Introduction to Multistate Tax Compliance

Guest post by Mikhail Parnes of Murphy Austin Adams Schoenfeld LLP

Among other notable outcomes, November 9, 2016, marked the American public’s steady attitudinal shift towards accepting the sale and use of cannabis as a mainstream business.[1] Four new states voted in favor of recreational sales and use of cannabis, while three new states approved medical cannabis.[2] By one estimate, these new markets can account for $7 to $8 billion in new revenue for the cannabis industry.[3] Twenty-nine states plus the District of Columbia have now sanctioned medical cannabis, and eight states plus the District of Columbia have sanctioned recreational cannabis.[4] Entrepreneurs, investors, and managers undoubtedly now see cannabis as a national opportunity not only for plant cultivation and sales but ancillary opportunities in software, real estate, testing devices, and professional services as well.


I, among many others, have spilled enough ink about the confiscatory effects of Internal Revenue Code § 280E on plant touching enterprises. Relatively little, however, has been offered to ancillary businesses in this community who may now look to opportunities beyond their home state.

To no one’s surprise, sales of recreational cannabis have proven to be an effective revenue producer for state and local governments, surpassing initial estimates in Colorado and Washington.[5] Much of this revenue has come from sales and other excise taxes imposed on sales of recreational cannabis.[6] As an ancillary business, your good or service may be subject to sales and use tax as well.

So let’s suppose your business is headquartered in Colorado and you want to sell your compliance software to California growers and dispensaries, do you have to collect California sales or use tax on your software sales? The answer turns on two issues: whether your business has substantial nexus with California and whether your software offering is taxable under California sales and use tax law. Taxability will not be covered in this article because its complexity merits an independent article.

“Substantial nexus” is a fancy legal term for a “legally sufficient connection” to a foreign state[7] that is one prong of a four part-test that the United States Supreme Court created to test the permissibility of a state tax.[8] For us state and local tax nerds, this is an area of law that can be maddeningly gray and therefore difficult to advise clients on.[9] Ambiguities notwithstanding, prudent business people can rely on some general rules to guide their businesses’ tax compliance decisions.

Substantial nexus analysis typically falls under two alternative constitutional tests: the physical presence test and the attributional (or agency) nexus test. Under the first, your Colorado business must collect California tax on taxable sales if your business has a physical presence in California.[10] Although the Supreme Court considers the physical presence test a bright-line rule, what qualifies as “physical” is not clear.[11] The Court implied that having real property in the state and a small sales force is sufficient physical presence.[12] And, the Court expressly rejected a “slightest presence” test stating that “a few floppy diskettes to which [the taxpayer held] title” was not enough for a finding of substantial nexus.[13] Case law predating this decision which the Court did not overrule offers more guidance.[14]

The attributional nexus test provides that the physical presence of independent representatives or others acting “on behalf of” an out-of-state seller generally will be attributed to the seller if those activities are “significantly associated with the [seller’s] ability to establish and maintain a market in the state.”[15] Market establishing or maintaining activities include improving the remote seller’s name recognition, market share, goodwill, and individual customer relations.[16]

The final step analysis is to analyze whether California state law compels, does not compel, or safe harbors your business from compulsory tax collection.[17] Stated plainly, if your business lacks real and personal property, employees, and independent representatives in the state, does this mean that your business lacks substantial nexus with California? Maybe.

What if your employees exhibited at a trade show in the state last year? California provides a statutory safe harbor for trade show exhibitors.[18] A business does not trigger nexus with the state by exhibiting at a trade show in California if (1) the business’ sole physical presence in the state is trade show activities, (2) the business or any of its associates engages in trade show activities for no more than fifteen days during a twelve-month period, and (3) the business does not derive more than $100,000 of net income from those activities in California during the prior calendar year.[19] Thus, if your business’ trade show activities were within these constraints, your trade show exhibition probably did not trigger nexus.

Although this article’s focus was limited to California, well-managed businesses should review their nexus exposure for every state where the business has sales. This has two primary benefits. First, this review will manage against the risk of an unexpected assessment by a tax administrator, like the State Board of Equalization in California’s case. Second, should a business realize that it had a historical responsibility to collect and remit another state’s sales or use tax but failed to, every state offers taxpayers the opportunity to limit their back tax liability by voluntarily disclosing themselves.[20]

Finally, readers should recognize that this article is limited to sales and use tax. Other state taxes, like income tax, are generally governed by different nexus rules[21] and should be reviewed independently from a sales and use tax nexus review.

[1] Sale and use of cannabis remains federally criminalized under federal law with limited exceptions. See United States v. McIntosh, 833 F.3d 1163 (9th Cir. 2016) (discussing the Hinchey-Rohrabacher amendment’s limitation to federal prosecution of cannabis enterprises compliant under state medical cannabis law).

[2] Eli McVey, Map: The Post-Election U.S. Marijuana Landscape, Marijuana Business Daily (Nov. 14, 2016), available at

[3] See id.

[4] See id.

[5] Gavin Elkins & Joseph Henchman, Marijuana Legalization and Taxes: Federal Revenue Impact, Tax Foundation (May 12, 2016), available at

[6] See e.g., Carlos Illescas, Marijuana Sales Tax Revenue Huge Boon For Colorado Cities, Denver Post (May 26, 2016), available at; Joseph Henchman & Morgan Scarboro, Marijuana Legalization and Taxes: Lessons for Other States from Colorado and Washington, Tax Foundation (May 12, 2016), available at

[7] Substantial nexus is also a complex issue that, although I will cover here in basic detail, demands individualized counsel.

[8] See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

[9] Nothing I write in this article should be construed as legal advice. I encourage readers to consult their competent tax advisors for proper guidance.

[10] See Quill Corp. v. North Dakota, 504 U.S. 298, 317-18 (1992).

[11] See id. at 315.

[12] See id.

[13] See id. at n.8.

[14] See e.g., Nat’l Geographic Soc’y v. Cal. Bd. of Equalization, 430 U.S. 551 (1977); Standard Pressed Steel Co. v. Wash. Dep’t of Revenue, 419 U.S. 560 (1975); Felt & Tarrant Mfg. Co. v. Gallagher, 306 U.S. 62 (1939).

[15] See Tyler Pipe Indus., Inc. v. Wash. Dep’t of Revenue, 483 U.S. 232, 250 (1987); see also Scripto, Inc. v. Carson, 362 U.S. 207 (1960).

[16] See Tyler Pipe Indus., Inc., 419 U.S. at 249-51.

[17] See Cal. Rev. & Tax Code § 6203; Cal. Code Reg. tit. 18, § 1684.

[18] See Cal. Rev. & Tax Code § 6203(d); Cal. Code Reg. tit. 18, § 1684(d)(3)(B).

[19] See Cal. Rev. & Tax Code § 6203(d); Cal. Code Reg. tit. 18, § 1684(d)(3)(B).

[20] See the Board of Equalization’s program here.

[21] See e.g., Wis. Dep’t of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992) (applying the federal statutory protection from state income tax imposition under Public Law 86-272, 73 Stat. 555, 15 U.S.C. § 381); Tax Comm’r of State v. MBNA Am. Bank, 220 W. Va. 163, 171 (2006) (holding that the physical presence test does not apply to business franchise and corporate net income taxes); Geoffrey, Inc. v. S.C. Tax Comm’n, 313 S.C. 15, 23 (1993) (holding that the presence of intangible property in South Carolina is sufficient to trigger state income tax nexus).

Mike Parnes is an Associate Attorney with Murphy Austin Adams Schoenfeld LLP. Mike advises clients regarding multistate state and local tax matters. Mike’s practice also focuses on providing litigation and counseling services to owners, developers, contractors, subcontractors, suppliers, sureties and public entities in all aspects of construction law. The Sacramento law firm of Murphy Austin Adams Schoenfeld LLP focuses on the core areas of business and real estate transactions, healthcare, construction, labor and employment law, and tax and commercial litigation.