The Internet and other technological developments have made it easy for companies to make sales to customers in states all over around the country. Unfortunately, along with these new business opportunities comes a new set of tax headaches.
Whether your business is required to collect another state’s sales tax depends on whether you have a substantial connection — or “nexus” — with that state. But the rules regarding nexus vary from state to state (and tax to tax), so understanding and complying with sales tax collection obligations can be a challenge. To avoid unexpected tax liabilities, consider conducting periodic nexus checkups.
A Matter of Presence
Traditionally, having sales tax nexus with a state has required physical presence in that state, such as retail stores, offices, manufacturing facilities or employees. But cash-strapped state and local governments have been stretching the boundaries of nexus in an attempt to bring in additional tax revenues.
At the federal level, the U.S. Supreme Court decision in Quill is still the law of the land: physical presence is required for a state to impose sales tax collection obligations on out-of-state businesses. Since Quill, the combination of increased e-commerce activity and state budget deficits have led many states to reduce to a bare minimum the contact necessary to establish a physical presence, thus expanding the universe of sellers they can require to collect sales tax. In some states, for example, brief trips by out-of-state sales reps are enough to create nexus. Several states now impose sales tax collection liability on out-of-state sellers without a traditional physical presence if those sellers are affiliated with an in-state business or if sales are generated through referrals from an in-state business’s website (so-called “click-through nexus” laws).
Two states, Alabama and South Dakota, have taken the definition of nexus further still, implementing “economic nexus” for sellers with sales into the state over a certain dollar threshold. Many expect these laws to form the basis for challenges to traditional physical presence.
The Next Frontier of Enforcement
Beyond nexus, out-of-state sellers must also monitor states’ attempts to require disclosure of customer information. If a seller does not have nexus and therefore does not collect sales tax on an otherwise taxable sale, a use tax will be owed by the purchaser. Relying on thousands, even millions, of purchasers to comply with use tax rules is inefficient. States know they are increasingly missing out on crucial revenues as more and more purchases are made online (rather than in-store where sales tax is routinely collected). To combat this, a few states including Colorado require out-of-state sellers to provide customer information to enable the states to better target use tax collection from individual purchasers.
Businesses will need to comply with confusing and often inconsistent sales and use tax obligations until Congress simplifies sales and use tax compliance. And this may not happen anytime soon.
So don’t wait. Work with your tax advisor now to give your business a nexus checkup by taking inventory of your activities in and connections with various states, ensuring compliance with all applicable tax laws and regulations, and identifying potential strategies for minimizing your tax burden.
For more information on state and local tax contact your MarksNelson professional.