Nexus in a Nutshell: Financial Institution Edition

The state taxation of financial institutions is a constantly evolving and increasingly complicated topic. Long gone are the days of only having to file and pay tax in the states in which a bank has a branch. States are struggling to get revenue and all states want their piece of the tax pie. This has been evidenced by the increasing numbers of states which have implemented “economic nexus” rules. This article is meant to broadly cover what nexus is, how nexus can be created, and what the implications of nexus would be for a financial institution.

What does nexus mean?

Nexus is a term that refers to the “minimum connection” required for a state to subject a taxpayer to its income and/or sales tax filing requirements. (This article will focus on income tax nexus.) Traditionally this meant having a physical connection to a state – having a branch, payroll, or other physical property in a state. Increasingly some states have been expanding this physical presence test to pull in even the most minimal contact – for example simply having employees physically set foot in the state, or the use of third parties to perform services for the bank (perhaps closing a loan or foreclosing on a property) in the state.

Then what is “economic” nexus?

Even if a business has no physical presence in a state, some states are asserting that nexus exists if there is an economic presence in the state. Therefore if a bank has no payroll in a state, does not send employees or third parties into the state, and has no physical connection with a state, it may still have economic nexus if it has loaned money that is secured by property in the state. There are a number of states that have indicated that this can create nexus – for instance Wisconsin has added language to its statute that loans secured by real or tangible personal property in Wisconsin will create a filing requirement.

Some states have set some clear nexus thresholds – for example Massachusetts will consider a financial institution to be subject to its financial institution excise tax if it is conducting business with 100 or more residents of Massachusetts during a taxable year, has $10,000,000 or more of assets attributable to sources within Massachusetts, or if it has $500,000 or more in receipts attributable to Massachusetts. Other states have broader language for economic nexus and all facts and circumstances would need to be considered when determining if nexus exists. For example New Hampshire looks at all “business activity” including the employment of business assets and evidence suggesting a purposeful direction of business toward the state, examined in light of the frequency, quantity, and systematic nature of a business organization’s economic contacts with the state. In other words states like New Hampshire do not have set thresholds so a variety of factors need to be considered.

It is important to calculate the tax exposure in states in which a bank may have nexus. When trying to determine all facts and circumstances, the bank will need to know the amount of interest income associated with loans for each state (based on the location of the collateral) and the total balance of the loans for each state. These can be used to estimate tax exposure and help determine the level of the bank’s activity in each state.

Nexus implications for financial institutions

When a financial institution starts to file and apportion income to other states, the results are often either a benefit or a disadvantage (rarely neutral). This is for two reasons:

  1. the amount of income apportioned is usually not exactly 100% (could be less or more) because states have varying apportionment methodologies; and
  2. it is likely that the tax rates are different in the additional states.

Therefore a bank could be both paying more (or less) tax, and driving up (or down) the effective rate on the financial statements.

Below is an example to help illustrate what could occur. For simplicity’s sake the two states chosen both use three-factor (sales, payroll, and property) apportionment.


First Bank of Roger is a Massachusetts bank with 3 locations throughout the state. They do not have a physical branch in New Hampshire but it has been determined that their activity within New Hampshire is sufficient enough to create nexus and therefore a filing obligation there. State taxable income for the bank is $10,000,000. 75% of the income is apportioned to Massachusetts and 25% to New Hampshire. The Massachusetts tax rate is 9% and the New Hampshire business profits tax rate is 8.2%. Therefore total tax is:

(10,000,000 * 0.75 * 0.09) + (10,000,000 * 0.25 * 0.082) = $880,000

If the bank had no nexus with New Hampshire all its income (in this example) would have been apportioned to Massachusetts and total tax would have been $900,000. Therefore, because a filing obligation exists in New Hampshire, the bank actually saved about $20,000 of income taxes.
(Please note that this example, for illustrative purposes, does not include the New Hampshire Business Enterprise Tax which is a non-income based tax that New Hampshire has in addition to its Business Profits tax.)

The bottom line

Nexus for banks in states in which they have no physical footprint is becoming increasingly common as banks lend to out-of-state residents and states implement economic nexus rules. Filing in more states can have a multitude of effects including paying more tax – or less tax. The other considerations are that, depending on the magnitude of the numbers, apportionment, tax rates, etc., there is also potential for various impacts on the effective tax rate and the deferred tax rates used in the tax accrual.

If you think your financial institution needs to look into potential nexus for a state (or states), or if you have any other questions regarding tax matters, please reach out to your BNN advisor at 800.244.7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.

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