Joe Guelda CPA, Tax Manager
The easy part of this is understanding the definition. Nexus is a connection or series of connections linking two or more things. Within the business and state and local tax environment, nexus is the minimum connection a business or individual has to a particular state. It is significant in understanding if a business or individual is subject to filing requirements within a particular state or locality.
Nexus can be established within a state in several different ways. The three general categories are payroll, property, and sales, which also are the three factors used in apportioning activities between states though many states have reduced apportionment to just the sales factor as it is generally easier to increase tax revenue by subjecting out of state companies to taxes. While having retail centers or warehouses located inside the state would be quite evident that nexus is established, it is often more complicated. For instance, what about a sales team that occasionally travels into a state or what if the company has its own vehicle for product deliveries. These factors often need additional clarification such as the number of days or deliveries. The following factors make it even more difficult:
1 – Different states have different factors which establish nexus
2 – Different states have different types of taxes (income, sales, payroll, property, franchise, gross receipts, etc.)
3 – Some factors establish nexus for certain taxes but not for others
4 – Different states have different bright line tests (minimal amounts or percentages of payroll, property, or sales)
5 – Factors change depending if your revenue is either service or sales based:
a – if sales based, what is your product – tangible, intangible, real, etc.?
b – if service based, what services do you provide?
By now, your head may be spinning and you may have already decided to not physically expand into additional states; however, you may still need to be mindful of slipping into nexus. For instance, what if you have a website? In some states, you may establish nexus even though you have never had a physical presence or performed sales activities targeting customers. Some states are following the lead that the Wayfair Supreme Court decision provided for sales tax requirements and are starting to pass regulations or look into how to expand the economic nexus concept to other taxes. Economic nexus can be established solely based on the number of receipts or transactions with customers located in a specific state. In addition, the Multistate Tax Commission (MTC) has recently introduced amendments to PL 86-272 which could allow states to pass legislation to tax companies doing business through the internet.
While you may not get overly excited about being subject to taxation in other states, identifying your nexus obligations with other states is beneficial for the following reasons:
1 – States and localities can deny you from doing business within their jurisdiction. Expanding into different states and localities can be an advantageous opportunity for many; however, in order to enjoy the benefits, it is important to maintain good compliance so that the opportunity stays available.
2 – To avoid double taxation, you likely will be able to claim a credit for at least a portion of the taxes paid to the non-resident state against your resident state’s tax liability. The credit can be eliminated if the tax paid to the non-resident state is paid after you file your resident tax return.
3 – Sales tax is collected from customers and paid to the state. If you fail to collect, you will likely be unable to collect after the sale is complete.
4 – Creating nexus in some states may be able to decrease your total state tax liabilities even though you have additional reporting requirements.
5 – If you discover your exposure through a tax notice, you will likely owe penalties. In addition, the state can go back to the very first date that you had activity in a particular state if the state finds you.
For these reasons, it is important to keep good records and continuously review your activities and sales in different states. For more information or assistance analyzing your nexus in different states, please feel free to contact us.