What is Nexus, and Why Is Nexus Important for Tax Planning Professionals?
Owning and operating a business is not for the faint of heart. Your clients have become the successful business owners that they are not because they shied away from new situations, but because they embraced them and tackled new problems head on. And that’s why it’s only a matter of time before your clients come to you with concerns or questions about their multistate activity.
When your clients expand into new territories – by opening a new business location, selling to customers in other states, or hiring remote workers – there may be tax implications they haven’t yet considered. If you are prepared for their questions and have the best tax planning software at your disposal, you can help them navigate this new world of multistate taxation with ease and confidence so that their business expansion is successful.
Trends in Multistate Activity
When the U.S. tax code was created in the early 1900s, few businesses operated across state lines. At that time, businesses were small and worked mostly to support their neighboring communities. In the last 30 years, this has changed, thanks in large part to the internet. With internet access, businesses found it much easier to expand into new territories. With the internet…
Business owners could more easily operate multiple offices from one centralized headquarters.
Businesses could more easily market and sell to individuals outside of their state.
Employees and contractors could perform their work duties remotely.
But as businesses expanded outward, states began to take notice. State governments noticed that their market was being split between domestic businesses that paid state taxes and remote businesses that did not. So, as businesses expanded, so did the tax laws.
What is Nexus?
A business becomes subject to the tax laws of a jurisdiction only once they have established a sufficient connection to that state. This connection is called “nexus.” Once nexus is established, the taxing jurisdiction can impose its tax filing, collection, and payment responsibilities on the business.
Nexus can be a difficult concept for business leaders to grasp for a few reasons.
Nexus laws are different in each jurisdiction.
Nexus laws are different for each type of tax – income, sales, gross receipts, etc.
Nexus laws are always being amended.
Although nexus laws differ from state to state and tax to tax, there are some basic nexus concepts your clients can learn to help them better understand what they’re facing.
What Generates Nexus?
The courts and state governments are constantly changing what activities generate nexus, but in general, there are two chief ways a business can generate nexus with a taxing jurisdiction.
Physical Presence
Physical presence is the simplest form of nexus to understand and was initially the only form of nexus. When a business initiates a physical connection to a state, they have established physical presence nexus. Each state defines physical presence a bit differently, but in general, the following activities generate physical presence nexus:
Operating within the state permanently or even temporarily
Sending employees or contractors to perform business activities within the state
Delivering a product or service within the state
Storing or using business property within the state
In general, if your clients cross states lines to perform any aspect of their job duties, they will have established a physical presence in that state.
Economic Presence
Economic presence is a bit more nuanced. Economic nexus exists when a business exploits a state’s marketplace for their own gain. Economic presence is defined differently in each state, but common activities that generate economic nexus are:
Having an affiliate within the state
Generating a certain volume or dollar amount of sales to that state’s residents
Marketing to customers within the state
Holding a trademark within the state
There are a few different types of economic nexus doctrines floating around that are worth mentioning.
Affiliate Nexus
Under the affiliate nexus doctrine, a remote business will be presumed to have nexus with a state if they are affiliated with a business that has nexus with that state. Consider an online seller who uses a subsidiary to fulfill orders to a certain state’s residence. This is a form of affiliate nexus for the online seller.
Click-Through Nexus
Click-through nexus is a particular form of affiliate nexus for sales tax that is important to understand because many states have passed click-through nexus doctrines over the past decade. Click-through nexus exists when (1) an internet seller in State X uses an affiliate located in State Y to advertise its products on a website that is marketed toward State Y residents, and (2) the seller pays their affiliate a commission for the advertisement when residents of State Y “click through” to the seller’s product and make a purchase. This type of click-through nexus was initially enacted in New York and was enforced against the online retailer Amazon, which is why some call click-through nexus the “Amazon Law.”
The Evolution of Interstate Commerce Laws
To fully understand where nexus laws are headed, it’s important for you and your clients to understand how interstate commerce laws have evolved over time.
Public Law 86-272
Public Law (P.L.) 86-272 was established in 1959 to protect businesses engaging in interstate commerce. It asserted that states could not impose income tax on out-of-state businesses whose only connection to their state was the solicitation of orders for sales of tangible personal property. As long as those orders were approved, managed, and shipped from outside the state, those businesses were protected. This law is quite narrow since it only applies to sales of tangible personal property (which means that sales of services, real estate, and intangible services were not similarly protected), but it provided a lifeline for many businesses in the last half of the 20th century.
Quill Corp. v. North Dakota
In the 1992 United States Supreme Court Case Quill Corp. v. North Dakota, the Court ruled that physical presence was required before a state could impose its sales tax collection responsibilities on a remote business. Although sales taxes are not the ultimate responsibility of the seller, the collection and filing responsibilities can be burdensome, and to encourage interstate commerce, the Court ruled against the states in favor of remote businesses.
South Dakota v. Wayfair
In 2018, the United State Supreme Court overturned the decision in Quill. No longer was physical presence required before a jurisdiction could impose sales tax collection responsibilities on a business. If states have economic nexus doctrines that allow for it, the states can impose filing responsibilities on out-of-state businesses who have no physical connection to the state. The Wayfair decision is having an impact to this day; states are continuing to pass economic nexus laws that help them take advantage of this newfound freedom.
Why Nexus Matters for Tax Planning
A lot has changed since Congress enacted Public Law 86-272 in 1959, and in some cases, the tax laws are just now catching up. As tax laws change, your clients will need to adjust how they do business. Their business decisions could have an impact that is much further reaching than they realize.
Tax planning professionals should take a close look at their client’s activity. If they are engaged in an online marketplace or travel to perform work functions, it might be wise to perform a nexus study. This service will look different for each client, but in essence, you would take a close look at your client’s activity and see where they have established nexus. This research could take time, but it could be well worth it to help your clients avoid penalties and interest for underreporting taxes or failing to file at all.
Once you know where your clients have nexus, see how their taxes will chan ge. This is where a good tax planning software will come in handy for a tax planning professional. With this knowledge, they can make the business decisions that are best for them and their company’s future.
