Understanding Nexus

The ins and outs of “complicated” nexus regulations.

By Anthony Bucci, Assistant Editor On Sep 5, 2016

As a business, it can be quite confusing whether or not you should be collecting and remitting sales and use taxes, or paying income taxes to states in which you have employees, remote locations, warehouses, etc. Or, even if you are selling products over the Internet through partner websites that are based in other states, you can be held responsible for collecting state sales taxes.

In order for states throughout the country to determine whether or not certain entities are required to pay state sales and income taxes, they implement “nexus” regulations. Nexus is the connection between a company and a state that allows the state to impose those taxes.

“Nexus is a Latin word meaning ‘connected,’” says Tim Brennan, CPA, MST of Bederson. “In the context of state taxation, it refers to a connection between your business and typically another state other than the one you are formed in and carry out your everyday operations in. Depending on the degree of connections you have to another state, it would traditionally determine whether or not you had ‘nexus’ with that state.”

Background of Nexus

The Commerce Clause of the US Constitution requires a taxpayer to have a connection with a state before the state can impose a sales tax jurisdiction. The US Supreme Court ruled that under the Commerce Clause, out-of-state sellers who do not have a physical presence in a state, cannot be required to collect the sales tax.

In 1992, the landmark Quill Corp. v. North Dakota case was aimed to challenge this. However, it was determined that to have nexus, a business must generally have a more than the minimum “physical” presence in a state before the state could impose income taxation or sales tax collection on a business. “The US Supreme Court ruled that requiring Quill – an out-of-state mail order company that sold goods to North Dakota customers – to collect North Dakota use tax, it violated the Commerce Clause since the vendor had no outlets, sales representatives or other significant property in the state,” Brennan says.

“Because of this case, it set the standard as to what general nexus is today,” adds Scott Smith, director of CohnReznick’s state and local tax practice.

A business with a physical presence in a state almost always has sales and use tax nexus. “Basically, the states are saying, ‘If you are located here, then you are required to register and collect sales tax on all taxable transactions,’” Smith says.

However, having a main office or a location in a particular state is not the only way to determine an obligation to collect sales and/or income tax. Each state has different definitions as to what determines nexus. In New Jersey, for instance, working within the US Constitution Commerce Clause, and as explained by the New Jersey Division of Taxation, “nexus-triggering” activities in the state include, but are not limited to:

“Selling, leasing or renting tangible personal property or specified digital products or services; maintaining an office, distribution house, showroom, warehouse, service enterprise, or other place of business; having employees, independent contractors, agents or other representatives working in the state; selling, storing, delivering or transporting energy to users or customers; collecting initiation fees, membership fees, or dues for access to or use of health, fitness, athletic, sporting or shopping club property or facilities; and parking storing, or garaging motor vehicles.”

Daniel Kruesi, director, state and local tax, at Smolin Lupin, stresses the fact that even though the precedent of the Quill case was set, states have become creative in the ways they define and impose nexus.

“There are a lot of gray areas between states as to whether or not an entity has nexus,” he says. “It makes it tough for businesses, because it is constantly evolving and it is doing so in 50 different places.”

Click-through Nexus

More recently, states have begun to adopt “click-through” nexus, due to companies like Amazon and the influx of businesses selling products over the Internet, which can even make things more complicated.

“‘Click-through’ nexus, frequently referred to as the ‘Amazon’ nexus, is a new form of nexus created when a business makes taxable sales into a state that they otherwise do not have traditional nexus (physical presence as defined by each state) with, via the internet or use of an agent,” Bederson’s Brennan says. “In this case [in 2008], Amazon did not maintain the requisite connections to the State of New York that would normally allow New York to impose the requirement for Amazon to collect sales tax. However, Amazon allowed various organizations to maintain links on its website, for which Amazon would receive a small percentage of any sales generated from those links. It was this connection which ultimately caused Amazon to have nexus with New York, requiring Amazon to collect sales tax on all taxable sales into the state. The Amazon case opened the door for many other states to enact similar ‘click-through’ regulations including ones similar to Amazon and others based on a dollar amount. At this point, most states have either enacted or are working on enacting ‘click-through’ nexus regulations.”

New Jersey was one state that followed in New York’s footsteps in constituting click-through nexus.

“New Jersey legislation (A.B. 3486, P. L. 2014, c. 13), enacted on June 30, 2014, adopts click-through nexus sales tax provisions,” says Jamie Brenner, partner, state and local tax, PwC. “The legislation creates a rebuttable presumption of nexus when a seller makes sales of tangible personal property, specified digital products or services via a commissioned independent contractor who directly or indirectly refers potential customers, by a link on an Internet website or otherwise, to the seller.”

Bederson’s Brennan adds that for this type of click-through nexus to apply, the cumulative gross receipts from such click-through sales must be in excess of $10,000 during the preceding four calendar quarterly periods, ending on the last day of March, June, September and December. “If these requirements are met, the out-of-state seller must collect and remit sales tax,” he says.

The creation of the click-through nexus has expanded the outreach of states to collect taxes that they may not have otherwise collected before.

“States have been looking to find more ways to generate revenue, without having to burden their own residents,” says Michele Vetlov, a tax manager at Wiss & Company, LLP. “It is all part of that evolution, where there were only brick-and-mortar stores driving these tax revenues for states, but that is no longer the case. There are a lot more companies conducting business online, so, many states figured they would go after that market.”

Sandy Weinberg, principal, state and local tax at PKF O’Connor Davies, LLP, says that states have lost billions of dollars in revenue due to internet sales, and click-through taxes are a way to recoup some of that.

“Because these online companies do not have a physical presence in the state, nexus never applied to them, and thus, states were losing revenue,” he says. “It never meant that sales tax was never due. Because, for example, individuals buying an item from an online retailer in New Jersey, were legally the ones with a sales tax obligation. But, that is a lot of people that the state would have to go after and frankly, they don’t have the dollars or manpower to go after all individuals. It is a lot easier to go after a company with a lot of sales. But, they never were able to do that, because those companies may not have had nexus. So, that is why click-through nexus was developed.”

Emerging Nexus Regulations

Click-through nexus has been adopted by approximately half of the states in the country. However, a few states, including Alabama and South Dakota, recently expanded their nexus regulations to all remote entities, challenging the requirements set forth by Quill v. South Dakota.

“Alabama requires remote sellers to collect and remit Alabama’s sales and use tax if annual sales of tangible personal property into the state exceed $250,000,” Vetlov says. “And, in South Dakota, if an out-of-state seller has more than 200 total transactions annually, or $100,000 in sales annually, to individuals or entities in its state, then that entity has to collect and remit sales tax as well, exactly as they would if they had a physical presence within the state.”

Many tax experts say that it is just a matter of time until other states follow suit as well.

“Other states are going to challenge the Quill v. North Dakota ruling,” O’Connor Davies’ Weinberg says. “But then, those sellers will point to that case and say ‘you can’t do that,’ and they will challenge whether or not they have nexus. So, right now, it is all still up in the air.”

How Can a Business Comply?

In this ever-changing tax landscape, what can businesses do to make sure they are following state nexus regulations and what type of penalties can they face if they are not complying?

“As nexus provisions expand, businesses will possibly have additional sales tax collections,” says CohnReznick’s Smith. “So, if you are not complying with the rules, you can become susceptible to audits. Audits can lead to fines and exposure as a company.”

“It is important to have an awareness of where your company is conducting its business activities, or what states your company is selling into to determine its nexus footprint,” PwC’s Brenner adds. “Failure to follow each state’s sales tax laws may subject the company and/or responsible individuals to civil or criminal penalties.”

Besides having to face an audit, companies may not only have to pay back sales and income tax, but interest and other fees.

“It can be quite costly for businesses if they don’t comply,” O’Connor Davies Weinberg adds. “And, for small- to mid-sized businesses that may not necessarily have in-house departments and/or resources to help them, having an advisor who knows the ins and outs of nexus and state sales and income tax laws, is something that is very important.”

Weinberg says that many companies are not aware that these nexus regulations exist. However, there are companies that are aware, but aren’t able to properly address them.

“Many times, the administrative burden might be simply too much and businesses aren’t going to engage in putting their time, energy and money towards complying,” he says. “Then, at some point, companies start to realize that they are growing, making enough money and say they have to fix the problem before it costs them a lot of money or even their entire business.”

At the end of the day, companies need to figure out whether or not they are conducting any form of businesses outside of the state in which they are located, find the right advisor, and make sure they are complying with state taxes.

“It is important to determine if [businesses] are selling remotely into states and whether they participate in any type of commission-based referral programs in these states,” PwC’s Brenner concludes. “If they have any in-state affiliates, either through websites or in-person, receiving payments for referring potential customers to your client, they may have nexus in these states [and can be] subject to taxes.”

 

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