A Delaware-based software company sells $2 million of cloud subscriptions into California, ships $3 million of packaged software boxes into Texas through a wholesaler, and has 4 remote engineers working from their homes in Colorado. It owns no offices outside Delaware and sends no salespeople into any of these states. Which states can tax it, and on what share of its income?
Nexus is the legal connection between a business and a state that lets the state impose tax. The Commerce Clause and Due Process Clause require "substantial nexus." Two flavors matter: physical presence and economic presence.
Physical presence nexus has no threshold: one employee, one rented office, or one third-party warehouse storing inventory (e.g., Amazon FBA) triggers it. Even a single remote employee or a few days of in-state contract work establishes physical nexus.
HIGH-FREQUENCY: P.L. 86-272 is a federal statute that limits a state's power to impose net income tax on out-of-state sellers of tangible personal property whose in-state activity is limited to solicitation of orders approved and shipped from outside the state.
Common mistakes
- Treating P.L. 86-272 as protecting all out-of-state sellers. Tangible personal property only, solicitation only, net income tax only. SaaS, consulting, software licensing, and financial services get zero protection. Trap answer: a Delaware consulting firm with $2M of California revenue is "protected", wrong, services excluded.
- Confusing physical and economic nexus thresholds. Physical nexus has no threshold: one employee triggers it. Economic thresholds ($100K, $500K, 200 transactions) apply only with no physical presence. A company with $50K of California sales and one California employee has full physical nexus, not "below threshold."
- Ignoring the post-Wayfair shift for sales tax. Pre-2018 (Quill) required physical presence. Post-Wayfair, economic nexus is enough. A remote seller at $200K into a state with no physical presence still must collect sales tax once threshold is met.
Bottom line
- Nexus is the connection that lets a state tax an out-of-state business; physical presence (no threshold) and post-Wayfair economic presence both qualify.
- Wayfair (2018) overturned Quill; economic sales tax nexus thresholds are typically $100,000 of sales or 200 transactions.
- P.L. 86-272 shields net income tax for sellers of tangible personal property whose in-state activity is limited to solicitation; it does NOT cover services, intangibles, or sales tax.
- Apportionment divides business income via formula (three-factor or single-sales-factor); allocation assigns nonbusiness income to the commercial domicile.
Exam shortcut
For an out-of-state seller, check four things in order: what is sold (tangible vs. services/intangibles), in-state activity (solicitation only vs. more), the tax at issue (income vs. sales), and economic nexus (post-Wayfair thresholds met). Tangible + solicitation only + net income tax only = P.L. 86-272 protected. Anything else = no protection.
The full lesson (about 2,754 words, 18 min read) adds 2 worked examples, all 7 common mistakes, a self-check, free in the app.
Learning objectives
- V.B2
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