Investment Advisors Beware: New State Nexus and Souring Rules May Snare You


“Economic nexus” and “market based sourcing” are two phrases many investment advisors will wish they had never heard. Growing budget deficits and in-state lobbying have caused states to become more aggressive in raising revenue, especially from non-local businesses. One appealing way for a state to broaden or shift the tax base is to tax income of persons that benefit from a state’s market or consumer base but do not otherwise have a physical presence in the state. The emerging economic nexus standards and market based sourcing rules, including in states such as California and Washington, could become a major headache to investment advisors around the country, if not the world. Although Congress has considered legislation that may have the effect of limiting a state’s ability to tax taxpayers without physical presence in their state, and thus undercut these new economic nexus provisions, to date the legislation has not been enacted.

As of January 1, 2011, a taxpayer is considered to be “doing business” (i.e., have nexus) in California, for purposes of applying California’s income or franchise tax, if such person satisfies one of three bright-line thresholds or tests. Most notable for investment advisors is that a taxpayer that has apportionable “sales” in California in excess of the lesser of (i) $500,000 or (ii) 25% of the taxpayer’s total sales will be considered to be doing business in California. For this purpose, “sales” generally include receipts from the provision of services. If a taxpayer is considered to be doing business in California, at the very least, the taxpayer will be required to file a tax return and pay a minimum fee.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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