Independent contractors (ICs) have long been the nexus lynch pin for unsuspecting multistate businesses. Companies have utilized the services of unaffiliated individuals and entities in a variety of ways in virtually every business environment, both past and present. For example, contractors have been used to perform payroll or accounting functions, and to solicit sales, and to provide services to out of state customers. ICs are often less expensive to use than employees. There are no payroll filings to worry about and administrative costs and logistical concerns are lower, particularly when the business activity is directed at another state. In today’s world of electronic commerce, the internet has provided a virtual office link between businesses and nonemployee individuals that has blurred the definition of just what an independent contractor is. How is it then that some activities performed by non-employees seem to create nexus for sales tax and other business taxes, while other activities do not create nexus? The answer is deceptively plain. When an individual or entity is compensated for activities it conducts within a state that enable a business “to establish or maintain a market” in that state, a connection is created that is often sufficient to allow the state to impose a tax. This rule applies today in much the same way it has applied for the past 25 years.
The Commerce Clause of the US Constitution provides that only Congress has the power to “regulate commerce…among the states.” As such, the US Supreme Court has interpreted this clause to mean that there must be a “substantial nexus” between a taxing jurisdiction and a business activity before a tax can be imposed. For sales and use tax purposes, that means that a substantial connection must exist before collection and remittance of a state’s sales tax can be required. How can an individual who is not even and employee create such a connection? To answer this question, a brief review of recent US judicial history is in order.
In 1987, the US Supreme court decided the landmark nexus case of, Tyler Pipe Industries, Inc., Appellant v. Washington Dept. of Revenue (No. 85-1963), 483 US 232 263 (1987). In this decision, the court ruled that the activities of independent sales representatives (ICs) utilized by the Tyler Pipe allowed the corporation to “establish and maintain a market” in Washington. In other words, the conduct of the independent representatives in Washington created a tax nexus between Tyler Pipe and the state. Tyler Pipe used these representatives in the state to solicit sales, provide the company with local marketing information, and to maintain and foster close relationships with the corporation’s Washington customers. Through this contact and these close relationships, Tyler Pipe was able to maintain and improve name recognition, market share, and company goodwill inside the state. Additionally, the court declared, in referencing, Scripto, Inc. v Carson, 362 US 207, 4 L Ed 2d 660, 80 S Ct 619 (1960), that the distinction between actual employees and ICs or “salesmen” is “without constitutional significance!”
With the Tyler Pipe case as a backdrop, just five years later the US Supreme Court decided the most significant sales tax nexus case to date. In Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the court clearly defined what “substantial nexus” is. According to the court, substantial nexus exists only if a business has a “physical presence” (representatives, employees, property, etc.) within that state. This bright-line physical presence requirement that the Quill court established was a welcome change in 1992 that simplified the sales and use tax nexus equation for many years. Considering the fact that the Tyler Pipe court made it clear that there is little difference between an employee and an independent sales representative, the Quill bright-line nexus standard of physical presence certainly applies to ICs.
Of course, nothing lasts forever and in 2011, the idea of physical presence has drastically changed. Amazon.com, LLC has embarked in an epic legal battle with the state of New York as the New York has attempted to force the internet giant to collect and remit sales taxes on its sales to its in state residents. Since the facts in this case are quite well documented, there is no need for me to revisit how New York State has attempted to change the definition of an independent contractor by amending its law. It is only important to point out that, under the US Supreme Court’s decision in Tyler Pipe, no state can impose a sales tax collection responsibility on any out of state business entity using in state independent contractors, unless the state can demonstrate that those independent contractors are establishing or maintaining a market for the out of state business. Any other outcome is a violation of the US Constitution.