As a business owner, managing income, franchise, sales, and use taxes is a routine part of operations. However, as your business expands its operations across state lines—whether through physical locations, online sales, or interstate transactions—it may create additional tax liabilities. This is due to Nexus, which establishes the connection between a business and a state that triggers tax obligations. When Nexus is established, a business is required to comply with that state’s tax laws, including reporting and paying taxes. Understanding Nexus is crucial for determining where your business may incur these liabilities.
What Is Nexus?
Nexus is the minimum contact a state must establish before subjecting a business to its taxing authority. Once your business meets a threshold specified by a state, it may be subject to sales tax, income tax, franchise tax, and other state business taxes related to that state. The minimum contact required is gained through either physical or economic presence in a state as follows:
- Physical presence occurs when you store inventory, own a brick-and-mortar storefront, or own a warehouse in a state. It can also occur when your business makes deliveries with company vehicles that cross state lines.
- Economic presence is determined by each state, as each sets a different threshold relating to gross sales or the number of sales transactions within state lines. This can be determined by dollar amount, business percentages, or the number of transactions that occur.
In short, you will have satisfied the physical presence requirement if you are physically conducting business in one or more states and not through online means. However, to meet economic presence, you must reach a certain threshold of sales transactions or gross sales within a state. For example, although there is no conformity to how the states treat economic presence, groups of states have adopted minimum contact thresholds of two hundred or more sales transactions or $100,000 in gross sales.
Potential Benefits
Although Nexus is often viewed as a compliance challenge, there are several potential benefits that, with careful planning, can make it a positive factor in the broader context of your business growth strategy.
- Access to Local Markets: Establishing Nexus in multiple states can open up opportunities to tap into local markets. This can result in increased sales and revenue by expanding the customer base in those states.
- State-Specific Incentives: Some states offer tax incentives or benefits for businesses that establish a physical or economic presence. These can include credits, exemptions, or other benefits designed to encourage business growth within the state.
- Increased Credibility: Having Nexus in various states can enhance the credibility of a business, as it shows a level of operational presence and commitment. This can be particularly beneficial when working with customers or partners who prefer dealing with companies that have local operations.
- Tax Planning Opportunities: By understanding the Nexus requirements and filing in the appropriate states, businesses may be able to strategically manage their tax obligations and take advantage of specific state tax laws or favorable jurisdictions for certain types of business activities.
Special Considerations: Interstate Income Act
The nexus requirement for imposing income tax also comes with a caveat: there is a federal law called the Interstate Income Act, which protects certain sellers from income tax nexus. This rule applies when a seller’s sole activity in a state is soliciting orders for the sale of goods, with the orders being approved and shipped from a location outside that state. Because of these specific rules, the Interstate Income Act will not apply to all businesses. The states are also finding ways to work around this law.
Planning Ahead
Understanding how Nexus functions is essential for addressing its impact on filing business tax returns. As a business expands operations beyond its state of incorporation, it may establish Nexus in other states. When Nexus is established in one or more states, the business becomes obligated to file tax returns in those jurisdictions. To ensure compliance and avoid potential issues with state revenue agencies, Nexus should be assessed on an annual basis. Although Nexus can be confusing, it is important to reach out to a professional who can assist you in determining if you have any multi-state obligations. Contact a trusted financial advisor if you have any questions regarding Nexus or other tax planning questions.
By Kim Arruda, Jordyn Gates, and Phuoc Le
