In recent years, much of the discussion in state and local tax (SALT) has focused on how nexus has evolved after South Dakota v. Wayfair (2018), particularly for e-commerce businesses and remote sellers.
But nexus addresses only one prong of the four-part test established in Complete Auto Transit v. Brady (1977).
The other three prongs remain fully in force—and they are often overlooked in multistate tax analysis:
- Be fairly apportioned
- Not discriminate against interstate commerce
- Be fairly related to the services provided by the state
Why the Nondiscrimination Prong Matters
The nondiscrimination prong is especially important.
A state tax cannot, on its face or in practical effect, discriminate against interstate commerce. One clear example is Fulton Corp. v. Faulkner (1996). North Carolina imposed an intangible property tax on stock owned by state residents, but it allowed a deduction based on the percentage of the corporation’s income subject to North Carolina tax.
The result was straightforward:
- Resident shareholders holding stock in corporations with more North Carolina activity (and a larger North Carolina tax base) received a larger deduction and a lower effective tax
- Resident shareholders holding stock in corporations with more out-of-state activity (and a smaller North Carolina tax base) received a smaller deduction and therefore a higher effective tax
In practical effect, interstate commerce was taxed more heavily—so the tax failed the nondiscrimination requirement.
When a Discriminatory Tax May Still Survive
A facially discriminatory tax is generally “virtually per se invalid” unless it can be justified as a valid compensating tax.
To satisfy that standard, the state must:
- Identify the specific intrastate tax or burden the tax is intended to offset
- Show that the tax on interstate activity roughly approximates, and does not exceed, the intrastate burden
- Apply the taxes to substantially equivalent events
Compensating Tax Examples
A classic example is a properly structured use tax that complements a state’s sales tax, as upheld in Henneford v. Silas Mason Co. (1937).
By contrast, in Associated Industries of Missouri v. Lohman (1994), Missouri imposed a 4.225% sales tax on in-state purchases but a 5.725% tax on out-of-state purchases. Because interstate transactions bore the heavier tax burden, the tax failed constitutional scrutiny.
Bottom Line
When evaluating multistate tax exposure, it is not enough to analyze nexus alone. You also need to consider whether the tax structure itself complies with the Commerce Clause, including the nondiscrimination requirement.
At The John Ellis Company, An Accountancy Corporation, we advise businesses and CPAs on SALT, multistate tax compliance, and tax controversy, with a focus on identifying constitutional and structural risks—not just filing obligations.