Nexus is the connection between a business and a state that allows the state to impose tax on the business. Economic nexus has gained particular importance in the years following the South Dakota v. Wayfair decision, which created a precedent for states imposing sales tax on out-of-state businesses selling in their state. Additionally, online sales pose new challenges for businesses in determining where they have triggered nexus.
Economic Nexus: Sales & Use Tax
The South Dakota v. Wayfair decision was particularly relevant for economic nexus as it relates to sales tax. As of January 1, 2023, all states that impose a sales tax have a threshold that, when met by out-of-state retailers, allows the state to impose sales tax on the business. These thresholds, generally, are either a certain amount of gross sales or a certain number of transactions sold to customers within the state. Missouri was the final state to impose this kind of threshold.
For your business, for states in which you have surpassed that state’s threshold, this will result in you having to collect sales tax from your customers and remitting this to the state. It is important to stay up to date on the thresholds in each state if your business sells to several states – you may have new sales and use tax requirements as your business grows. You can reference this economic nexus by state chart for the most up-to-date information regarding economic nexus thresholds for sales and use tax.
Economic Nexus: Income Tax
While nexus is a significant factor in sales and use tax considerations, it is also important when determining the states in which your business will have an income tax filing requirement. Each state has its requirements for what creates nexus. Some states place emphasis on having employees or physical property located in the state, while most focus on a business having substantial economic activity in the state. This is called having an “economic presence.”
Economic nexus for income tax purposes is limited by P.L. 86-272, which prohibits a state from imposing income tax on a business if its only activity in the state is the solicitation of orders for tangible personal property. It’s important to note that many states have explicitly listed transactions that aren’t protected under P.L. 86-272, and therefore will trigger economic nexus in that state. Examples include the sale of intangible goods, such as software, leasing property and providing repairs or maintenance within the state.
What is Physical Nexus?
Physical presence in a state, such as employees, inventory or office space, automatically creates nexus, often referred to as “physical nexus.” If a physical nexus is established, you must register, collect and remit sales tax, regardless of whether you meet the state’s economic thresholds. Having even one employee working in a state creates nexus, as can independent contractors or agents acting on your behalf. Leasing or owning property, including inventory stored in a warehouse, will also create nexus obligations.
Internet and Website-Based Activities
In 2021, the Multistate Tax Commission (MTC) issued its fourth revision to P.L. 86-272; this focused on internet and website-based activities as they relate to economic nexus. The MTC stated that “as a general rule, when a business interacts with a customer via the business’s website or app, the business engages in a business activity within the customer’s state.” In their guidance, certain examples, such as use of chatbots, cookies and accepting applications through the website, aren’t protected under P.L. 86-272 and will therefore create economic nexus in a state.
With so many sales taking place online, the landscape of economic nexus is changing – it’s not as easy to determine when you have an economic presence in a state. It’s important to stay up to date on the latest rulings and work with a tax advisor to determine where your business may have a filing requirement.
State Registrations
Economic nexus laws require businesses to register and collect sales tax in states where their economic activity exceeds the specified threshold. To determine if you’re registered where you need to be:
- Regularly monitor your gross sales and transaction counts for each state where you operate.
- Understand state-specific rules because each state sets its own thresholds which may differ from federal standards or neighboring states.
- Once you surpass a state’s economic nexus threshold, you are generally required to register, collect and remit sales tax moving forward, so moving quickly to prepare for these actions is vital.
Failing to register promptly can result in fines, interest and back taxes, so periodic compliance checks are essential.
Surpassing Sales Thresholds
After your business surpasses a state’s economic nexus thresholds, it triggers an obligation to:
- Register with the state’s tax authority
- Collect sales tax
- File and remit taxes
Act as soon as you exceed a threshold. Delays in compliance can result in unexpected tax liabilities and damage to your reputation. Working with a tax professional can simplify this process and ensure all filings are accurate and on time.
Impact of Sales and Marketing on Nexus
Some business activities, such as marketing and sales solicitation, can also trigger nexus. These activities are known as affiliate or click-through nexus in some states. Examples include:
- Sending employees or contractors to a state for sales presentations or client meetings
- Marketing efforts in which an in-state partner refers customers to your business via links or a website in order to purchase tangible personal property or services from the out-of-state business
- Repeatedly attending trade shows or events in a state may also establish nexus, depending on the level of activity
Consider documenting all in-state activities and consulting with a tax advisor to evaluate your nexus obligations. Serious consequences can arise if your business is subject to state nexus obligations that aren’t quickly addressed.
Anders State and Local Tax advisors work closely with clients to help determine your tax obligations while guiding you towards solutions that help lower your tax burden. Learn more about our services, and the associated costs, by requesting a meeting below.
