Trailing Nexus - Constitutional?

Let's take a break from the drama of whether we go off the fiscal cliff to look at an interesting state tax issue - trailing nexus.  Trailing nexus means that even after the activity or event that causes a business to have either income or sales tax nexus in a state ends, the jurisdiction might say that nexus continues for some time afterwards.

For example, Washington, which has been specific on this topic provides for its B&O tax:

"A person who stops the business activity that created nexus in Washington now continues to have nexus for the remainder of that calendar year, plus one additional calendar year. (See RCW 82.04.220)"

Washington further provides for its retail sales tax:

"The trailing nexus period for retail sales tax (RST) is still four years, plus the current year, under WAC 458-20-193 (Rule 193)."

Bloomberg BNA State Tax Blog for 12/18/12 notes how a few states either specifically provide for trailing nexus or specify that it does not exist. They note that their 2013 State Tax Department Survey will include a question about trailing nexus. I think that is great. This is an issue that needs more attention.

Big question - is trailing nexus constitutional?  What is the difference between regular nexus and trailing nexus? Isn't only "regular nexus" constitutional?

Of course, when does "regular nexus" end?  That is a good question. California Board of Equalization Annotation 220.0275 describes how a retailer might have "lingering effects" of its physical presence after such presence ends. For example, the retailer distributed coupons in the state that continue to be effective after physical presence ends.

But, should the "lingering effects" be different from any non-present vendor who provides coupons to people in a state?  Does it really matter that one vendor previously had a physical presence?  Isn't it creating complications to the physical presence sales tax nexus standard?  Isn't it creating differences among states?

How do you advise your client as to how long nexus lasts? What is permissible constitutionally?  What if State X with a throwback rule tells you that the business no longer has nexus in State Y which has a statute providing for a long trailing nexus period, so a sale to State Y should be thrown back to State X? This is a big topic. I have it on my list for a more detailed research project.

What do you think about trailing nexus? How do you advise your clients as to when they can assume nexus has ended in a state?

Washington to Remove Exemptions for Candy and Bottled Water

SB 6143 signed into law by Governor Gregoire on April 23, 2010 includes several provisions that will generate additional revenue for the state including an economic nexus standard for income taxes. [See Washington Legislature site on SB 6143 and Deloitte summary for more information on the entire bill.]

SB 6143 also removes the sales tax exemption for candy and bottled water. Washington, like most states, does not apply sales tax to most food items. Generally, this is done so that the tax doesn't apply to "necessities of life." However, as noted in this blog and 21st Century Taxation reports, this is a poorly targeted exemption because high income individuals spend a lot more on food than do lower income individuals so the exemption provides a greater tax break to higher income individuals. Also, any exemption from the general rule complicates a law because definitions are needed to distinguish between taxable and non-taxable items.

SB 6143 and its change in exemptions is a good example of the complexity of exemptions. Here are some excerpts from this new law:

"Until July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, bottled water, candy, or dietary supplements. Beginning July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, candy, or dietary supplements."

""Candy" means a preparation of sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the form of bars, drops, or pieces. "Candy" does not include any preparation containing flour and does not require refrigeration."

""Bottled water" means water that is placed in a sealed container or package for human consumption. Bottled water is calorie free and does not contain sweeteners or other additives except that it may contain: (i) Antimicrobial agents; (ii) fluoride; (iii) carbonation; (iv) vitamins, minerals, and electrolytes; (v) oxygen;(vi) preservatives; and (vii) only those flavors, extracts, or essences derived from a spice or fruit. "Bottled water" includes water that is delivered to the buyer in a reusable container that is not sold with the water." Tax won't apply though to "sales of bottled water for human use dispensed or to be dispensed to patients, pursuant to a prescription for use in the cure, mitigation, treatment, or prevention of disease or other medical condition."

So, cookies are not taxable, but candy is. A bottle of plain water is taxable, but not one with enough sweet flavoring to add a few calories. This illustrates another issue with exemptions, they can violate the neutrality and equity principles. The law change may lead buyers to prefer sweetened bottled water over plain bottled water. This is also odd because how is sweetened bottled water a necessity of life?

The simplest, more efficient way to go would be to tax all food and provide relief to low-income taxpayers via a refundable income tax credit. This would also raise more revenue than the current system and that revenue could be used to either lower the sales tax rate a bit.

What do you think?