The Basics of Determining Nexus in a State

Nexus represents the connection between a business and a taxing jurisdiction that gives the jurisdiction authority to impose taxes on that business. In today’s digital economy, understanding nexus has become increasingly complex yet crucial for tax compliance. This guide will help you navigate the multifaceted world of state tax nexus determination.

Nexus refers to the sufficient minimum connection a business must have with a state before that state can legally impose its tax laws on the business. When your business establishes nexus in a state, you may be required to: - Collect and remit sales and use tax - File income or franchise tax returns - Comply with other state-specific tax obligations - Register with the Secretary of State or similar agency

Nexus rules vary by both state and tax type, adding layers of complexity to multi-state business operations.

Physical nexus is established when a business has a tangible presence in a state. This traditional form of nexus includes: - Maintaining an office, warehouse, distribution center, or retail location - Employing sales representatives, service technicians, or other workers in the state - Storing inventory in the state (including inventory in Amazon FBA warehouses) - Owning or leasing real or personal property in the state - Delivering goods in company-owned vehicles - Attending trade shows or conferences on a regular basis

Example: A California-based retailer opens a small showroom in Nevada. This physical presence immediately creates nexus in Nevada, requiring the business to register for and comply with Nevada’s sales tax laws, regardless of the showroom’s size or revenue generated.

Following the landmark Supreme Court decision in South Dakota v. Wayfair, Inc. (2018), states can now impose tax obligations on businesses that exceed certain economic thresholds, even without physical presence. Economic nexus is typically based on: - Sales revenue in the state (commonly $100,000-$500,000 annually) - Number of transactions in the state (often 100-200 transactions)

These thresholds vary by state and can apply differently to sales tax versus income tax.

State-Specific Examples: - California: $500,000 in sales for sales tax purposes - New York: $500,000 in sales and 100 transactions for sales tax - Texas: $500,000 in sales for sales tax and franchise tax - Florida: $100,000 in sales for sales tax purposes

Example: An online retailer based in Oregon (which has no sales tax) sells $250,000 worth of products to customers in Washington state. Despite having no physical presence in Washington, the company exceeds Washington’s economic nexus threshold and must register to collect and remit Washington state sales tax.

Most states have enacted marketplace facilitator laws that shift the sales tax collection obligation from third-party sellers to the marketplace itself (like Amazon, eBay, or Etsy). However, these laws don’t necessarily eliminate all nexus concerns for marketplace sellers.

Important considerations for marketplace sellers: - While the marketplace may handle sales tax on marketplace sales, direct sales from your website still trigger nexus obligations - Some states still require marketplace sellers to register even if the marketplace collects the tax - Income tax nexus can still be created even if the marketplace handles sales tax collection

Example: A small business sells products both on Amazon and through its own website. Amazon collects sales tax on the marketplace sales, but the business must still evaluate whether its total sales (including marketplace sales) create economic nexus requiring it to collect sales tax on its direct website sales.

Click-through nexus is created when an in-state business refers customers to your business via links on their website, and you pay them a commission for sales generated from these referrals. These are sometimes called “Amazon Associate” or “affiliate marketing” relationships.

Requirements typically include: - In-state referrers who receive compensation for directing customers to your business - Sales generated through these referrals exceeding a certain threshold (often $10,000 annually)

Example: A New York-based blogger promotes products with affiliate links to an out-of-state online retailer. If the retailer pays commissions to the blogger and generates more than $10,000 in annual sales through these links, the retailer could have click-through nexus in New York.

Affiliate nexus occurs when a business has corporate affiliates operating in a state who perform certain activities on behalf of the out-of-state business. This can include: - Shared branding between in-state and out-of-state entities - In-state affiliates providing services that help maintain a market in the state - Common ownership between in-state and out-of-state businesses

Example: A retail corporation operates stores under one legal entity in Texas and has a separate legal entity for its e-commerce operations based in Delaware. The Texas stores accept returns of items purchased online. This relationship could create affiliate nexus for the e-commerce entity in Texas.

Public Law 86-272 is a federal law that limits a state’s ability to impose income tax on out-of-state businesses when their only activity in the state is soliciting orders for tangible personal property that are approved and shipped from outside the state.

Key limitations: - Applies ONLY to income tax (not sales tax, franchise tax, or gross receipts tax) - Protects ONLY sellers of tangible personal property (not services or digital products) - Activities must be limited to solicitation of orders

Example: A manufacturing company based in Michigan sends salespeople to Illinois to solicit orders that are approved at and shipped from the Michigan office. As long as these salespeople don’t engage in activities beyond solicitation (like providing technical support or training), the company may be protected from Illinois income tax under P.L. 86-272.

A thorough nexus study involves: - Mapping all business activities by state - Documenting physical presence factors - Analyzing sales data by state - Reviewing affiliate and marketplace relationships - Comparing findings against state-specific thresholds

Each state defines nexus differently. Resources to check include: - State department of revenue websites - Multistate Tax Commission guidelines - Tax research databases (like CCH, RIA, or Bloomberg Tax) - Industry association resources

Establish ongoing monitoring of: - Sales by state (both revenue and transaction count) - Employee travel and activities - Inventory locations - Changes in state nexus laws

Once nexus is identified: - Prioritize registration based on risk factors - Consider voluntary disclosure agreements for historical exposure - Implement systems for ongoing compliance - Document nexus determinations and decision process

Due to the complexity and constant evolution of nexus rules, working with tax professionals who specialize in state and local taxation is highly recommended.

If you discover you have established nexus in a state where you haven’t been filing, a VDA can help limit exposure: - Most states offer VDA programs with limited lookback periods - Penalties are typically waived - Interest may be reduced - Some anonymity is provided during the initial process

Example: A business discovers it created nexus in Colorado three years ago but hasn’t filed any tax returns. Through Colorado’s VDA program, the company might only need to file returns and pay taxes for a limited lookback period (often 3-4 years) with no penalties.

Business structure can impact nexus determinations: - Separate legal entities for different functions (e.g., holding company structures) - Intercompany agreements documenting relationships - Proper implementation of economic and operational separation

Caution: States increasingly challenge artificial separation of entities with anti-tax avoidance provisions and economic nexus concepts.

• SaaS and cloud computing present unique nexus challenges
• Server locations may create physical nexus
• Software licensing vs. service classification varies by state

• Marketplace facilitator laws affect compliance responsibilities
• Drop-shipping arrangements may create nexus
• Flash or pop-up stores create temporary physical nexus

• Installation, repair, and warranty work often create nexus
• Consignment inventory arrangements create physical nexus
• Trade shows can establish temporary nexus

Failing to address nexus issues can lead to significant consequences: - Back taxes for all open tax periods (up to 10+ years in some states) - Penalties (up to 25-50% of tax due) - Interest (which continues to accrue during audits) - Increased audit risk as states share information - Personal liability for responsible parties in some cases - Potential obstacles during business sale or financing

Since the 2018 Wayfair decision, states have continuously refined their nexus standards: - Increasingly aggressive enforcement of economic nexus - Expansion to other tax types beyond sales tax - Decreased threshold amounts in some jurisdictions - Enhanced data sharing between states

The taxation of digital products continues to evolve: - More states asserting nexus for digital goods and services - Marketplace facilitator laws expanding to cover digital marketplaces - International adoption of digital services taxes creating additional complexity

Businesses with international operations face additional complexities: - Permanent establishment rules in foreign jurisdictions - Value-added tax (VAT) registration requirements - Treaty considerations that may override local nexus rules - Special economic nexus thresholds for foreign entities in some states

Understanding nexus is no longer optional for businesses operating in multiple jurisdictions. As states continue to expand and refine their definitions of nexus, businesses must stay vigilant about their multistate tax obligations.

A proactive approach to nexus determination—including regular reviews, documentation of decision processes, and consultation with tax professionals—is essential for proper tax compliance and risk management. When in doubt, seeking qualified professional guidance is the best way to navigate the complex landscape of state tax nexus.

Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or business advice. Call Now For A Free Consultation – 720.878.2280

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