The Tennessee Department of Revenue's Hearing Office upheld a franchise and excise tax assessment against an out-of-state manufacturer because an engineer was providing services from his Tennessee home office.

Background

Under Tennessee law, business taxes can be assessed on out-of-state businesses where there is "substantial nexus" in the state. Under its "bright-line presence" test, a business has substantial nexus if:

• The taxpayer's total receipts in the state during the tax period, as determined under the apportionment formula, exceed the lesser of $500,000 or 25% of the taxpayer's total receipts everywhere during the tax period

• The average value of the taxpayer's real and tangible personal property owned or rented and used in the state during the tax period, as determined under the apportionment formula, exceeds the lesser of $50,000 or 25% of the average value of all the taxpayer's total real and tangible personal property
  
  Or
• The total amount paid in the state during the tax period by the taxpayer for compensation, as determined under the apportionment formula, exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer

Federal exemption

Under federal law (P.L. 86-272), a state is prohibited from imposing its income taxes on out-of-state taxpayers if the only connection to the state is the solicitation of orders for sales of tangible personal property when those orders are approved and shipped from outside the state.

The ruling

The out-of-state manufacturer in this ruling had annual Tennessee sales exceeding $500,000 per year and three employees in Tennessee, including an engineer working from home.

The Hearing Office held that the company is subject to Tennessee's franchise and excise taxes because its annual sales met the nexus standard under the "bright-line presence" test, and the engineer performing services from his Tennessee home office was not engaged in activities involving sales solicitation; therefore, the company cannot claim an exemption under P.L. 86-272.

Ernst & Young LLP insights

As this case demonstrates, out-of-state remote workers can trigger not only withholding and employment tax obligations, but also business tax obligations in states where they might not otherwise apply. If employers have not already done so, they should carefully review with their tax advisors the nexus standards in each state where remote workers provide services to determine if there are business tax obligations not being met.

Further, withholding, employment tax and business tax requirements should be identified before agreeing to remote work arrangements in states where the business does not currently operate. 

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor