According to IRS estimates, Americans spend approximately $133 billion each year on out-of-pocket expenses to comply with the tax code. When combined with other compliance costs, the total reaches $546 billion annually, accounting for nearly 2% of the nation’s GDP.
But why are Americans spending so much money? Because states are becoming increasingly aggressive in enforcing sales tax rules and businesses are at risk of significant losses if they don’t meet their obligations. But fulfilling your obligations is not rocket science, and we’re here to help break it down. In this article, we help you do that by looking at ‘sales tax nexus,’ a critical concept for businesses operating in the US to understand their obligations.
This blog will guide you through the essentials of sales tax nexus, including its various types, state-specific thresholds, and common misconceptions. By the end, you’ll have the clarity and the tools you need to confidently navigate sales tax regulations, minimize risks, and protect your business from costly surprises.
Introduction to Sales Tax Nexus
Sales tax nexus defines a company’s obligation to collect and remit sales tax based on its connection to specific state jurisdictions. With states enforcing increasingly complex tax laws, understanding the sales tax nexus is essential to stay compliant and avoid costly penalties.
What is the Sales Tax Nexus?
Sales tax nexus refers to the connection between a business and a state that requires the business to collect sales tax. A business must have a nexus in a state for the state to mandate sales tax collection on sales made within that state. A nexus can be established through various forms of business activity within the state—such as having employees, a physical presence, or exceeding certain sales thresholds.
If you have a sales tax nexus in a state, you are required to collect sales tax from buyers in that state.
This involves identifying the applicable sales tax rate, including any local taxes. For instance, the sales tax rate in Beverly Hills (90210) is currently 9%. This rate consists of a 6.5% California state tax, a 1% Los Angeles County tax, and a 1.5% district tax.
Sales tax rates can vary significantly between localities. To determine the correct rate, consult Commenda or use Commenda’s convenient Sales Tax product & services.
Origin-Based v. Destination-Based Sales Tax
Understanding whether your state is origin-based or destination-based is crucial for calculating sales tax:
- Origin-Based Sales Tax States: In these states, sales tax is calculated based on the seller's location. If your business is based in an origin-based state, you apply the state and local sales tax rate effective at your office, warehouse, or other location where your inventory is stored, regardless of where your buyers are located within the state.
- Destination-Based Sales Tax States: These states require sales tax to be calculated based on the buyer’s location. If you have a sales tax nexus in a destination-based state, you must charge the sales tax rate effective at your customer’s address. This often involves applying multiple sales tax rates within the same state, depending on the delivery destination.
Understanding these distinctions helps ensure accurate tax compliance in each state where you operate. Commenda can help you understand the compliance applicable to your business, book a call with Commenda today.
Why Is the Sales Tax Nexus Important?
The sales tax nexus important because it helps with the following things:
- Compliance with Tax Laws: Sales tax nexus ensures businesses comply with state tax laws, avoiding penalties and interest.
- Avoiding Penalties: If a business does not comply with nexus requirements, it could face fines, penalties, and back taxes.
- Business Planning: Understanding nexus helps businesses make informed decisions about expansion and market strategies.
- Protects Consumer and State Interests: Nexus ensures states collect the appropriate sales tax on transactions, which supports public services and infrastructure.
What are the Different Types of Nexus?
In the US, nexus classifications are designed to ensure that businesses pay taxes fairly, based on their level of interaction with a state. These classifications account for various activities and relationships that may trigger a nexus, helping ensure a comprehensive tax system.
1. What Constitutes a Physical Nexus?
Physical nexus is established when a business has a tangible presence in a state. This presence can include having an office, employees, or warehouses within the state.
Physical nexus is one of the most straightforward ways a business can establish a sales tax obligation in a state. States are particularly vigilant about businesses with a physical presence, as it’s a clear indication of ongoing economic activity within their jurisdiction. This tangible connection often leads to the automatic requirement for businesses to collect sales tax, regardless of the volume of sales or transactions.
An example of physical nexus is:
- Employees: Having workers residing or working in a state creates a nexus.
- Warehouses or Property: Storing inventory or having a physical location in the state.
- Sales Representatives: A business sending employees or independent contractors into a state to make sales or solicit business.
2. What Is the Economic Nexus for Sales Tax?
Economic nexus refers to a business meeting certain sales or transaction thresholds in a state, even without a physical presence.
This type of nexus has become increasingly important following the landmark South Dakota v. Wayfair Supreme Court decision, which expanded nexus beyond physical presence. This ruling allowed states to require businesses to collect sales tax based on economic activity, such as the volume of sales or the number of transactions in that state.
As a result, businesses with no physical presence can still be subject to sales tax collection obligations if they meet the state’s economic thresholds. This has led to a surge in state-specific rules, making it essential for businesses to regularly review their sales in each state to ensure compliance.
An example of economic nexus is as follows: A state may require businesses to collect sales tax if their annual sales exceed $100,000 or they have 200 transactions within the state. These thresholds vary by state, so businesses must stay updated on specific requirements.
3. What Is the Affiliate Nexus for Sales Tax?
Affiliate nexus occurs when a business has a connection to another entity (an affiliate) in a state. This can be in the form of shared branding, joint advertising, or other relationships that facilitate sales within the state.
Affiliate nexus is another complex area of sales tax compliance that businesses must be mindful of. States often define an “affiliate” as any entity that plays a role in promoting or facilitating sales for a business within the state. This can include marketing partnerships, referral programs, or shared business operations.
As affiliate relationships grow in prominence, especially with online businesses, the risk of inadvertently triggering a nexus becomes more likely. Businesses must be diligent in assessing any affiliate arrangements to ensure that they are meeting their tax obligations in all relevant jurisdictions.
An instance of this type of nexus may be a business that uses an affiliate marketer located in a state. Its action may create a sales tax obligation for that business in that state.
4. What Is Click-Through Nexus for Sales Tax?
Click-through nexus arises when a business has a relationship with individuals or entities in a state that refer customers to the business through affiliate links or click-throughs.
Click-through nexus has gained significant attention with the rise of online advertising and affiliate marketing. When a business works with affiliates or third-party websites to drive traffic via links or ads, it may be creating an indirect connection with the state where the affiliate or referrer is located.
Many states have passed laws requiring businesses to collect sales tax if they pay commissions or referral fees to individuals or entities within their jurisdiction. This means that even without a direct physical presence, the mere act of compensating an affiliate for referrals could trigger a sales tax obligation, making it vital for businesses to understand the rules around click-through arrangements.
For example, if a business pays a referral fee to someone in another state for driving traffic to its website, the business may establish a nexus in that state.
5. What Is the Marketplace Nexus for Sales Tax?
Marketplace nexus refers to situations where online marketplaces (such as Amazon, eBay, or Etsy) are responsible for collecting and remitting sales tax on behalf of their sellers. Many states have passed marketplace facilitator laws that require these platforms to collect sales tax on sales made by third-party sellers. However, sellers may still have additional tax obligations depending on their nexus status.
For example, Amazon, as a marketplace facilitator, automatically collects and remits sales tax for transactions made by sellers on its platform in states with marketplace facilitator laws. However, even if the marketplace collects sales tax, individual sellers may still have additional tax obligations depending on their own nexus status. For instance, a seller may be required to file sales tax returns for sales made outside the marketplace or if they have a direct nexus in a state.
Sales Tax Nexus Thresholds
Understanding sales tax nexus thresholds is crucial for businesses operating in multiple states. These thresholds act as a trigger point, determining when a business must start collecting and remitting sales tax in a particular state. Below, we break down what these thresholds entail and how they vary across jurisdictions.
What Is a Sales Tax Nexus Threshold?
A sales tax nexus threshold refers to the specific criteria a business must meet in a state before it is required to collect sales tax. These thresholds can vary based on the total revenue from sales or the number of transactions made in the state. Some states use revenue thresholds, while others use transaction thresholds, or both.
How Do Thresholds Differ Across Jurisdictions?
The sales tax nexus thresholds vary widely across different states, making it essential for businesses to monitor specific thresholds based on their operational locations.
It’s also important to note that these thresholds can change over time as states continue to adjust their tax policies. For instance, some states may lower their sales or transaction thresholds to capture more businesses within their tax base, while others may raise them to encourage business growth. Businesses must proactively check for updates in the jurisdictions where they operate. Failure to meet the nexus thresholds can lead to unexpected tax obligations, while exceeding them can trigger sales tax collection requirements. Understanding these variations and staying informed about changes is critical for maintaining compliance and avoiding costly penalties.
The example below showcases how sales tax nexus thresholds vary across jurisdictions. It demonstrates the differences in sales thresholds (total revenue) and transaction thresholds (number of transactions) that trigger a sales tax nexus in different states.
Thresholds are designed to ensure businesses that have a significant economic presence in a state are required to collect sales tax, while smaller businesses are not overburdened by tax collection responsibilities.
Sales Tax Nexus Rules
Sales tax nexus rules determine when a business must collect and remit sales tax in a specific state. Understanding these rules is crucial to ensure compliance and avoid penalties. A nexus can be triggered by various factors, including physical presence, economic activity, and other business operations. This section outlines the general rules for determining whether your business has a nexus in a state.
What are the General Rules for Determining Nexus?
Several key rules can help businesses determine whether they have nexus in a state:
- Physical Presence: Having offices, employees, or property in a state.
- Economic Activity: Meeting revenue or transaction thresholds in a state.
- Affiliate Relationships: Conducting business through affiliates or partners in the state.
- Click-Through Referrals: Working with entities that refer sales to your business.
- Marketplace Facilitator Laws: Sales made through platforms like Amazon or eBay.
How Do Businesses Identify Their Nexus Obligations?
To determine nexus, businesses should follow these steps:
- Assess Physical Presence: Evaluate whether your business has any physical property, employees, or contractors in a state.
- Review Economic Activity: Check if your sales or transactions meet the state’s revenue or transaction thresholds.
- Check Affiliate Relationships: Look for affiliate marketers, partners, or other entities in the state.
- Identify Click-Through Referrals: Review any referral agreements with individuals or businesses in other states.
- Confirm Marketplace Obligations: Ensure you understand the tax obligations if you sell through platforms like Amazon, Etsy or eBay.
- Use Tax Tools: Leverage tax compliance tools, such as Avalara or TaxJar, to automate and track nexus obligations.
- Seek Professional Advice: Consult a tax advisor to navigate complex nexus rules and avoid compliance issues.
Compliance Requirements for Sales Tax Nexus
Meeting compliance requirements for sales tax nexus is essential for businesses to operate lawfully and avoid costly penalties. Compliance involves registering for sales tax permits, collecting and remitting taxes accurately, and maintaining proper records. As nexus rules and regulations can vary by state, staying informed and organized is key.
This section provides a step-by-step guide to help businesses navigate sales tax compliance effectively.
What General Compliance Steps Should Businesses Follow?
Sales tax compliance can be complex, especially for businesses operating in multiple states. To meet the legal obligations tied to sales tax nexus, businesses must follow a series of steps to ensure they are adhering to state regulations. Below is a detailed guide to the general compliance requirements:
1. Register for Sales Tax Permits
Before collecting sales tax in a state, businesses must obtain a sales tax permit from that state’s tax authority. This step is crucial because collecting sales tax without a valid permit is illegal in most states.
- How to Register:some text
- Visit the website of the state’s Department of Revenue or equivalent tax authority.
- Complete the application process, which may involve providing business details, such as your Employer Identification Number (EIN), business address, and information about your sales activities.
- Pay any applicable registration fees, if required.
- Key Considerations:some text
- Each state has its own registration process and requirements, so it’s important to research specific state guidelines.
- Some states may also require a bond or prepayment for sales tax registration.
2. Collect Sales Tax
Once registered, businesses are required to collect sales tax on taxable transactions in states where they have nexus.
- Determining Sales Tax Rates:some text
- Identify whether the state is an origin-based or destination-based sales tax state to apply the correct tax rate.
- Consider both state-level sales tax and any applicable local taxes, such as county, city, or district taxes.
- Automating the Process:some text
- To streamline compliance, many businesses use sales tax software or tools like Commenda’s Sales Tax Calculator to ensure accurate tax collection.
- Train your team and update your systems (e.g., POS software or e-commerce platforms) to calculate and apply sales tax correctly.
3. File Sales Tax Returns
Businesses must submit sales tax filings to report and remit the sales tax they have collected. Filing requirements typically include:
- Frequency:some text
- Filing schedules vary by state and are often determined by the volume of sales tax collected (e.g., monthly, quarterly, or annually).
- States may adjust your filing frequency based on your business’s reported sales over time.
- What to Include:some text
- Gross sales for the reporting period.
- Total taxable and non-taxable sales.
- The amount of sales tax collected, broken down by jurisdiction (state, county, city, etc.).
- Filing Platforms:some text
- Most states offer online filing portals, though some may still allow paper returns.
4. Pay Sales Tax
After filing your return, you must remit the collected sales tax to the appropriate state authority.
- Payment Methods:some text
- Payments can often be made electronically through state tax portals.
- Some states may accept paper checks, though electronic payments are generally faster and more secure.
- Deadlines:some text
- Pay attention to state-specific deadlines to avoid late fees or penalties.
- Many states offer incentives, such as a small discount, for businesses that file and pay on time.
5. Maintain Records
Proper record-keeping is essential for sales tax compliance. Keep detailed records of:
- Sales transactions, including invoices and receipts.
- The amount of sales tax collected and remitted.
- Copies of sales tax returns and payment confirmations.
- Exemption certificates for tax-exempt transactions.
States typically require businesses to retain these records for a specific number of years (commonly 3–6 years), as they may be subject to audits.
6. Monitor Changes in Nexus Laws
Sales tax laws are subject to change, particularly after events such as the 2018 South Dakota v. Wayfair ruling, which expanded economic nexus requirements.
- Stay Updated:some text
- Regularly review state laws where you operate, as thresholds for economic nexus may change.
- Consider subscribing to updates from tax authorities or using a compliance tool that monitors law changes.
By following these steps, businesses can maintain compliance with sales tax nexus regulations and avoid costly penalties or legal issues.
How Can Businesses Stay Compliant Amid Changing Rules?
Given that sales tax nexus laws are constantly evolving, businesses must stay informed about updates in tax laws. Here’s how to manage compliance:
- Monitor Tax Law Changes: Regularly check state and local tax regulations for updates.
- Automate Compliance: Use tax software to automate sales tax calculations, filings, and remittance.
- Consult with Professionals: Work with tax advisors to ensure adherence to changing sales tax rules. Commenda can be your guide in ensuring compliances.
Common Misconceptions About Sales Tax Nexus
1. Nexus Only Apply to Physical Presence.
No, nexus is not limited to physical presence. The landmark Wayfair decision expanded nexus to include economic and other types, such as affiliate and marketplace nexus, for businesses even if they don’t have a physical presence in the state.
2. Marketplace Sellers Are Always Exempt.
Marketplace sellers are not always exempt from sales tax obligations. While marketplaces like Amazon may handle sales tax collection for certain transactions, individual sellers may still have tax obligations based on their nexus status.
For example, sellers in states with marketplace facilitator laws may not have to collect tax on sales made through the marketplace, but may still have obligations on sales outside of the platform.
Moreover, marketplace sellers may also have additional responsibilities if they have nexus in a state independent of the marketplace facilitator.
For example, if a seller has a physical presence, such as a warehouse or employees in a state, they may still be required to collect and remit sales tax on transactions made outside the marketplace, even if the marketplace collects tax on their behalf for platform sales. This means that marketplace sellers must evaluate their nexus status in each state to ensure they are in full compliance with both marketplace facilitator laws and their individual tax obligations.
3. Amazon Does Not Have a Sales Tax Nexus.
Amazon is a marketplace facilitator and is responsible for collecting and remitting sales tax on behalf of sellers in many states. However, sellers may still have to collect and remit sales tax if they have additional nexus in a state.
4. eBay Does Not Have a Sales Tax Nexus.
Similar to Amazon, eBay is subject to marketplace facilitator laws in many states. eBay collects and remits sales tax for transactions made through its platform, but sellers should still be aware of their nexus status.
5. Shopify Does Not Have a Sales Tax Nexus.
Shopify, like other platforms, facilitates sales for its users. Shopify itself is not responsible for collecting sales tax, but sellers must ensure they comply with sales tax laws based on their own nexus status.
Frequently Asked Questions
Q. Do I Collect Sales Tax Nexus?
You need to collect sales tax if you meet the nexus criteria in a state. This could include physical presence, meeting sales thresholds, or engaging in affiliate relationships.
Q. Do I Collect Sales Tax for Listings on eBay?
If you are selling through eBay, you may not need to collect sales tax, as eBay is responsible for tax collection in many states. However, sellers must still be aware of their nexus obligations.
Q. Does Advertising in a State Create Nexus?
Yes, certain types of advertising, especially physical advertising like billboards, can create a nexus. It is important to evaluate whether your advertising activities in a state trigger sales tax obligations.
Q. Does Advertising on a Billboard Create a Nexus?
Yes, physical advertising in a state, such as a billboard, can trigger nexus, depending on the state’s laws. This means businesses may be required to collect sales tax if their advertising activities generate significant business in the state.
Conclusion
Sales tax nexus is a complex but essential concept for businesses to understand. With different types of nexus, varying thresholds, and evolving laws, businesses must stay vigilant to ensure compliance. By identifying their nexus obligations and leveraging available resources, Commenda can help companies avoid penalties and continue to grow in an ever-changing landscape. Book a call today.
Sam Suechting
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