What Is Nexus and How Does It Affect Your Small Business?

profile_Publicity_photo by Katherine Gustafson on February 11, 2014
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Nexus, also called “sufficient physical presence,” is a legal term that refers to the requirement for companies doing business in a state to collect and pay tax on sales in that state. For example, if you sell goods or services in Los Angeles, you must file and pay California state taxes.

It sounds relatively simple, but it’s anything but. Before the advent of e-commerce, physical presence in a state was fairly straightforward. But the rise of online retail — dominated by Amazon and its extensive affiliate network — has prompted states to find new ways to collect sales and income taxes from companies that conduct business virtually. Amazon now pays sales tax in 19 states, though it has long argued it has a physical presence in only a few of them.

What’s the Story?

The U.S. Supreme Court held in National Bellas Hess v. Department of Revenue (1967) and Quill Corp. v. North Dakota (1992) that states may not collect taxes on sales in a state from retailers that do not have a physical presence in the state.

To get around this, according to the Journal of Accountancy, some states are replacing the traditional approach to nexus with one of “economic nexus,” which emphasizes financial dealings in a state above physical presence. For example, New York asserts that Amazon created nexus in the state via its affiliates, or N.Y.-based online retailers that receive commissions from Amazon when shoppers click through to Amazon from their websites. Other states have followed suit with similar laws.

Due to this and other changes, the definition of “nexus” differs from state to state and continues to evolve as governments try to capture revenue from online sales.

“Craziness Happening”

“There is craziness happening around nexus definitions,” says Derek Sasaki, co-founder and president of My Pet Chicken, which maintains employees in multiple states and does all of its business online. “Ninety percent of changes are related to Amazon.”

He relates how his company used to store some inventory in Pennsylvania but had no employees based there. For a while, the company wasn’t required to pay sales taxes there, but then the state changed its definition of nexus to require businesses storing inventory in the state to pay. My Pet Chicken was suddenly on the hook to file, a process that took time and money to execute. The company has considered moving its warehouse out of the state, but has stayed in Pennsylvania due to its satisfaction with its fulfillment company there and the cost and time it would take to move. Sasaki estimates that moving to another state would probably net out to about the same as paying the taxes does.

In some states, the rules are convoluted or unsettled. For example, the Journal of Accountancy reports that even the payment of a fee to a local office for a trademark may establish nexus, as might a teacher handing out a company’s book-order form in a local school. In Alabama, the creation of nexus hinges on the definition of “salesman,” which the law does not sufficiently clarify.

Efforts to Bring Order

A bill passed by the Senate in April 2013 (S. 743: Marketplace Fairness Act of 2013) would require all online companies to collect and remit sales tax in states where they do more than a million dollars in annual revenue, a change that would provide a single standard for sales tax laws.

There is also an effort to establish a Streamlined Sales and Use Tax Agreement, which would simplify and standardize state tax laws, reducing the confusion and easing the burden on small businesses. Twenty-four states have signed on so far.

“I am fine with that idea that we have to collect and remit sales tax in all states to kind of level the field,” Sasaki says. “The problem is the amount of accounting that would go into it. In California, for example, it’s unbelievably complicated. It takes four hours each month to file this stuff. It’s a huge burden on small, online businesses if they have to collect taxes in 40 states.”

A good solution, he believes, would be “one location you could send [all sales taxes] to that would then distribute them.”

What “Nexus” Means for You

If your company operates in multiple states — and especially if you operate online — look out for changes in state tax laws that may affect you.

Regularly review the state tax profile to make sure you are filing sales tax returns everywhere you are required to do so. Pay special attention if you have inventory going through Amazon fulfillment centers in a given state.

Of special note: The Journal of Accountancy advises that if you have nexus in a state for sales tax, your nexus might not also apply to income tax. Income-tax nexus often requires a more intense level of business dealings in a state.

To say the least, figuring this out and satisfying all the requirements can be a confusing, time-consuming process. You may want to consider hiring a qualified accountant and/or tax attorney help you.

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Katherine Gustafson is a freelance writer based in Seattle, Washington, who loves writing about small business and entrepreneurship. Her first book, Change Comes to Dinner, explores the way entrepreneurs and other visionaries—from greenhouse innovators to no-till wheat farmers—are changing the business of food.

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