State Tax Nexus: Frequently Awkward Questions

Mark Hugh, CPA

In the last two years, 43 states have expanded their rules regarding tax “nexus”, whether a business has to collect and/or pay state taxes to a state. The requirement for compliance has exploded with now smaller businesses having multiple tax connections to multiple jurisdictions, even with very limited activity and very limited contact.

If you have not reviewed your filing obligations within the last two years, it is important to review them immediately. As a guide we present the following FAQ: Frequently Awkward Questions.

What is nexus? A “sufficient link” or “tie” with the power of a jurisdiction to tax. Nexus is created by transitory activities such as visits to a state, as well as permanent activities such as having an employee or inventory in a state, or recently, merely a certain amount of transactions or sales made in a state. South Dakota required sellers with no physical presence

Is this a sales tax thing or an income tax thing? Nexus is an every "thing". These rules apply to all taxes, and taxing authorities may use different standards internally for different types of taxes. This has created an explosion of new nexus standards: based upon net income. It provides a state

What are common nexus standards? “Physical presence” or “economic nexus” and states are free to pick and choose one or all. Many states have chosen both.

What is physical presence? “Physical presence” is generally property or employees/independent contractors within a state on even a transitory basis, or in-state activities to establish or maintain a market.

In Scripto Inc v. Carson (1960), the U.S. Supreme Court held that third parties create nexus and whether salespeople were employees or not was “without constitutional significance”. It noted “to permit such formal ‘contractual shifts’ to make a constitutional difference would open the gates to a stampede of tax avoidance”.

Illustrations: © iStock/ojogabonitooProperty in a state on a permanent or temporary basis; an employee in a state on a permanent or temporary basis; soliciting sales in a state by an employee or by using an agent; or installing, assembling, or repairing goods in a state. What is economic nexus? Affirmed by the U.S. Supreme Court in Wayfair et. All v. South Dakota (2018), a seller with no physical presence in a state is required to collect or pay taxes to a state if sales or transactions sourced to a state are over certain annual thresholds.

to collect and remit sales tax if annual South Dakota sales exceeded $100,000 or 200 or more annual South Dakota transactions.

since 2018, 43 of the 45 states that impose sales taxes have adopted economic nexus standards, many similar to South Dakota’s.

Are there any federal protections? One very old federal law still applies to state income taxes. The Federal Interstate Income Act of 1959, known as P.L. 86-272, provides a safe harbor for taxes What are examples of physical presence?

income tax safe harbor for: soliciting orders; for sales of tangible personal property; with the orders sent outside a state for acceptance; and filled by shipment or delivered from outside a state.

What does P.L. 86-272 not apply to? Business taxes not based upon net income, such as Delaware, Hawaii, Nevada, Ohio, Oregon, Texas, Washington; minimum taxes in any state such as the California minimum tax; sales of other than property such as services or royalties; or sales taxes.

What financial information should I review? Gross income by jurisdiction, generally sourced to the customer location or the delivery location; gross income should be separated by service and property; and gross income should be separated by whether at wholesale or retail.

For sales tax purposes, it is important to review the number of state sourced transactions per year. Under general Wayfair standards, the test is more than $100,000 of annual sales in a state OR more than 200 annual transactions in a state. An average transaction of $50 in a state times 200 annual transactions creates an obligation to collect the sales tax with total annual sales in a state of only $10,000.

What else to think about?

There is a reasonable connection between the amount of gross sales in a state and the marketing activity in that state, higher gross sales usually mean more marketing activities and connections in a state. Employees based in or entering any state generally creates nexus unless narrowly protected under P.L. 86-272. Ownership of property always creates nexus.

Low gross sales states may result in low income tax, potentially immaterial, but sales tax may be more material, as based upon gross amounts and new Wayfair based standards apply to a low level of activity or transactions in a state. What about materiality? Materiality is for CPAs, not state taxing authorities. Even in low gross receipt states, if nexus exists, taxing authorities want returns with no or low activity, as state and local governments fiercely defend their sovereign taxing power, and relief runs through unfavorable state and local courts.

Mark Hugh, CPA, is the principal of Mark Hugh PLLC. You can contact him at mark@markhugh.com.

Learn more from Mark

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