As a small business owner, you’ve likely been introduced to all kinds of financial and legal terminology you’ve never seen before. Today’s word-of-the-day is “nexus.”
The primary usage example of “nexus” is as a legal term that refers to the obligation for businesses to collect and pay state sales taxes. However, taxing jurisdictions in the United States cannot impose sales taxes until they establish nexus—a connection between your business and local jurisdiction.
While it might sound straightforward, it’s anything but. There are a variety of circumstances that may establish a sales tax nexus for your business, even if you don’t have a physical store there. The growth of e-commerce and the explosion of online sales following the COVID-19 pandemic have also further complicated how sales tax nexus applies to businesses, and there are key elements to understand when it comes to tax compliance.
To help you sort out whether you are obligated to pay sales tax to certain states, we’ve created this guide. To understand what a nexus is, the various requirements, and why it matters for your business, keep reading. Or use the links below to jump to a specific section.
- What is a sales tax nexus?
- Nexus criteria for online sales
- How to determine if you have sales tax nexus in a state
- Why it’s important that small business owners understand sales tax nexus laws
- What to do once nexus is established
A sales tax nexus is the connection a business has with a state taxing jurisdiction, which establishes an obligation to collect and remit sales taxes in that state.
Establishing nexus has been increasingly complicated with online sales and the advent of remote sellers. This is because the taxation of online sales was just mandated in 2018—which we’ll cover in the next section. So understandably, there’s still a lot of confusion among new and established business owners as to whether nexus applies to their online sales and how they must approach sales tax collection.
Currently, 45 states collect statewide sales tax from state retailers. The other five states—Alaska, Delaware, Montana, New Hampshire, and Oregon—do not collect sales tax on a statewide basis, but some of their municipalities do.
The U.S. Supreme Court held in National Bellas Hess v. Department of Revenue and Quill Corp. v. North Dakota that states may not collect taxes on sales in a state from retailers that do not have a physical presence in the state, giving these businesses an exemption from the state business tax due.
However, according to the Journal of Accountancy, some states began replacing the traditional approach to nexus with one of “economic nexus.” This would mean that a physical presence was not required to establish nexus.
For example, New York argued that Amazon created a nexus in the state through its affiliates or NY-based online retailers that received commissions from Amazon when shoppers click through to Amazon from their websites. Other states followed suit with similar laws. These laws were known as “click-through nexus” laws.
This all changed and became much less murky in 2018 with the Supreme Court’s ruling in South Dakota v. Wayfair, Inc. This ruling upheld a law that overturned the Quill court case and enabled states to charge sales tax to out-of-state sellers, even if they don’t have a physical presence. This brings us to the present era of state sales tax nexus.
Here’s a general overview of how the state tax nexus process unfolds:
- Your business starts selling or operating in a state, such as Illinois.
- At a certain point, your business activities meet the economic or physical nexus threshold.
- Sales tax nexus is legally established.
- You are required to register as a seller in that state—this goes for every state that the sales tax nexus applies.
- You begin collecting sales tax, which you will then turn over to the state taxing authority when you pay taxes.
There are generally two different types of sales tax nexuses: physical nexus and economic nexus.
There is a physical connection between the business and the tax authority—meaning the business is located in the state. This could be a primary headquarters or secondary brick-and-mortar locations, offices, or warehouses.
However, it is important to note that physical nexus is not only based on business property. It can also pertain to sales activities via traveling personnel, remote employees, or even trade show attendance. The laws for establishing non-property physical nexus can vary from state-to-state.
In summary, physical presence can be established by:
- Owning or renting an office
- Having a mailing address
- Having a warehouse
- Having employees
- Maintaining inventory stores
- Having an affiliate
A business earns a certain amount of money in sales in the state. Economic nexus can be established regardless of physical presence because it applies to both in-person and online sales. To establish an economic nexus, there must be sufficient business activity to warrant taxation.
Economic nexus can be established by a sales dollar amount or transaction volume. In some states, both thresholds need to be met to require economic nexus.
In summary, economic nexus can be established for online retailers who meet the state’s threshold for:
- Total sales transactions
- Dollar amount sold
Physical nexus is generally easier to establish. In general, if your business operates in a state, you can establish the tax obligation.
Amazon is a good example of how the rise of online retailers has complicated nexus. Amazon now pays sales tax in 45 states, plus Washington, D.C. The only reason it doesn’t pay tax in the other five states is that these states don’t have a state level sales tax. However, Amazon does not have a physical presence in all of these states. Amazon must pay sales tax because of nexus. This is the result of a recent Supreme Court ruling, which we’ll dive into below.
Here are some examples of current state economic nexus thresholds for selling tangible property remotely:
- California: $500,000
- Arizona: $150,000
- Texas: $500,000
- Alaska: $100,000 or 200 retail sales
- New York: $500,000 and the business made more than 100 sales delivered to the state
It is important to note that these requirements can change. Check with your relevant taxing bodies at least annually to determine whether an economic nexus applies to your business. Pay special attention if you have inventory going through Amazon fulfillment centers in a given state.
While states can require businesses to pay sales taxes, not all do. Determining if you have sales tax nexus in a certain state may be easier said than done. Not only do general rules for establishing nexus vary by state, but the specifics—most importantly sales thresholds—can vary as well.
Here are a few things you’ll need to research to determine if you have a sales tax nexus in a certain state:
- Does the state have a sales tax? You need to check whether there’s a statewide sales tax and if individual municipalities are allowed to establish their own sales tax rates. If the answer is no to both, then you won’t have to research further.
- Does the sales tax nexus in the state apply to sales volume based on the number of transactions, the total dollar amount of sales, or a combination?
- Has your business met that threshold yet?
If you’re close to the sales dollars or transaction volume threshold, it’s time to start preparing to register with the state taxing authority. This is a necessary step to start charging customers sales tax.
As the business owner, you are responsible for meeting your sales tax obligations. This includes knowing whether a sales tax nexus applies to your business in any state that you operate in. Here are a few reasons understanding sales tax nexus is important:
- You are responsible for collecting sales tax from your customers. If you fail to do so, your business is the one left holding the bill for state taxes.
- You need to register for a nexus. If you fail to register for nexus in a specific state, you may be responsible for paying back taxes plus interest.
- You’re responsible for being aware of all laws pertaining to sales tax nexus. For example, businesses are not permitted to advertise that they don’t collect sales tax merely because they have not established nexus. So, you can’t state that you have the lowest prices around because you don’t charge sales tax.
Some states can be quite aggressive about pursuing sales tax nexus because it means more revenue for them. If you think there’s a chance you may have missed a nexus registration, a tax professional can help you by performing a nexus study.
Nexus studies can reveal the date you should have registered, determine what your current tax exposure is, and identify how to limit past liabilities. So long as you’re forthcoming about your failure to apply for a nexus, you will likely need only to repay the taxes owed with a small percentage added on. In an effort to get companies to register, some states also offer tax amnesty periods, during which you register and may be relieved of obligation for past liabilities.
As we mentioned, it’s your responsibility as a business owner to ensure you’re complying with tax laws. This includes paying sales tax to states where there’s a nexus established. Nexus obligations can be confusing with all the different state requirements and how they may apply to your business. However, it’s essential that you understand what sales taxes you’re responsible for.
Once you’re aware that the state’s nexus threshold has been met—whether that’s in sales volume by dollars or transactions—you will need to:
- Register with the state’s tax authority. Your accountant can help you determine where you need to register.
- Start collecting sales tax ASAP. Keep in mind that there are circumstances where sales tax does not apply to certain products or buyers.
Research the state’s sales tax rate to ensure you’re charging the right amount. If you have physical nexus, check the local jurisdiction’s rate.
- This is essential because local tax rates can significantly increase your overall sales tax rate.
- For example, Tennessee’s statewide sales tax is 7%. However, in certain jurisdictions, combined sales tax can be as high as 9.75%.
- Because you met the nexus treshold, keep track of all the sales taxes you’ve collected throughout the period.
- File your sales taxes by the due date. Each state may have their own due date, so double-check the filing deadline. Note that your business may be required to file a sales tax return for periods you didn’t collect sales taxes.
- Pay sales taxes owed by your business based on sales. This is where good organization comes in handy, because you’ll need to total all sales tax collected
Figuring out the sales tax rate based on the state, the type of product, and other factors can be difficult, especially if it’s new to you. Plus, you have to keep track of all the sales taxes you’ve collected for the period, which presents its own challenges—that is, unless you have an automated system calculating, tracking, and organizing all this information for you.
With QuickBooks, you can easily manage sales tax, so you’ll never have to wonder whether you’re collecting the right state taxes. We keep track of the ever-changing sales tax laws so you don’t have to. That way, you can get back to focusing on what’s important, managing and growing your business.
Managing your sales tax obligations
If you own a business, sales tax nexus is something that you should be very much aware of. Business owners often don’t realize that nexus has been established in a state and that they owe sales tax. Using reliable accounting software like QuickBooks, can go a long way toward helping you maintain compliance and pay money that you owe.
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