Sales Tax Nexus Basics: What Every Business Needs to Know
Sales tax regulations are more complex than ever before. Businesses now face registration and reporting requirements in states where they don't necessarily have a physical presence. Read about state rules governing sales taxable activity and how to register for sales tax.
Every business must meet specific sales tax obligations to stay compliant with the laws in every state in which it sells. In this article, we help you understand basic sales tax and nexus concepts needed to navigate sales tax compliance.Jump To:
- Sales Tax Defined
- Sales Tax Nexus Defined
- Ways to Trigger Physical Presence Nexus
- Ways to Trigger Economic Nexus
- What It Means to Be Sales Tax Compliant
Sales Tax Defined
Most people are familiar with sales tax, which is a tax on the consumption of goods or services. Sales tax is calculated as a percentage of the sale price of a product or service. Some items are not taxable. Sales tax is only calculated on the sum of the taxable portion of a sale. While the customer generally pays sales tax, the business is responsible for tracking and collecting it.
Sales Tax Facts
- Sales tax is charged on purchases of all taxable goods and services.
- What qualifies as taxable vs. tax-exempt varies from state to state. Details can usually be found on your state tax authority website.
- Compliance requires math.
- To accurately calculate sales tax, the business must add any applicable state, city, county, and other local taxes together. To further complicate things, some jurisdictions also have special taxes, such as a restaurant or cigarette tax. These are typically flat-rate taxes only added to applicable transactions.
- Tax and revenue agencies vary by jurisdiction.
- U.S. state tax authority divisions go by a variety of names, such as the Department of Revenue, Comptroller, Department of Finance, and Board of Equalization, to name a few. Generally, this division is responsible for reporting the state’s own compliance and for managing and processing business sales and use tax returns.
- Miscalculated or missed remittance sales tax payments may lead to an audit.
- Each state has an audit division dedicated to investigating tax compliance. While sales tax frequently triggers audits, use tax is one of the highest-frequency errors in an audit. However, both sales and use tax can be considered when determining when a business owes unpaid taxes.
- State legislation sets local rules for sales tax.
- Local governments can also spur the creation or repeal of special taxes that pertain to a specific city, town, or zip code. These taxes are often used to fund special projects like infrastructure or road repairs.
Sales Tax Nexus Defined
Sales tax nexus, or simply “nexus,” is the minimum connection a business must have with a state in order to be required to collect and remit sales tax in that state. Having sales tax nexus means the business is required to collect and remit sales taxes in that state. There are two types of nexus, either physical (resulting from a direct presence in a state) or economic (based on activity reaching customers of a state).
Physical Presence Nexus
Physical presence nexus is triggered when a business has a direct connection in a state that allows said state to impose sales tax obligations on the business. For example, physical presence nexus is generally triggered when a business operates out of a brick-and-mortar location in a particular state.
In 2018, the Supreme Court decision in South Dakota v. Wayfair, Inc.South Dakota v. Wayfair, Inc. held that a state can require businesses to collect sales tax under an economic nexus standard, even if they have no physical presence in that state. Before Wayfair, businesses only needed to monitor physical presence. Now, to ensure compliance, businesses must assess both their physical presence and economic activity in any given state.
Economic nexus is created when a business reaches a certain threshold of economic activity in a given state, typically the number of sales or amount of revenue generated. Unlike physical presence nexus, economic nexus is not reliant on whether the business has a direct presence in a state.
Under the definition of economic nexus, businesses must collect and remit sales tax if they meet or exceed that state's threshold. As a result, a business may be required to collect and remit sales tax in additional states as its sales activity ramps up, regardless of whether the company is physically located in those states. Economic nexus applies to brick-and-mortar retailers and online retailers and resellers alike.
Today, 45 states have passed laws that allow them to collect sales tax based on economic nexus.
Ways to Trigger Physical Presence Nexus
There are multiple ways to trigger physical presence nexus, which may be property-based or non-property-based.
Property-based triggers include having a physical location or brick-and-mortar business. Other triggers include owning or leasing a business office or warehouse in another state.
Non-property-based triggers include sending employees or agents to another state. For example, many businesses send traveling sales reps to other states to solicit new business. In light of COVID-19, many businesses also hire remote employees who telecommute—another possible trigger.
Non-property-based triggers also include storing property in a facility in another state. For example, Fulfillment by Amazon sellers who store inventory in Amazon warehouses, which involves property, but not property owned or leased by the business itself.
Ways to Trigger Economic Nexus
Economic nexus is triggered when a business meets the threshold defined by the state or taxing jurisdiction. Each state sets its own rules, and while most follow a similar formula, businesses should be aware of the common and special considerations governing economic nexus.
Common Economic Nexus Threshold Triggers
The two most common economic nexus threshold triggers are based on sales volume in a particular state.
- Revenue-based economic nexus threshold. For example, gross revenue from sales is greater than or equal to certain dollar amount, usually ranging from $100,000 to $500,000.
- Transaction-based economic nexus threshold. For example, a business does a certain number of transactions or more per year, usually ranging from 100 to 200 transactions.
Special Economic Nexus Considerations
- Be Mindful of “And” vs. “Or”
- Some states require only one of these common thresholds to be met to trigger nexus, while others require both be met. When assessing their own economic nexus, businesses should review legislative language carefully for the words “and” and “or” with the applicable legal and accounting professionals.
- Watch for Specific Threshold Timelines
- A threshold lookback period is the amount of time during which sales activity needs to occur for nexus to be triggered. Threshold lookback periods vary by state. Some states calculate thresholds using the current or prior calendar year, but others use less common timelines, such as the trailing 12 months or trailing 4-quarters.
What It Means to Be Sales Tax Compliant
Businesses have a core set of responsibilities to ensure compliance with state sales tax requirements. These generally include:
- Identifying every state where their business has sales tax nexus.
- Registering in every state where their business triggers nexus.
- Accurately calculating sales tax on every applicable transaction.
- Collecting and securely storing tax monies until business taxes are filed.
- Correctly reporting sales tax in applicable states on a predefined filing schedule.
- Remitting tax payment to every state where nexus has been triggered.
With increased complexity in state sales tax regulation, businesses face increasingly higher risk of penalties for non-compliance. Businesses should take a proactive view of sales tax compliance to safeguard against risk and reduce long-term costs.
To see where your business stands today, start by completing a no-cost compliance risk assessment.Continue reading “What is South Dakota vs. Wayfair, and How Does it Impact My Business?”