Until recently, a business was said to have a nexus in a state if it maintained a physical presence there. Where nexus existed, a business was required to remit taxes to the state. This understanding served until digital commerce wholly revolutionized the global economy.
Today, a retailer can operate from their living room, selling goods without any physical presence outside their own home. Clearly, the old definition of nexus is obsolete. New definitions—offered up mostly by states looking to recoup lost sales tax revenues—rely on murky rationales of “economic nexus” and “factor presence.”
Unfortunately, neither the Supreme Court nor Congress has offered to clarify the issue, leaving businesses across the country to work things out on their own.
Every retailer selling goods over state lines should understand modern interpretations of nexus and what it means for their business.
Physical Nexus: The Old Standby
Let us start with what constitutes physical nexus. The Sales Tax Institute defines nexus as “maintaining, occupying, or using permanently or temporarily, directly or indirectly through a subsidiary, an office, place of distribution, sales or sample room or place, warehouse or storage place or other place of business.”
While the STI definition is rather wordy, what is clear is that physical nexus implies more than simply operating an actual office or warehouse in a state. Paying an employee, storing inventory in a third-party facility, drop shipping from a third-party provider, and even doing transitory business at a craft fair all qualify as establishing a nexus.
Retailers with a physical nexus are subject to state sales taxes and must collect and remit those taxes to the proper authorities.
Economic Nexus: Murkier Waters
When it comes to economic nexus, a little history is relevant.
In 1992, the Supreme Court determined in Quill Corp. v. North Dakota that states may not collect sales tax from retailers lacking physical nexus. Though Quill revolved around mail-order catalog sales, by the end of the decade the full impact of the decision would reverberate throughout the economy.
Quill, it turned out, applied not only to mail-order sales, but online retail as well. As digital commerce skyrocketed, the National Conference of State Legislatures estimated sales tax revenues plummeted $23 billion annually.
In direct response to these losses, states began evolving new business taxes. Colloquially these were called “Amazon nexus rules” in regards to the online retail giant, which had formulated numerous tax-avoidance strategies for years.
In South Dakota, for example, retailers with annual sales exceeding $100,000 (or 200 separate transactions) must collect and remit sales taxes—whether they have a physical nexus in the state or not.
In Alabama, $250,000 of annual in-state sales puts you in the same boat.
In fact, as of 2017, over a dozen states have some form of business taxation based not on a physical presence but on an economic nexus. Economic nexus is defined by the amount of business conducted within a specific state. As such, it is a definition that shifts from state to state.
State vs Federal: The Future of Nexus
Entrepreneurs can be forgiven for throwing up their hands in frustration. Clearly, taxes based upon economic nexus fly directly in the face of the Supreme Court ruling in Quill. Even so, no litigation has come before the Court since 1992 to overturn the decision, and Congress has passed no new legislation to clarify the issue.
In 2013, the Marketplace Fairness Act was brought before the US Senate. The bill would legally allow states to impose sales tax based upon economic nexus rules, but the bill has languished since its passage through the Senate, unable to gain traction in the House.
Without a clear direction from the federal government, businesses are left to figure out things on their own.
What’s It All Mean?
So, what is a business owner to do? Follow the federal law laid out in Quill or adhere to various state requirements? While not exactly comforting for entrepreneurs, one thing is certain: businesses failing to remit the required state taxes will be penalized in those states and likely have their authority to do business there revoked.
This leaves businesses with the task of being knowledgeable about the assorted economic nexus requirements in every state where they conduct business. In states with economic nexus rules, taxes must be collected and remitted.
States that have passed economic nexus laws include (but are not limited to):
- Alabama: Economic Nexus Limit of $250,000 in sales
- California: $500,000 in sales
- Colorado: $500,000 in sales / $50,000 in property or payroll / 25% total prop/pay/sales in-state
- Connecticut: $500,000 in sales
- Michigan: $350,000 in sales
- New York: $1,000,000 in sales
- Ohio: $500,000 in sales / $50,000 in property or payroll / 25% of total prop/pay/sales in-state
- Pennsylvania: 6% sales tax on specific digital downloads
- South Dakota: $500,000 in sales
- Tennessee: $500,000 in sales
- Washington: $250,000 in sales
Unfortunately, this puts the onus squarely on business owners, who must keep up with rules that fluctuate state to state or risk the possibility of non-compliance. In addition, it is possible for municipalities to enforce local sales tax as well, as the city of Chicago did in 2015 when it extended municipal sales tax to electronically delivered amusements and nonpossessory computer leases—so-called “Netflix Taxes.”