How to Handle Sales Tax Nexus Issues

Sales tax nexus is the connection between a business and a state that requires the business to collect and remit sales tax. The rise of e-commerce has magnified its importance, transforming how businesses approach their tax obligations across the country. Navigating these requirements is a process that involves identifying where you have nexus, registering, and managing ongoing compliance.

Understanding Nexus Triggers

A business can establish a sales tax obligation, known as nexus, in a state through several distinct activities. These triggers vary by jurisdiction, requiring businesses to evaluate their operations against each state’s specific rules.

Physical Presence Nexus

The traditional standard for creating a sales tax obligation is a physical presence, established when a business has a tangible footprint within a state’s borders. Common examples include maintaining an office, storefront, or warehouse. Having employees who work from the state, even from a home office, also constitutes a physical presence.

Other activities that create physical nexus include sending traveling salespeople into a state or storing inventory there. Participation in fulfillment programs like Fulfillment by Amazon (FBA) is an example of storing inventory. When a business uses such a service, its products may be stored in warehouses across multiple states, creating a physical presence and a tax obligation in each of those locations. Attending trade shows to make sales can also trigger physical nexus.

Economic Nexus

A more recent standard is economic nexus, which is based on a business’s sales revenue or transaction volume within a state. This concept became widespread following the 2018 Supreme Court decision in South Dakota v. Wayfair, which allowed states to mandate tax collection from remote sellers who meet certain economic thresholds.

These thresholds differ by state but commonly follow the model of $100,000 in gross sales or 200 separate transactions into the state within the previous or current calendar year. A business does not need any physical location or employees in a state to trigger economic nexus. If its sales or transaction volume surpasses a state’s specific threshold, it is required to register and collect sales tax.

Other Nexus Types

Beyond physical and economic connections, other activities can create nexus. One such trigger is “affiliate nexus,” which is established when a business has a relationship with an in-state company that helps generate sales, such as a subsidiary with a physical presence in the state.

Another form is “click-through nexus,” which applies to online retailers. This is created when an out-of-state business receives customer referrals from a link on an in-state company’s website and pays a commission for resulting sales. If sales from these in-state referrals exceed a state’s monetary threshold, the remote seller is considered to have nexus.

How to Determine Your Nexus Footprint

A business must identify every state where it has nexus. This process, often called a nexus study, involves a detailed review of a company’s activities and sales data to pinpoint its connections to each state. A thorough study provides a clear picture of where tax responsibilities exist and the potential financial exposure from past-due taxes.

Information Gathering

To begin a nexus study, you will need to compile gross sales revenue figures for both the current and previous calendar years, broken down by the state where the customer is located. You must also assemble the total number of individual sales transactions for the same periods, also organized by state.

Beyond sales data, document all owned or leased properties, such as offices and warehouses. You must also record the locations of all employees and independent contractors, including the home addresses of remote workers. Create a detailed list of every location where your inventory is stored, including third-party logistics (3PL) providers and FBA warehouses.

Analysis

Once the information is gathered, analyze it against each state’s nexus laws. This involves comparing your sales and transaction data to each jurisdiction’s economic nexus thresholds. You must also review your physical presence data, including the locations of employees, offices, and inventory, to identify where you have a physical connection.

The Sales Tax Registration Process

After completing a nexus study and identifying the states where a tax obligation exists, the next step is to register for a sales tax permit in each of those jurisdictions. It is illegal to collect sales tax from customers without first being properly registered with the state’s tax authority.

Methods of Registration

Businesses have a couple of primary options for registration. The most direct method is to register individually with each state’s Department of Revenue, as most states offer an online registration portal. This approach allows a business to register only in the specific states where it has confirmed nexus.

For businesses with nexus in many states, a more efficient option may be to use a streamlined, multi-state registration system. The Streamlined Sales and Use Tax Agreement (SSTP) offers a single, free online application that allows a business to register in its 23 full member states at once. This simplifies the initial paperwork, though businesses are still responsible for filing returns directly with each state after registration.

Post-Application

After submitting a registration application, the state will process it and issue a sales tax permit. Along with the permit, the state will assign a filing frequency, such as monthly, quarterly, or annually, often based on the volume of sales. The state will also provide login credentials for its online tax portal. Securely store the permit number and online account information, as they are needed for all future filings.

Managing Ongoing Sales Tax Obligations

Once a business is registered for a sales tax permit, it must adhere to a recurring cycle of compliance tasks. This is a continuous process of calculating, collecting, filing, and remitting sales tax for each jurisdiction where nexus exists.

Tax Collection

The first step in ongoing compliance is to accurately calculate and collect sales tax at the point of sale. This requires configuring your e-commerce platform or point-of-sale system to apply the correct tax rate for each transaction. The complexity arises from the thousands of different tax jurisdictions across the country, with rates that can vary by state, county, and city.

Adding to the complexity are the different rules regarding the taxability of products and services. For example, some states exempt items like groceries or clothing from sales tax. Sourcing rules also differ; some states are “origin-based,” where tax is charged based on the seller’s location, while most are “destination-based,” where the tax rate is determined by the buyer’s location.

Filing Sales Tax Returns

After collecting the tax, businesses must report their sales activity by filing a sales tax return with each state where they are registered. The return details the company’s total sales, taxable sales, and the amount of sales tax collected during a specific reporting period. Late filings can result in penalties and interest charges. Businesses must file a return for every period, often referred to as a “zero return,” even if they had no sales in that state.

Remitting Taxes

The final step is to remit the sales tax that was collected from customers to the respective state tax authorities. This payment is made at the same time the sales tax return is filed. Most states require electronic payment through their online tax portals or via an ACH transfer. The sales tax collected is held in trust for the state and is not the business’s money. Failing to remit these funds on time can lead to severe consequences, including personal liability for business owners.

Automation

For businesses with nexus in multiple states, manually managing these ongoing obligations can be overwhelming. Sales tax compliance software can automate many of these tasks. These systems can integrate with e-commerce platforms to perform real-time tax calculations, track varying rates and rules, and automatically file returns and remit payments. Leveraging automation can significantly reduce the administrative burden and minimize the risk of costly mistakes.

Resolving Past Nexus Liability

During a nexus study, a business may discover it had a sales tax obligation in a state for a prior period but failed to register and collect the tax. This creates a past liability for uncollected taxes, which can be a significant financial risk. States can identify non-compliant businesses, leading to audits and assessments for back taxes, along with penalties and interest.

Voluntary Disclosure Agreements (VDAs)

The primary mechanism for resolving this historical liability is a Voluntary Disclosure Agreement (VDA). A VDA is a formal, binding agreement between a business and a state tax authority. To be eligible, the business must not have been previously contacted by the state regarding the liability.

The VDA Process and Benefits

The VDA process begins with an application, often submitted by a tax professional on the business’s behalf, to negotiate terms. Once an agreement is reached, the business quantifies the tax owed for a defined period, files the back-returns, and pays the tax due. The main benefit of a VDA is that states will almost always waive penalties.

Another benefit is a limited “look-back” period. Instead of assessing taxes for every year the business had nexus, the state agrees to limit the liability to a shorter period, typically three to four years. This can result in considerable savings if nexus existed for a much longer time.