Physical Nexus and Sales Tax: A Comprehensive Guide to Compliance in 2025

In today’s rapidly changing business world, staying compliant with sales tax laws is more important than ever. One key concept that can significantly affect your compliance obligations is “physical nexus.” 

Physical nexus is what determines if your business must collect and remit sales tax in a state based on physical presence (such as employees, property, or inventory). Whether you run an e-commerce store, a hybrid business, or operate in multiple states, understanding whether there is a “physical nexus” is crucial to avoid penalties and ensure compliance.

This guide covers everything you need to know about the physical nexus in 2024 from the basics to state-specific rules, how to calculate your tax obligations, and the difference between physical and economic nexus. So let’s get started and keep your business on track!

Basics of Physical Nexus in Sales Tax

It’s important to understand how the physical nexus in sales tax works, as it decides when a business needs to collect and remit sales tax in a state. This happens when a business has a physical presence, such as employees or inventory, in that state. Let’s take a closer look at what physical nexus is and how it affects businesses operating in different states.

What is the Physical Nexus in Sales Tax?

Physical nexus refers to a business’s obligation to collect and remit sales tax in a state based on its physical presence within that state. This presence can take various forms, including having employees, inventory, or property located in the state. When a business meets certain physical presence criteria, it is considered to have a nexus in that state and is required to follow the state’s sales tax rules.

For example, a company based in Delaware may have remote employees working from New York. Even though the company is physically located in Delaware, it would still be obligated to collect sales tax on sales made to New York residents because it has a physical nexus in New York.

Another example is Amazon FBA (Fulfillment by Amazon) sellers who store inventory in Amazon warehouses across various states. If a business stores inventory in a warehouse in, say, Texas, it would have a physical nexus in Texas, making it subject to Texas sales tax laws.

Who is Affected by the Physical Nexus?

Physical nexus affects businesses of all types, including:

1. E-commerce businesses: Online retailers with employees or inventory in a state will have a nexus in that state.
2. Brick-and-mortar businesses: Traditional businesses with a physical store, warehouse, or office in a state will be subject to local sales tax laws.
3. Hybrid businesses: Companies that operate both online and in physical locations (like a retail store and an online shop) may have nexus obligations in multiple states based on their physical presence.

Industries most likely to face nexus obligations include:

1. Retail: Whether it’s a small shop or an online marketplace, retail businesses are heavily affected by physical nexus rules, especially if they have multiple locations or warehouses.
2. Services: Similarly, service-based businesses with employees, contractors, or physical offices in different states may also encounter nexus concerns.
3. Manufacturing: Manufacturers with operations or inventory in different states will need to navigate varying nexus requirements, potentially impacting their tax responsibilities.

When Does Physical Nexus Apply?

Physical nexus applies when a business has sufficient physical presence or activity in a state to trigger sales tax obligations. This typically includes:

1. Employees: Having employees working in a state, even remotely.
2. Inventory: Storing goods or inventory in a state (e.g., in warehouses or fulfillment centers).
3. Property: Owning or leasing property (such as offices, warehouses, or equipment) in a state.
4. Trade Shows and Events: Participating in physical trade shows or events in a state may also establish a nexus.

Once a physical nexus is established in a state, the business is required to collect and remit sales tax for sales made within that state.

Where Does Physical Nexus Apply?

Physical nexus rules vary significantly from state to state, with each state having its own threshold and criteria for when the nexus is triggered. Some states have strict rules and low thresholds for nexus, while others have more lenient standards.

Here are a few examples of how physical nexus rules apply in key states:

1. California: To trigger a physical nexus, businesses must have either employees or inventory in the state, in addition to meeting a strict $500,000 revenue threshold in sales made within the state (Source: California Department of Tax and Fee Administration, or CDTFA).
   
   
2. Texas: Businesses must have $100,000 in revenue or property (such as inventory) in the state for nexus to apply. This rule ensures that businesses with a significant physical presence, whether through employees or inventory, are required to comply with Texas sales tax laws (Source: Texas Comptroller of Public Accounts).
   
   
3. New York: The state requires both $500,000 in sales and 100 transactions in a given year to establish nexus. In addition to meeting these revenue and transaction thresholds, businesses must have employees or inventory in the state to trigger nexus (Source: New York State Department of Taxation and Finance).

It’s important for businesses to be aware of these specific rules and thresholds in every state where they operate, as failing to comply could lead to severe penalties.

Why Understanding Physical Nexus is Important for Any Business in the US

Understanding “physical nexus” is essential for businesses with a multi-state presence. Here's why:

Advantages:

1. Avoid Penalties: Staying compliant with sales tax laws helps prevent costly penalties and interest charges for non-compliance.
2. Maintain Compliance: By understanding and adhering to state-specific nexus rules, your business reduces the risk of legal issues and audits.
3. Ensure Competitiveness: Compliance ensures your business doesn’t face unexpected tax liabilities that could impact pricing and market competitiveness.
4. Manage Risk: Proactively managing nexus obligations minimizes the risk of audits, investigations, and back taxes owed to multiple states.
5. Tax Planning: Clear understanding of nexus helps with budgeting and tax planning, ensuring tax obligations are accounted for in your business operations.

Disadvantages:

1. Complexity: Nexus rules vary by state, making compliance complicated and requiring careful tracking of different criteria and thresholds.
2. Increased Costs: Navigating nexus obligations often requires additional resources, such as tax professionals, system updates, and state registrations, raising operational costs.
3. Risk of Audits: The more states you have nexus in, the greater the risk of audits, which could lead to significant financial and legal consequences.

Physical Nexus Sales Tax Thresholds

Thresholds determine when a business must start collecting sales tax in a state. These thresholds vary widely between states and can be based on either sales volume or the number of transactions.

For example:

1. Revenue Thresholds: Some states require businesses to collect sales tax if their annual sales exceed a certain amount. For instance, this threshold is $500,000 in California.
2. Transaction Thresholds: Other states set thresholds based on the number of transactions. New York, for instance, relies on such a transaction threshold, in addition to a revenue threshold. The transaction threshold is set at 100 sales per year.

Thresholds are important because they provide clarity on when a business must begin collecting sales tax. If a business surpasses the state’s threshold, it triggers a nexus, making the business responsible for compliance. These thresholds are particularly important for small businesses or those expanding into new markets.

State-Specific Physical Nexus Rules: A Sales Tax Chart

Below is a comparison of physical nexus thresholds for several key states:

This chart is simply a starting point. As a business owner, you must consult each state’s tax authority for more detailed rules and updates.

Physical Nexus Sales Tax Example

Let’s walk through a scenario where a business with remote employees and inventory stored in multiple states determines its sales tax obligations.

Example

Consider a company based in Ohio that sells products online. This company has employees working remotely in California and New York, as well as inventory stored in third-party fulfillment centers located in Texas and Illinois. 

In this case, the company would establish a physical nexus in California and New York due to the presence of employees in those states. Additionally, the company would have a nexus in Texas and Illinois because of the inventory stored in fulfillment centers in these states. 

This scenario triggers sales tax obligations in all four states, requiring the company to collect and remit sales tax based on each state’s specific regulations.

Step 1: Determine Where Nexus Applies

1. California: The business has employees in California, which establishes a physical nexus. Therefore, it must comply with California’s sales tax rules.
2. New York: Similarly, the business has employees in New York, so it has a nexus in New York and must collect sales tax on sales to New York residents.
3. Texas: The business has inventory stored in Texas, triggering nexus in Texas as well.
4. Illinois: The business also has inventory in Illinois, which establishes a nexus in that state.

Step 2: Register with State Tax Authorities

The business must register for sales tax permits in California, New York, Texas, and Illinois to comply with their respective sales tax requirements.

Step 3: Determine Tax Rates

Sales tax rates vary by state, county, and city. 

For example:

1. California: The statewide base sales tax rate is 7.25%, but local jurisdictions (such as cities and counties) can impose additional taxes, which can increase the overall rate in certain areas. For example, some localities may have a combined sales tax rate that exceeds the state base rate.
   Source: California Department of Tax and Fee Administration (CDTFA) 
2. New York: The statewide base sales tax rate is 4%, but local jurisdictions add their own sales taxes, bringing the total rate to as high as 8.875% in some areas, such as New York City.
   Source: New York State Department of Taxation and Finance 
3. Texas: The statewide sales tax rate is 6.25%, but local jurisdictions (cities and counties) can levy additional sales taxes, which can increase the total rate. In some areas, such as Houston, the combined rate can be as high as 8.25%.
   Source: Texas Comptroller of Public Accounts 
4. Illinois: The statewide sales tax rate is 6.25%, but local taxes can be added by cities and counties, raising the total rate in some areas. For example, in Chicago, the combined sales tax rate is 10.25%.
   Source: Illinois Department of Revenue

Step 4: Calculate Taxes

Assuming a sale price of $100:

1. California (San Francisco, 8.625% rate):
   $100 × 0.08625 = $8.63
   (Note: The base rate in California is 7.25%, and the local surtax in San Francisco adds 1.375%)
   
   
2. New York (New York City, 8.875% rate):
   $100 × 0.08875 = $8.88
   (Note: The base rate in New York is 4%, with local taxes in New York City bringing the total to 8.875%)
   
   
3. Texas (Houston, 8.25% rate):
   $100 × 0.0825 = $8.25
   (Note: The base rate in Texas is 6.25%, and local surtaxes in cities like Houston bring the total to 8.25%)
   
   
4. Illinois (Chicago, 10.25% rate):
   $100 × 0.1025 = $10.25
   (Note: The base rate in Illinois is 6.25%, with additional local taxes in Chicago bringing the total to 10.25%)

The business will need to collect and remit the applicable tax in each state, ensuring compliance with their respective sales tax regulations.

Determining Physical Nexus Sales Tax

Step-by-Step Process

1. Identify States Where You Have Nexus: Review where you have physical presence, including employees, property, inventory, and sales activity.

2. Register with State Tax Authorities: Register for a sales tax permit in each state where you have nexus.
3. Determine Tax Rates: Research the applicable sales tax rates at the state, county, and city levels.
4. Calculate Sales Tax: Use the applicable rates to calculate sales tax on each transaction.
5. File Sales Tax Returns: File returns and remit the taxes collected according to each state’s schedule (monthly, quarterly, or annually).

Examples of Calculation

If a business sells an item for $200 in California (rate 8.25%), the sales tax would be calculated as:

$200 × 0.0825 = $16.50 in sales tax to collect.

Physical Nexus vs. Economic Nexus: What’s the Difference?

While the physical nexus is based on physical presence in a state, the economic nexus is triggered by sales activity, such as a certain revenue threshold or number of transactions, even without physical presence. 

In 2018, the US Supreme Court’s South Dakota v. Wayfair ruling allowed states to collect sales tax from out-of-state sellers with no physical presence, provided they meet economic nexus thresholds.

Conclusion

Understanding physical nexus is crucial for any business selling products or services across state lines in 2025. Businesses must navigate varying state thresholds and compliance requirements to avoid penalties and audits. By registering in the states where nexus exists, accurately calculating sales tax, and filing returns on time, businesses can maintain compliance and protect themselves from costly mistakes.

Whether you are an e-commerce entrepreneur, a hybrid business owner, or a brick-and-mortar retailer, understanding the complexities of physical nexus and sales tax is essential for smooth operations and sustained growth in today’s economy. But, navigating sales tax and physical nexus rules doesn’t have to be a hassle. 

At Commenda, we help businesses like yours stay compliant, avoid penalties, and streamline tax processes. Let us handle the details while you focus on what you do best growing your business.

Book a demo today!

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