The last time the U.S. Supreme Court weighed in on nexus issues was in 1993, and it has indicated that any further action on the issue should come from Congress. Legislation regarding nexus has been introduced in the House, but it is unclear when or whether it will move forward. As a result, "the state courts are not getting any guidance, so they're just saying we'll do what we think is right," says Kirsner.

Audit Thyself
Another approach gaining favor with state revenue departments is to require unitary reporting, in which companies must consolidate all their business units or affiliated companies and report their combined income in the state if any single unit conducts business there. The state can then levy a tax on that income based on a formula that varies by state, but typically considers the proportion of the company's sales, property, and personnel in the state relative to its overall business. "It's a way of bringing out-of-state business into your web," says Faber.

Massachusetts is moving to unitary filing this year, says Paul Beecy, a Boston-based partner with Grant Thornton. Historically, states east of the Mississippi have used single-entity or some form of combined reporting, with every parent or sister company filing its own return, while those west of the Mississippi have generally taken the unitary approach. Now, a number of eastern states are considering unitary filing, says Beecy. Besides Massachusetts, Vermont, New York, and West Virginia have moved to unitary reporting, while Maryland is starting to gather data from companies about what their filings would look like on a combined basis.

"States argue that by considering these companies as a single entity, you avoid situations where the companies can shift income around into a low-tax or no-tax state," says KPMG's Duncan. Implementation poses a challenge for corporate tax departments, as each state approaches unitary filing slightly differently.

The move to unitary filing does not necessarily raise a company's tax bill in any given state, notes Beecy. "Let's say you've had a very profitable business in Massachusetts. What unitary filing means is you're pulling into the tax base not only the income of non-Massachusetts subsidiaries, but also the losses," he says. Of course, the hope for states moving to the unitary system is that they get a percentage, however small, of a much bigger pie.

Federal stimulus funds aside, states' finances are unlikely to improve any time soon. Companies should therefore prepare for tougher scrutiny from tax auditors and creative tax legislation from state legislatures. Tax directors should conduct thorough self-audits, advises Kirsner, looking at every part of the company — everywhere the business has customers, offices, and full- or part-time sales reps. "Do your own review before the state tax authority does it for you," he says.

Kate O'Sullivan is a senior writer at CFO.

The 2009 CFO State Tax Survey: Methodology

This is the sixth CFO state tax survey of corporate tax officials since 1996. The survey, conducted with the help of KPMG, aims to capture tax executives' impressions about differing tax environments, and the results are driven by those opinions.

To determine the top and bottom five states in each category, we calculated the average score for each state on each question, calculated the mean of all the states' scores, and identified the five furthest from the mean on either side. — K.O'S.

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