Navigating State Tax Nexus for US Income and Sales Tax

US State tax nexus is a critical concept for any business operating across state lines, especially with the growth of internet-based commerce. It dictates whether a state has the authority to tax a business's income or require it to collect and remit sales taxes. Understanding nexus is essential for tax compliance and avoiding potential penalties.

What is Nexus?

In the context of US state income taxes, nexus refers to the degree of a business's activity or presence within a state that allows that state to impose income taxes. Essentially, it's the connection a business has with a state that triggers tax obligations.

Factors That Create Income Tax Nexus

Generally, income tax nexus is created when a business:

• Derives sales within the state.

• Owns or leases property in the state.

• Has employees in the state performing activities beyond mere solicitation.

It's important to note that the specifics of what constitutes nexus can vary significantly from state to state.

Sales and Use Tax Nexus: The Physical Presence Rule

States are becoming increasingly aggressive in asserting nexus for sales and use tax collection. A key factor in determining sales and use tax nexus is physical presence.

The physical presence rule, established by the U.S. Supreme Court in Quill Corp vs. North Dakota, states that a seller must have a physical presence in a state before the state can require the collection of sales tax.

However, like income tax nexus, the definition of what constitutes physical presence can differ between states.

Determining Your Obligations

To determine sales and use tax collection obligations, businesses should consider the following:

• Location of Property: This includes inventory, products on consignment, leased property, real estate, warehouses, equipment, computer servers, and vehicles. Even some intangible property, like computer software, can potentially create nexus.

• Employees and Their Activities: The presence of any employee, independent contractor, sales agent, or representative working in a state could establish nexus. Because state definitions, exceptions, time limits, and activities vary, there's no universal rule. Generally, the activity must be related to sales.

• Substance of Transactions and Relationships: Some states are expanding the types of relationships that can create nexus. For instance, some states consider a seller to have nexus if they have a specific relationship with an in-state business that promotes sales or has a similar product or company name.

Nexus and the Internet

The internet has further complicated the issue of nexus. Some states have taken aggressive positions, such as New York’s law that presumes a seller is soliciting business through resident representatives if they are compensated for referring customers. This means that sellers who use affiliate programs where in-state associates earn commissions by placing links on their websites may be subject to sales tax collection obligations in that state.

While most states still consider advertising alone as not creating nexus, businesses must stay vigilant as states adapt their laws to the evolving digital economy.

Protecting Your Business

To avoid past-due tax liabilities, penalties, and interest, businesses must be aware of their activities across state lines, including internet activities. What begins as a small-scale online seller can quickly evolve into a business with significant tax collection obligations. New services or out-of-state employees can also create unexpected nexus and tax obligations.

The Importance of Accounting Systems

Before preparing tax returns, businesses must ensure their accounting systems can capture and track activity at the state level to provide the necessary detail for state tax return allocations. At a minimum, accounting systems should be capable of capturing gross sales, employee wages, independent contractor payments, and property and equipment acquisitions on a state-by-state basis.

This is where we can help set up the accounting systems correctly to mitigate state and sales tax nexus and reporting risks. Contact us today for a personalized accounting solution tailored to your needs.