Navigating Sales Tax Nexus: A Guide for Businesses
What is Nexus?
Nexus is a crucial concept and one of the most cited terms in the world of US sales and use tax. Nexus can be defined as a minimum connection or link between the taxpayer and the US state before the state has jurisdiction to tax the taxpayer. Nexus could trigger a requirement for the seller to register to collect or pay tax in that state.
Traditionally, nexus was primarily based on the seller’s physical presence, such as having a storefront or employees in a state, which is called physical nexus.
In 2018, the US Supreme Court made a groundbreaking decision in South Dakota v. Wayfair that overturned the traditional physical presence rule, no longer making it a minimum requirement for a state to mandate a seller to collect sales tax. Instead, the Court recognized that economic presence (for example, sales to a state) could also create nexus, which is referred to as economic nexus. This decision led states to introduce economic nexus laws for remote sellers, meaning that an out-of-state seller can now establish nexus by exceeding a specific dollar amount of sales or a number of individual transactions delivered into a particular state without a physical presence. Wayfair has posed new challenges for foreign and US businesses that operate across state borders, greatly expanding the scope of what is considered nexus.
Evolution of Nexus
In 1967, the US Supreme Court’s ruling in Bellas Hess v. Illinois set a precedent for sales tax collection requirements. The Court determined that a state could not impose sales tax collection on an out-of-state retailer unless the retailer had a physical presence within the state.
This decision was reaffirmed in 1992 with Quill Corp. v. North Dakota, which maintained the in-state physical presence requirement for sales tax collection.
In 2018, the US Supreme Court's decision in South Dakota v. Wayfair marked a significant change in the sales tax landscape. The Court recognized that the traditional physical presence rule was outdated in today's e-commerce and online retail economy. With the physical nexus rules in place only, states were unable to effectively collect taxes on cross-border sales from remote sellers, which became a pressing issue with the rise of the internet and online sales. With Wayfair, the Supreme Court overturned its decision in Quill and ruled that economic presence in a state above certain thresholds, without physical presence, was enough to create nexus. This led to all states with sales tax adopting economic nexus rules, which require out-of-state sellers to collect and remit sales tax to a state based on their economic activity within that state, regardless of physical presence. It's important to note that physical nexus still exists and that economic nexus doesn't replace it. However, the impacts of this significant shift have been far-reaching, affecting foreign and out-of-state businesses across the United States.
How to comply with Nexus requirements?
Determine where you have nexus in the US
Determining your nexus in the US can be a tricky process. Traditionally, physical presence has been the easiest way to establish nexus, with a storefront, warehouse, or employees located in a state being key indicators.
However, economic nexus has gained increasing importance in recent years after Wayfair. States have introduced economic nexus thresholds that take into account business sales, transactions, or revenue in a state. Each state with a sales tax has its threshold for establishing economic nexus, with some using a sales amount (such as $100,000 in a calendar year) or a number of individual transactions (over 200 transactions in the state), while others employ a combination of the two. Another layer of complexity is that states differ in how they calculate the sales amount that triggers economic nexus. Some exclude nontaxable sales, while others exclude sales to resellers or exempt customers. Furthermore, a few states don't count sales that a business makes through a marketplace facilitator. Additionally, the time period used for calculating sales also varies, with most states using the calendar year, but a few considering a 12-month period. In light of these nuances, remote sellers must keep a watchful eye on their sales and transactions in each state to determine whether they have crossed the threshold and have economic nexus in that particular state.
Additionally, states have also enacted marketplace facilitator laws following the Wayfair decision. These statutes shift the burden to collect and remit sales tax from from sellers transacting on the marketplace to the marketplace platform itself. Marketplaces also have to deal with the economic nexus rules.
What happens if a business meets the nexus threshold?
Once a business meets the nexus threshold in a state, the next step, in general, is to register for a sales tax permit and commence collecting and remitting sales tax on taxable sales made within that state.
While specific steps and requirements for registration and collection may vary by state, businesses can generally anticipate furnishing basic information regarding their business, such as their tax ID number, contact information, and details about their sales and activities in the state. After registration, businesses will be required to charge and collect sales tax on taxable sales made within the state.
Once registered, businesses need to calculate taxes
After registering for sales tax in a state, businesses must ensure that they charge the appropriate sales tax rate on all taxable sales made within that state. The sales tax rate can be a complex and confusing issue for businesses, so it is essential to follow the correct procedures.
Firstly, the business must determine the location of the sale based on the sourcing rules. There are two methods of sourcing: origin and destination. Origin sourcing is based on the seller's location, while destination sourcing is based on the location of the buyer. Once the location has been determined, including the state and any applicable local jurisdictions, the business needs to look up the sales tax rates for that location. With over 11,000 sales tax jurisdictions in the United States, each with its unique rates, accurately determining the correct tax rate can be challenging. Furthermore, sales tax rates and rules can frequently change, making it necessary for businesses to stay up-to-date on these changes to ensure they charge and remit the correct sales tax amount.
To make this process more manageable, many businesses use automated sales tax software to calculate and collect the correct amount of tax on each sale. This software can integrate with a business's sales platforms and point-of-sale systems to ensure that the correct amount of tax is collected from customers. By using this software, businesses can ensure that they are charging and remitting the correct amount of sales tax, avoiding any penalties or fines that may result from an incorrect or inaccurate tax collection.
Once businesses have started collecting sales tax in a state, it is also their responsibility to remit that tax to the appropriate agency on a regular basis. The frequency of tax remittance may differ by state, but businesses are generally required to file sales tax returns and submit the tax they have collected on a monthly or quarterly basis.
Therefore, it is crucial for businesses to maintain accurate records of their sales and tax collections in each state to ensure they file accurate returns and remit the correct amount of tax.
Non-compliance with sales tax laws, as well as failing to collect and remit the right amount of tax, can result in serious consequences such as penalties and legal issues. It is, therefore, crucial for businesses to remain well-informed and take a proactive approach towards sales tax compliance.
How can Fonoa help?
If you have sales directly, or you facilitate sales to the United States as a marketplace, it is prudent to consider the following:
- Can you track whether you exceed nexus thresholds in all states where you have sales?
- Can you keep track of sales and use tax rates in over 11.000 US jurisdictions?
- Can you react quickly enough when there is a change in the law requiring that you charge tax (or allowing you to stop charging tax)?
- Can you easily manage new products or business lines in the US?
As a tax technology company, Fonoa can help businesses navigate the complex world of sales and use tax. Our tax engine takes care of all these issues and then some. Get in touch to discover how we can help you meet the challenges posed by the shifting tax landscape and take the complexity out of tax.