State taxes used to be simple. You have a store in Chicago; you pay Illinois tax. You have a warehouse in Indianapolis; you pay Indiana tax. But what if you have sales people visiting Denver? Or you work with an online reseller with a location in Denver? Do you need to pay Colorado tax? The tax term used when determining in which localities a business must pay tax is called nexus. How nexus works often stumps even the most tax-savvy business owners, especially with the impact of online sales and constantly changing rules. By understanding and correctly determining nexus, you can avoid unnecessary penalties.
What is nexus?
Simply put, nexus is the factor that dictates a states’ ability to assess tax. Nexus, or sufficient presence, is determined by a number of factors, including a business’ temporary or permanent presence of people or property in a state.
- People can include employees, service people, independent sales agents and independent service agents.
- Property can include inventory, offices, warehouses and temporarily consigned physical space.
- Temporary presence can include making sales calls, visiting customers or attending trade shows.
How is nexus determined?
Some aspects of nexus are clear. For example, if a business has a permanent location in a particular state, there is no federal limitation on a states’ ability to subject the business to income tax. Beyond the obvious, however, each state defines nexus in its own way, and differently for different tax types.
For example, states may consider the following when determining nexus:
- If products are sold in a particular state but there is no physical presence or employees in that state, the business is exempt from that state’s income tax, but may owe sales tax.
- If a business physically sends sales people to a different state, they would generally owe sales tax in that state. However, if the salesperson conducts the entire sale from one state, and there is no other connection to the other state, the business would only owe sales tax in the state in which they conducted the sale.
- Some states may charge sales tax to online resellers. Because online sales are still relatively new to the business world, click-through nexus rules are one of the most complicated and debated areas of state tax.
- Most states consider nexus present if delivery is made in a state using the business’ own vehicles. Using a common carrier can help to limit nexus.
Why are nexus definitions changing?
States’ definitions of nexus are adapting to evolution in technology. Constantly changing technology changes the way we do business. As online sales grow, businesses conduct more and more business out of state. In addition, advances in technology make it easier for states to collect information about sales occurring within their state.
Additionally, given budget constraints, states are becoming more aggressive in seeking out additional tax revenue.
How do changes in nexus impact the small business owner?
The lack of a consistent definition of nexus state-to-state creates confusion and exposure to tax liability. Small businesses with little to no internal accounting departments may not have the time or the expertise to properly assess nexus. For businesses with interstate activity that only file a home state tax return, the potential tax exposure and tax complexity can be a significant cause for concern.
How does what’s next for nexus impact you?
A federal nexus definition has been spoken of for years, but thus far has not become a reality. In the meantime, it’s important for business owners to understand their risk. Consult with an accountant to determine how nexus is defined in the states in which you do business. Find out if you need to register to do business in other states or file additional state tax forms. Explore voluntary disclosure programs and statutes of limitations. Most importantly, any time you have a question about whether or not you have nexus in a particular state, check in with your accountant. Don’t be stumped by your nexus questions. Contact us today.