Checklist · Tax

Determining State Tax Exposure or Contesting an Assessment: A Practical Checklist

15 U.S.C. § 381

Type
Checklist
Jurisdiction
National
Date
2024-10-24
Topic
Tax

This checklist covers state tax exposure analysis and assessment defense. The nexus track runs a contact inventory state by state and tax type by tax type, since the standards differ and a conclusion for one tax does not carry to another. The federal protection track audits what personnel actually do, since the statutory shield covers only solicitation of orders for tangible personal property against net income taxes. The base track documents the unitary determination, which is factual and examined years later. The formula track covers receipts sourcing, throwback, and the modeling required under differing state rules. The assessment track works the defenses in order of strength. Further tracks cover remote employees, transaction diligence, and the standing compliance process.

Determining State Tax Exposure or Contesting an Assessment: A Practical Checklist

Tax > State Tax Nexus, Apportionment, and Combined Reporting | Published 24 October 2024 - Updated 23 May 2026 | UpLaw - uplaw.us

Track one: the contact inventory

Build it state by state. Property owned or leased. Employees, including remote workers, with what each actually does. Independent contractors and representatives acting on the company's behalf. Inventory, including inventory held at third-party fulfillment providers. Sales volume and transaction counts. Registrations, licenses, and permits. Deliveries in company vehicles. Installation, training, repair, and warranty work.

Separate the tax types. Sales and use tax collection, governed after South Dakota v. Wayfair, Inc. by economic thresholds. Income tax, where economic standards also apply in most states. Gross receipts and franchise taxes, which have their own standards and fall outside the federal protection. Employment tax and withholding, which follow employees.

Apply the constitutional test. Complete Auto Transit, Inc. v. Brady requires substantial nexus, fair apportionment, absence of discrimination, and fair relation to state services.

Recognize what changed. South Dakota v. Wayfair, Inc. overruled National Bellas Hess, Inc. v. Department of Revenue and Quill Corp. v. North Dakota ex rel. Heitkamp, so physical presence is no longer required.

Consider attribution. Tyler Pipe Industries, Inc. v. Washington State Department of Revenue asks whether in-state activities conducted on the taxpayer's behalf are significantly associated with its ability to establish and maintain a market.

For trusts and estates, apply North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, which holds that in-state beneficiaries alone do not supply the minimum connection where they received no distributions and had no right to demand income.

Track two: the federal protection

Test the elements of 15 U.S.C. § 381: only solicitation of orders for tangible personal property, sent outside the state for approval or rejection, and filled from outside the state.

Audit what personnel actually do, not what job descriptions say. Installation, training, repair, credit investigation, inventory maintenance, and in-state approval of orders all forfeit the protection.

Note the exclusions. Services, intangibles, and leasing fall outside. The protection runs only against net income taxes as defined in 15 U.S.C. § 383, leaving gross receipts and franchise taxes unaffected.

Check the assessment and collection provisions in 15 U.S.C. § 382, and the construction provisions in 15 U.S.C. § 384.

Run the analysis per tax type, since a conclusion under the income tax does not carry to any other levy.

Track three: the apportionable base

Apply the unitary business principle. Under Mobil Oil Corp. v. Commissioner of Taxes of Vermont it is the linchpin of apportionability, and income of a unitary business is apportionable regardless of where it was generated.

Assess the three indicia described in Container Corp. of America v. Franchise Tax Board: functional integration, centralization of management, and economies of scale.

Do not rely on internal divisions. Exxon Corp. v. Department of Revenue of Wisconsin rejects the argument that functionally separate departments are separate businesses.

Test the boundary. ASARCO Inc. v. Idaho State Tax Commission and F.W. Woolworth Co. v. Taxation and Revenue Department of New Mexico hold that ownership and dividends alone do not establish unity, and that unexercised potential control does not either.

Consider the operational function concept under Allied-Signal, Inc. ex rel. Bendix Corp. v. Director, Division of Taxation, as clarified by MeadWestvaco Corp. v. Illinois Department of Revenue, which describes when an asset is part of the unitary business rather than supplying an independent ground.

Document contemporaneously. Organizational charts, intercompany agreements and their actual operation, board minutes showing where decisions are made, shared service arrangements, employee movement, and branding. The determination is examined years after the facts.

Maintain consistency. Positions on unity taken in one state and one year are used against the taxpayer in others, and departments face the same constraint.

Track four: the formula

Identify each state's formula — three-factor, weighted, or single sales factor.

Compute the factors correctly, with property valued and payroll assigned as each state requires.

Source receipts under each state's actual rule. Destination sourcing for tangible personal property; cost of performance or market-based sourcing for services and intangibles, with differing cascading provisions.

Model throwback and throwout. Sales protected by 15 U.S.C. § 381 in the destination state may be thrown back to the origin state, and establishing nexus in a destination state can eliminate that throwback.

Understand the constitutional limit. Moorman Manufacturing Co. v. Bair holds that a state need not use three factors and that overlap among states is a matter for Congress. The taxpayer's burden is clear and cogent evidence of a result out of all appropriate proportion.

Do not model under a single assumption. State sourcing rules differ enough that a uniform model produces the wrong answer in every state but one.

Document sourcing determinations contemporaneously, since the audit asks why receipts were assigned as they were.

Track five: reporting regime

Determine whether each state requires combined or separate reporting.

In combined states, the unitary group is a single taxpayer, income and factors are combined, and intercompany transactions are eliminated — which means intercompany structures accomplish nothing.

In separate states, check add-back statutes requiring the payor to add back intercompany royalty and interest deductions, and the exceptions where the recipient was subject to tax elsewhere.

Check the combination scope. Water's edge is the norm; worldwide combination is permitted under Container Corp. of America v. Franchise Tax Board and Barclays Bank PLC v. Franchise Tax Board of California, with elections available in most states that permit it.

Model any restructuring under every regime, not only the states where a benefit arises.

Track six: contesting an assessment

Test nexus first, under the state's standard and against 15 U.S.C. § 381 where a net income tax is at issue.

Test the base, using the unitary framework and the boundary cases.

Test the formula, including factor computation and receipts sourcing.

Test internal consistency, following Comptroller of the Treasury of Maryland v. Wynne, which asks whether the scheme would produce multiple taxation if every state adopted it.

Test discrimination in operation as well as in form.

Consider alternative apportionment, available where the standard formula does not fairly represent the taxpayer's activity, with a substantial burden on the party seeking deviation.

Preserve procedure. Protest deadlines, administrative appeal requirements, payment-under-protest rules, and judicial review availability vary by state and are applied strictly.

Assess penalties separately, since a reasoned contemporaneous determination supports abatement and an unexamined failure does not.

Track seven: remediation

Recognize that unfiled years do not close, since limitations generally run from filing.

Evaluate voluntary disclosure, which typically limits the look-back period and waives penalties in exchange for registration and payment, and which is unavailable after the state initiates contact.

Consider amnesty programs where available.

Understand prospective registration's limits. It addresses the future without resolving the past and can invite inquiry about it.

Quantify before choosing. Tax, interest, and penalties by state and year, compared against the cost and terms of each remediation route.

Track eight: remote employees

Maintain a current record of where employees actually work.

Assess nexus consequences, recognizing that 15 U.S.C. § 381 rarely protects remote work.

Assess payroll factor and withholding consequences, including convenience rules that assign income to the employer's location.

Assess throwback effects, since new nexus can eliminate throwback and reduce liability in the origin state.

Review before hiring, since a single employee can create enterprise-wide filing obligations in a new state.

Common failure points

Concluding nexus for one tax and assuming it for all.

Relying on the federal protection without auditing what personnel actually do.

Assuming physical presence is required, which South Dakota v. Wayfair, Inc. rejected.

Treating internal accounting divisions as separate businesses, contrary to Exxon Corp. v. Department of Revenue of Wisconsin.

Assuming dividends make an investee unitary, contrary to ASARCO Inc. v. Idaho State Tax Commission.

Modeling apportionment under one sourcing assumption across all states.

Restructuring for a separate reporting benefit without testing the combined reporting states.

Waiting to address unfiled years until the state makes contact, which forecloses voluntary disclosure.

Failing to document sourcing and unity contemporaneously, and reconstructing under audit years later.

Missing a protest deadline, which forfeits the substantive defenses entirely.

Worked scenarios

The software company with distributed engineers. A subscription business hires remote engineers in a dozen states. Each creates income tax nexus, and 15 U.S.C. § 381 does not protect because the engineers do not solicit orders for tangible personal property. Subscription receipts must be sourced under each state's market rule, and the differing cascading provisions produce both overlap and gaps. Establishing nexus in a destination state may eliminate throwback of those receipts to the origin state, which reduces liability there — a benefit frequently overlooked while the new obligations are being tallied. Separately, whether the subscription is taxable for transaction tax purposes varies, and thresholds under South Dakota v. Wayfair, Inc. may create collection duties.

The manufacturer's minority investment. A manufacturer sells a minority stake in an unrelated company at a gain, and a state seeks to apportion it. Under Allied-Signal, Inc. ex rel. Bendix Corp. v. Director, Division of Taxation and MeadWestvaco Corp. v. Illinois Department of Revenue, the gain is apportionable only if the investment was part of the unitary business, which under ASARCO Inc. v. Idaho State Tax Commission and F.W. Woolworth Co. v. Taxation and Revenue Department of New Mexico is not established by ownership and dividends. The evidence is how the investment was managed, whether the businesses transacted, whether systems or people were shared, and what the acquisition documents say about purpose.

The intangible holding structure. A group considers moving intellectual property to a holding company. In separate reporting states the structure may reduce tax, subject to add-back statutes. In combined reporting states it accomplishes nothing, since intercompany transactions are eliminated and the group is taxed as a unit under the principle applied in Container Corp. of America v. Franchise Tax Board. The risk is a structure that produces a benefit in some states while supporting a department's argument for forced combination or alternative apportionment in others.

The retailer with unfiled years. A seller that never filed receives an assessment covering many years. Because limitations generally run from filing, the periods remain open. The defenses are whether the state's standard was met in each year — recognizing that economic nexus provisions took effect on identifiable dates and that Quill Corp. v. North Dakota ex rel. Heitkamp governed earlier ones — whether receipts were properly sourced, and whether a reasoned contemporaneous determination supports penalty abatement. Voluntary disclosure was the better route and is now foreclosed.

The resident with out-of-state income. An individual taxed by the resident state on all income, with a credit for other states' taxes allowed against only part of the levy, has the argument that succeeded in Comptroller of the Treasury of Maryland v. Wynne: applying internal consistency, the scheme operates as a tariff on interstate activity if every state adopted it.

Sequencing note

Three habits produce accurate multistate advice.

Run nexus per state and per tax. The standards differ, the federal protection covers only one tax type, and a conclusion for one levy does not carry to another.

Document unity and sourcing contemporaneously. Both determinations are factual, both are examined years later, and both are decided on records that either exist or do not.

Address unfiled exposure before the state makes contact. Voluntary disclosure limits the look-back and waives penalties; an assessment does neither, and periods that never began to run do not close on their own.

Counsel who install those three habits will handle multistate matters accurately. Counsel who begin with the client's sense of where its income was earned will be arguing against a framework that abandoned that intuition decades ago and has not revisited it since.

Track nine: transaction taxes

Determine taxability by state for each product and service line, and document the basis, since classification of software, digital goods, information services, and bundled offerings varies and is the second most common source of assessment.

Implement rate and address determination, since destination sourcing with local taxes requires accuracy below the state level.

Manage exemption certificates. Collect at the time of sale, validate, track expiration, and refresh periodically. Missing or defective certificates are the most common adjustment in transaction tax audits and are entirely preventable.

Monitor economic thresholds in each state and register promptly when crossed, recognizing that liability accrues on gross receipts rather than on income and grows quickly.

Confirm marketplace facilitator treatment where sales occur through platforms, and determine which party is responsible for which transactions.

Reconcile collected tax to remitted tax periodically, since a mismatch is both an exposure and an indicator of a system problem.

Track ten: transaction diligence

Compare the target's filing footprint against its employee locations, inventory locations, and sales by destination. Unfiled states are the principal risk because periods do not close.

Review transaction tax compliance: whether collection occurred where required, whether taxability determinations are documented, and whether exemption certificates were maintained.

Review apportionment positions for consistency with each state's sourcing rules, and flag aggressive positions.

Review unitary positions, since they constrain the buyer and since combination with the buyer's group in combined reporting states may change the result materially.

Address structure consequences. A stock acquisition carries the history; an asset acquisition may not, subject to successor liability provisions that many states impose for transaction taxes.

Satisfy bulk sale and clearance requirements, which are procedural, inexpensive, and costly to overlook.

Negotiate deal terms covering filings and collections, with indemnification sized to the identified exposure, escrow, and a covenant to pursue voluntary disclosure where unfiled exposure exists.

Model post-closing apportionment before closing rather than discovering it at the first combined return.

Track eleven: the standing compliance process

A nexus register. One row per state, listing the contacts establishing or approaching nexus for each tax type, updated as the business changes. Trigger events: new employees, new inventory locations, new in-state contractual relationships, and crossing economic thresholds.

A filing calendar. Income and franchise returns, transaction tax returns with their varying frequencies, information returns, and annual reports, with extensions tracked separately.

A sourcing methodology document. For each revenue stream, how receipts are sourced in each state, with the statutory or regulatory basis and the data relied upon. This is the most valuable document in an audit and the one most often absent.

A taxability matrix. Product and service lines by state, with determinations and their bases, revisited when statutes or regulations change.

A unitary file. Group structure, intercompany agreements, shared services, and management arrangements, maintained contemporaneously.

An audit protocol. Who responds, what is produced, how requests are logged, and how positions are cleared before communication.

A change process. New states, products, employees, and acquisitions each trigger review before the fact.

Why standing process matters. Nexus accrues silently. A business reviewing annually may find it crossed a threshold eleven months earlier and accrued a liability it never charged customers. The register and the trigger events prevent that, and nothing else does.

A closing note

The single most useful thing counsel can do for a growing multistate business is unglamorous: build the nexus register and the sourcing methodology document before anything goes wrong.

Both are inexpensive. Both answer the questions an audit will ask. And both are unavailable afterward, because the facts they record — where employees worked, where inventory sat, why receipts were sourced as they were — are reconstructed poorly and remembered badly.

A business with those two documents defends an assessment from records. A business without them defends from testimony about events several years old, which is the same position as having no defense at all.

The same point applies to the unitary file. Whether operations are integrated, whether management is centralized, and whether economies of scale exist are questions answered by documents created in the ordinary course — organizational charts, intercompany agreements, board minutes — and not by an argument constructed after a department has taken the opposite position.

Maintaining those records costs a few hours each year and determines the outcome of every examination the business will face.

It is the highest-return work available in this practice, and the least likely to be requested.

Counsel should propose it rather than waiting to be asked, and should propose it early.

Clients rarely regret having done it, and frequently regret not having.

That asymmetry is the whole argument for doing it now.

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