State Tax Nexus, What Is It? – Everything About Nexus That You Were Afraid To Ask!
[Editor’s note: Suddenly nexus issues and strategies are paramount in business operators’ and advisors’ minds, though a thorough understanding lags. SALT and tax-nexus authority Sylvia Dion begins a primer in this 1st of 2 parts]
Nexus! It’s a term you may or may not be familiar with. And, no, I’m not talking about that tablet sized mobile device that goes by the same name. I’m talking about the tax law concept of ‘state tax nexus‘ – one that if ignored, can literally cause a company to shut down and its owners to possibly even face jail time!
You see, “nexus” is a tax term that’s used to describe a “connection” or “tie” between a state and an “out-of-state” company. If a company’s activities in a state are sufficient enough to create “nexus,” this gives the state the authority to tax the out-of-state company or impose other responsibilities on the out-of-state company, such as the duty to collect the state’s sales & use tax. And if it seems you’re hearing this term often these days, you most likely are! It’s a term that’s used frequently in the debate about whether on-line retailers should be required to charge tax on internet sales.
In my work as a State & Local Tax (“SALT”) consultant, I spend a significant amount of time advising clients on state tax nexus and determining whether their particular activities in a state have exceeded a state’s nexus threshold.
If they do indeed have nexus in a particular state, I also help them comply with the various state laws. And if there’s one point that I repeatedly make, it’s that nexus is much more complex than how it’s described in the news where it’s often referred to as simply having an obvious or direct presence in a state like a storefront or corporate office.
The State Tax Nexus Reality
The reality today is that most companies do not confine their business activity to their home state. Companies that want to grow and expand realize that they must venture across state lines (and even across the ocean) to prospect new customers, attend trade shows, train their current customers on their products or equipment, or perform installation or service work. So, yes, while opening a physical location, such as an office, storefront or distribution center in a new state is certain to subject an out-of-state company to the new state’s tax laws, there are many other common business practices which may not seem to create nexus, but very well could! So let’s take a look at a few of these not-so-obvious nexus creating activities.
A State Tax Nexus Can be Created by Non-Employees
Let’s face it – a company won’t survive unless it’s bringing in sales, which is one reason why a company’s sales function will often include independent (non-employee) sales representatives. But sending independent sales reps into a state to solicit sales is a sure way to create nexus for sales & use tax purposes. It often comes as a surprise that a non-employee sales rep can create nexus for a company. And the fact that the independent sales may represent multiple manufacturers, or that the company has no physical location in the state doesn’t matter. In the view of most states, independent sales reps are acting “agents” of the business they represent.
A State Tax Nexus Can be Created by a Telecommuting Employee
I just pointed out how non-employees can create nexus, but would you be surprised to find out that a single telecommuting employee in state can create nexus? On one hand, it’s logical to see how a company with a sales employee working from his home might create nexus since the sales employee is likely to meet with customers in the normal course of his job and may even list his home address as a corporate location. But what about a telecommuting employee who strictly performs back-office administrative work or an engineer who works from home writing software code?
Every year, Bloomberg BNA, the legal and tax research arm of Bloomberg, conducts its Annual Survey of State Tax Agencies. In its 2013 Annual Survey, states were asked whether a single telecommuting employee performing administrative work would create state tax nexus for corporate or business taxes – and believe it or not, thirty-three states said “Yes.” Most of these same states said a single employee performing product development functions (e.g. software coding), would also create state tax nexus. And many of these states replied that their answer would be the same even if the single employee only worked part-time!
Nexus Can be Created by Affiliates in States with “Amazon Laws”
The use of third-party marketing affiliates to drive customer traffic to retailer websites has grown enormously in the past few years, with the Amazon Associates program being perhaps the best known affiliate program. In the last few years many states have also passed laws which attribute sales tax nexus to out-of-state sellers that enter into marketing affiliate contracts with individuals or companies that post a web-link on their in-state website that sends their website visitors to the out-of-state seller’s on-line store. The marketing affiliates are compensated generally via a commission if the “click” ends up generating a sale – which is why these laws are often referred to as “click-through” nexus laws, as well as “Amazon Laws” after their largest target. States with these laws take the position that the in-state marketing affiliate is effectively an in-state sales rep that is effectively soliciting sales for the out-of-state seller. And even though these laws target mega-internet retailers, any business using marketing affiliates in a “click-through” nexus state may find that this arrangement has created sales tax nexus for them. (By the way, if you’d like to know which states have an “Amazon Law” in effect, see my recent SalesTaxSupport.com “Amazon Law” update, “Amazon Laws Are Not All Created Equal”)
Nexus Can be Created With Ownership or Use of Internet Servers & Hosting
Here’s one that certain to be of interest to readers of this blog – whether the ownership or use of internet servers and of web-hosting services creates nexus. Once again, Bloomberg BNA’s 2013 Annual Survey of State Tax Agencies asked which type of internet server or hosting activities might create nexus in a state. Thirty-seven states said owning a server in a state would create nexus, 26 states said sharing space on a third party server would create nexus, and 12 states (plus D.C.) said using the services of a web-hosting provider with a web server in their state would create nexus. (Note that this survey question focused on income tax nexus. By the way, you can see a slide share of BloombergBNA’s 2013 Survey results in this AccountingToday article, “The State Tax Dragnet”.)
Final State Tax Nexus Points
As I said early in the post, having an obvious or direct physical presence in a state will certainly create nexus for various types of state taxes. As I illustrate above, there are also many “not-so-obvious” activities that can create nexus too. But here’s another final point – often, when I’m asked whether a specific activity creates state tax nexus, my response is “it depends.” This is because state rules are not uniform from state-to-state, so a particular activity could create nexus in one state but not another. Here’s one more point – a particular activity can create nexus for one type of state tax but not another. For instance, a company might have nexus for sales & use tax purposes, but yet not be subject to the same state’s corporate income tax. State tax nexus is indeed a complex topic – and one which can have complex consequences if it’s ignored! Yes, nexus, a topic I never tire of speaking about.
Consider today’s post a primer – a general overview of how easily state tax nexus can be triggered. I’ll be back for a second guest post – a part two – that will focus on nexus and technology; such as how states are taxing cloud services, software and other technologies. In the meantime, if you have questions or comments, I love to hear from you!
Sylvia F. Dion, MPA, CPA is the Founder & Managing Member of PrietoDion Consulting Partners LLC, a tax consulting firm specializing in providing State & Local Tax (SALT) and Employment Tax Consulting Services to companies throughout the United States and in Europe. One of Sylvia’s primary services includes helping companies with a multi-state presence understand their “nexus profile” and assisting them in resolving their state tax nexus exposure. Sylvia is the creator and publisher of “The State and Local Tax ‘Buzz’ ”, a professional tax blog focused on SALT developments which has received favorable mention in Forbes.com. She is also the “Internet Sales Tax” contributor for the SalesTaxSupport’s Sales Tax Issues, Insights and Ideas blog, the “Sales Tax for Foreign Sellers” contributor for SalesTaxSupport’s Industry blog, and a tax contributor for AllBusinessExperts, the “Experts” blog of AllBusiness.com. Visit Sylvia’s website at www.sylviadioncpa.com, and follow her on twitter at @SylviaDionCPA.