Michigan Court of Appeals Tells Tax Tribunal to Consider Income Tax Nexus in Light of Wayfair

A few jurisdictions have begun to enact Wayfair-type economic nexus rules for income tax purposes, but this Michigan case raises the possibility that states may apply economic nexus principles for periods prior to the Wayfair decision.

By Jess Johannesen, SALT Manager

Since the expansion of economic sales tax nexus rules following the U.S. Supreme Court Wayfair decision, several jurisdictions have extended these economic nexus standards to income tax regimes. However, economic nexus principles are not novel in the income tax area, as states like California and New York have used a similar factor presence nexus standard that predates Wayfair. In addition, state courts have upheld income tax economic nexus concepts in cases where taxpayers derive revenue from licensing intellectual property, franchise fees and interest from credit card holders.

Since the Wayfair decision, some states have enacted newer economic nexus income tax provisions through state legislatures, while other states have promulgated regulations or issued administrative rulings instead.  For example, states such as Hawaii, Massachusetts, and Pennsylvania, and even cities such as Philadelphia have enacted rules for income tax economic nexus that utilize bright line thresholds similar to Wayfair.[1]

However, a recent Michigan Court of Appeals decision illustrates that some jurisdictions may apply Wayfair-like economic nexus concepts in the judicial process, absent any legislative or regulatory guidance, and that such application may be applied to tax years that precede the Wayfair decision.[2]

The initial case in the Michigan Tax Tribunal addressed whether a taxpayer had nexus with Detroit for purposes of the City of Detroit Income Tax in 2010 and 2012.  The Tax Tribunal addressed a myriad of factors concerning whether the taxpayer had established some type of physical presence in Detroit.  The case ultimately concluded that the taxpayer did not have nexus with Detroit as the taxpayer had no employees in the city, owned no real or personal property in the city, and never made sales of goods or services in the city.

Detroit appealed this decision that eventually reached the Michigan Supreme Court, and that court remanded the case back to the Court of Appeals for, “reconsideration in light of” Wayfair.  The Michigan Court of Appeals notes in this case that the Tribunal, in reaching its decision, repeatedly stated that its holding was based on the taxpayer’s lack of physical presence in Detroit.  Indeed, the Michigan Court of Appeal’s decision in May 2018, upholding the Tax Tribunal’s determination, occurred one month prior to the Wayfair decision.

Therefore, the Michigan Court of Appeals remanded the case back to the Tax Tribunal to consider each party’s arguments in light of the Supreme Court’s Wayfair decision.

While we will need to wait and see how the Wayfair opinion impacts the Tax Tribunal’s analysis of income tax nexus in light of the facts of that particular case, the fact that the Michigan courts have remanded this case, which deals with tax years that predate Wayfair, is significant.  Specifically, this signals the possibility that Michigan, which has generally viewed income tax nexus as requiring a physical presence, may reconsider how it views such nexus generally, and that such reconsideration may impact taxpayers for years prior to the Wayfair decision.  In addition, the outcome of this case may influence how other state and local jurisdictions view income tax nexus.

Aprio’s SALT team has experience addressing sales tax and income tax nexus issues, both from a physical presence standpoint and in light of Wayfair.  We can assist your business with a better understanding of where it might have state tax filing and payment requirements so that you can be in compliance with your state tax obligations and not incur unexpected exposures and penalties.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen, SALT manager, at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2020 SALT Newsletter.

[1] Washington and Texas have also enacted similar rules for Business and Occupation Tax and Franchise Tax, respectively.

[2] Apex Laboratories International, Inc. v. City of Detroit, Michigan Court of Appeals, No. 338218, 01/02/2020.  To read the original Michigan Court of Appeals decision from May 2018, which provides more detail of the specific facts, click here.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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