In the state tax world, one of the most important concepts is “nexus.” Also known as “taxable presence, “nexus” is the term that describes the minimum connection a company needs to have with a state in order to be subject to the state’s taxing scheme. This includes sales tax, income tax, gross receipts tax and more.
There’s a lot that goes into the discussion around nexus, and with the recent state tax law changes, there are frequent updates. This post is a helpful start to understanding what nexus is and how it affects your business.
How Does Physical Presence Nexus Establish State Tax Exposure?
One primary way companies establish nexus is through having a physical presence in that state. For example, if a business has “boots on the ground” in terms of employees or third-party contractors working in the state, or has inventory, other personal property or real property in the state, the company likely has nexus and needs to collect and remit state tax.
When it comes to physical presence nexus, there are a few specific areas we look at:
1. How People Establish Nexus for a Company
When we consider the people that can establish a company’s nexus in a state, it’s important to note that it can be more far-reaching than you may think. All of the following can create nexus (both for sales tax and income tax purposes) if engaged in activities in the state:
- Engineers or salespeople working from their homes
- Employees traveling regularly into the state from other states (often this includes salespeople or consultants engaged on-site with customers)
- Third-party contractors (1099s) working on the company’s behalf or representing the company (an example would be independent contractors that engage in training or trouble-shooting at customer locations periodically, or those that engage in product installation)
Note that there is a “safe harbor” for income tax only under Public Law 86-272. The Federal P.L. 86-272 prohibits a state from imposing its income tax on a company if:
- The company’s only activity in the state is soliciting orders of tangible personal property
- Those orders are approved from out of state
- The orders are shipped to the customer from inventory located outside the state
Note that all of these requirements must be met in order for Public Law to protect the activity from creating nexus.
While this may seem like a broad exception, it is actually fairly narrow considering today’s more service-based economy. We often encounter clients that would meet the exception for their sales of widgets into a state (at first), but then the complete customer service package often includes the installation of the widget, training on how to use the widget or frequent visits to the customer location to customize the widget. Once the company begins to sell services or engage third party contractors for training and installation, the protection of P.L. 86-272 is lost and they’re responsible for the state’s tax measures.
2. How Property Establishes Nexus
When property is physically located in a state and the company retains title to it while in the state, nexus has likely been created. Some examples of property that generally creates nexus in a given state include:
- Renting a warehouse to hold inventory (both the rental and the presence of inventory create taxable presence)
- Renting office space
- Maintaining assets in the state (including computers, servers, R&D equipment, etc.)
- Renting or leasing company property to customers – this one often trips-up companies. For example, if a company leases a point-of-sale device to a customer and those items are physically located in a state, nexus is created if the company retains title to the device (which is generally the case in this type of lease). Often the lease or placement of this small device is not the main source of revenue, but its presence in the state can pull in other revenue because it creates nexus.
Keep in mind that there is a concept of de-minimis property. How much inventory or how much personal property can a company have in a given state before nexus is created? The answer is, of course, “It depends.” But states are fairly aggressive and their definition of “de-minimis” is likely to be much lower than a company’s would be. Each case should be analyzed in an overall manner, taking all the facts into account so you can ensure you’re complying with all the necessary state tax legislation.
How Does Economic Nexus Establish State Tax Exposure?
In June 2018, in South Dakota v. Wayfair, the U.S. Supreme Court ruled that states could establish economic nexus standards, meaning that if a company makes a certain number of sales or brings in a minimum gross revenue from consumers located in that state, nexus is established.
States reacted to this ruling quickly, with most legislatures establishing economic nexus provisions within a year. After the initial legislation passed, some began looking at ways to apply economic nexus beyond sales tax, to include other income tax or franchise tax.
There are regular updates to the economic nexus landscape and its role in state tax compliance, so keep an eye out for future posts!
Why Is Nexus So Important?
In summary, why is the determination of nexus so important and the cornerstone of state tax concepts? Because, once you are deemed to have created nexus, then you are subject to a state’s tax laws. For sales tax, that can mean collecting and remitting taxes from customers (and filing returns). For income tax it means apportioning income to a state, filing returns and paying applicable state income taxes. As noted above, there are other taxes that can be tripped by having nexus as well. That’s why many of our clients start with a nexus study and taxability analysis as the first steps in the analysis.
Do you want to learn more about nexus and how it affects your company? Contact us today! We’d be happy to help you determine in which states you’ve established nexus, develop a plan for compliance and more. Of course, we can help with any other multi-state tax issues your business may be facing as well.
