go?

Megan A. Stombock*

“The very purpose of the Commerce Clause is to ensure a national economy free from . . unjustifiable local entanglements.”

I. Introduction

Article I, Section 8, Clause 3 of the United States Constitution, known more commonly as the Commerce Clause, grants Congress the power to regulate interstate commerce. The U.S. Supreme Court held in Complete Auto Transit v. Brady that, for a state tax to be considered valid under the Commerce Clause, it must (1) be applied to an activity that has a substantial nexus with the taxing state (the “substantial nexus requirement”), (2) be fairly apportioned to the activities carried on by a taxpayer in the state, (3) not discriminate against interstate commerce, and (4) be fairly related to the services and benefits provided by the state.

States, courts, Congress, taxpayers, and practitioners continue to debate whether a taxpayer’s physical presence or economic presence satisfies the substantial nexus requirement. A nonresident corporation is generally physically present in a state if it has a tangible investment, e.g., real property, employees, or equipment, located in that state. In contrast, a nonresident corporation is generally economically present in a state if it derives income from a state’s local market, e.g., from customers or intangible property, located in that state.

Quill v. North Dakota held that, to satisfy the substantial nexus requirement, a nonresident corporation must have physical presence in a statebefore that state may impose a use tax collection obligation on the corporation. Some states and courts have strictly interpreted this holding to require a nonresident corporation’s physical presence in the taxing state only as a prerequisite to impose a sales and use tax, and do not extend the physical presence requirement to corporate income, franchise, excise, or gross receipts taxes (each, a “Business Activity Tax”). For example, the West Virginia Supreme Court of Appeals delivered a controversial decision permitting West Virginia to impose corporate and franchise taxes on nonresident corporations that have no in-state physical presence, but rather derive only economic benefits from their West Virginia customers. Other states and courts interpret Quill’s holding to require physical presence before a state may impose a Activity Tax and therefore prevent a state from imposing any type of tax based solely on a nonresident corporation’s economic presence. Since many states limit Quill’s application to sales and use taxes and others adopt a physical presence standard for Business Activity Taxes, a lack of uniformity has developed among states’ nexus standards. Several commentators agree that the current landscape burdens interstate commerce because states’ varying nexus standards prevent corporations from determining with any certainty where they are liable for Activity Taxes.

This Article discusses the current Business Activity Tax nexus debate. Part II provides an overview of the substantial nexus requirement. Part III examines physical presence case law. Part IV examines economic presence case law. Part V considers the arguments supporting an economic presence standard and arguments supporting a physical presence standard. Finally, Part VI recommends adopting a uniform physical presence standard for Business Activity Taxes or a “hybrid” nexus standard that incorporates elements of physical presence with some minimum economic presence threshold.

*Cadwalader, Wickersham & Taft LLP


Published by the
American Bar Association Section of Taxation
in Collaboration with the
Georgetown University Law Center


If you are an ABA member, you can receive The Tax Lawyer and the Section NewsQuarterly, both quarterly publications, when you join the Section of Taxation. Anyone can subscribe to The Tax Lawyer by contacting the ABA Service Center.