What is Economic Nexus

I’ve done a few posts on the B&O tax, but none of them have touched upon how Washington taxes businesses that aren’t located in our state but that still carry out transactions here. Before June 2010, the law said that businesses could only be taxed if they had a physical presence in the state where the transaction occurred. This is referred to as the physical nexus, which is based on a U.S. Supreme Court case Quill Corp. v. North Dakota (1992).  However, in the 20 years since this decision was heard, the Internet completely changed how businesses and people interact around the world.  It was time to update the tax code to reflect this evolution.

This change came in the form of SB 6143 - Modifying excise tax laws to preserve funding for public schools, colleges, and universities, as well as other public systems essential for the safety, health, and security of all Washingtonians – which expanded nexus rules to include businesses that have an economic nexus in Washington. Economic nexus applies to certain business classifications such as professional services, interest from loans, or royalties. If these businesses have more than $250,000 of gross income attributed to Washington then they don’t have to be physically in Washington to be subject to B&O taxes.  Most other business classifications, like retail and wholesale, are only subject to physical nexus rules.  The Department of Revenue has a tutorial that explains these differences in more detail.

As the bill title above shows, this change was implemented to save money for programs and services that were being reduced due to the Great Recession.  The Washington State Budget and Policy Center said that “under the physical presence nexus standard some businesses that benefit from Washington’s public structures – i.e. courts, roads, and other services that improve access to markets -- are not required to help pay for their maintenance.” Also, this update helped to level the playing field. In a message to the Tax Foundation (which opposed the measure), Representative Ross Hunter responded with:

I fail to see why a business located outside the state and performing services inside the state should be able to avoid paying taxes on their activity. When the B&O tax was created, the only way a business could perform a service for a customer was over a handshake. This clearly hasn't been true since Al Gore invented the Internet. Imagine two businesses are set up 50 miles from each other, but one is across the border in Oregon. They both perform services for customers in Washington State. Why would they have different tax treatment?

Even though they agreed to disagree, the Foundation brought up an interesting point: What should matter more, that all products face the same tax, or that state powers are limited and prevented from harming interstate commerce?  I think Washington was right to include economic nexus when taxing businesses.  The Internet has changed the variables of interstate commerce and how we communicate. It’s time our tax code reflected this fact.