Definition
Income tax nexus is the level of connection between a business and a state that allows the state to impose its corporate income, franchise or similar tax. Physical presence through employees, property or inventory commonly creates nexus. Many states also assert economic nexus, using receipts thresholds, and some use factor-presence tests with dollar limits for property, payroll or sales. Public Law 86-272 can protect some sellers of goods. Income tax nexus is tested separately from sales tax nexus, so a company can have one and not the other.
Why it matters in an audit or review
Unfiled returns can lead to tax, penalties and interest that management must evaluate under ASC 740 for uncertain tax positions. Auditors ask where employees work, where property is held, how revenue is sourced, and whether management ran a nexus study.
Example
Illustrative: a software company allows two employees to work remotely from State C and has no other presence there. The auditor asks management whether those employees create nexus, whether Public Law 86-272 applies given that the company sells software, and whether an exposure should be recorded.
Common mistakes
- Treating remote employees as having no tax effect.
- Relying on a sales tax study to conclude on income tax.
Sources
- FASB ASC 740-10-25-6 and 740-10-50, uncertain tax positions
- 15 U.S.C. 381, Public Law 86-272: https://www.law.cornell.edu/uscode/text/15/381
- Each state's revenue department rules on income and franchise tax nexus
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error