Know Your Nexus: Don’t Get Blindsided by State Tax Rules
October 18, 2015
If you do business with out-of-state customers, does your business have nexus with the states where those customers are located? If your answer is, “I don’t know what ‘nexus’ means,” you could be in for an unpleasant surprise.
“Nexus” is the legal term for a business presence that allows a state to impose an income tax obligation or to require sales tax collections. You might think you have no tax obligations to other states because you have no place of business in those states. However, the U.S. Supreme Court has long held that more limited types of business presence, such as soliciting sales in a state through employees or independent contractors, creates a sufficient “nexus” to permit a state to impose tax obligations on an out-of-state company.
Many states are very aggressive when determining the degree of “presence” required to impose a tax obligation on an out-of-state company. For example, New Jersey has taken the position that making one delivery or pick-up in the state in a particular year is sufficient contact to impose tax on an out-of-state company.
Federal statute prohibits states from imposing an income-based tax on companies that simply solicit sales of tangible property in the state. However, once that pitch turns into a sale, related activities can easily result in loss of the benefits provided by the Federal statute, if a company does not carefully limit its activities in the state.
In addition, the mere solicitation of sales by representatives who visit customers or potential customers in another state is a sufficient contact for that state to require a company to collect sales or use tax on property delivered to customers in that state. Importantly, if your company fails to properly collect sales tax from your out-of-state customers, your company could end up paying the tax that was not collected from your customers.
Be alert for activities that can establish nexus:
- Installation and service of products. If you sell equipment or other property out of state and send staff or a contractor to install it, this could establish nexus. The same applies for service and repairs.
- Delivering the product yourself. The United States Supreme Court has ruled that delivering by mail or by common carrier, such as UPS, doesn’t create nexus with another state for sales tax purposes. However, sending your own trucks into some states does the trick.
- Having representatives in the state. That means someone on the ground doing work on your behalf – perhaps a salesperson or someone calling on customers to resolve disputes. This could also include picking up damaged or returned property.
- Independent contractors or others doing work attributed to your company could create nexus.
You’ve likely read about tax collection disputes between states and online retail giants such as Amazon.
Never assume that an online sale is or is not subject to sales tax without further examination.
It all depends on the business’s physical presence in the state where the customer is located, and the specific tax rules of each state. If your company makes an online sale to a customer located in a state where your company has some direct or indirect physical presence, your company may be required to collect that state’s sales tax. In some states, an in-state presence can be established when in-state businesses put up website links for online concerns and are compensated based on sales resulting from those links.
As an example, Pennsylvania’s guidelines revolve around some part of a transaction having an in-state connection. Details are spelled out in Pennsylvania Department of Revenue Sales and Use Tax Bulletin 2011-01. In general, a remote seller has to collect sales tax if:
- Any of the seller’s merchandise is stored at a facility in Pennsylvania, even if it’s a location that stores products for multiple companies.
- The seller has a contractual relationship with a company or person in Pennsylvania whose website encourages purchasers to buy from the remote seller, if the in-state entity or person receives payment from the remote seller for sales made through its website.
- Employees of the seller regularly travel to Pennsylvania for any purpose related to its business activities.
- The seller uses affiliates or agents in Pennsylvania to provide repair, delivery or other services relating to property it sells to Pennsylvania customers.
Ways to avoid problems
The consequences for ignoring sales tax collection obligations and income tax liabilities owed to another state can include payment of back taxes, fines, and interest and penalties. On top of that, of course, are professional fees and the costs of gathering records. I recommend the following:
- Evaluate your out-of-state activities and get sound legal advice: Review all of your contacts with the states in which your customers are located. Then, evaluate whether your activities are sufficient to create a tax obligation in those states. In addition to state tax services and publications, state websites and “customer service” departments are good sources of information. But, even if you call or email with questions, a state is generally not legally bound by what they tell you. Make sure you engage an attorney familiar with state tax laws if you have a substantial potential exposure in other states.
- Consider voluntary disclosure: If you come forward, a state may waive penalties and limit the “look back” period. A business can reach out anonymously through a representative such as an attorney to determine if voluntary disclosure is a viable option for limiting its liability for back taxes.
- Document exempt sales: Be sure to get documentation at the time of sale to support tax-exempt sales. Maybe you sold equipment to a customer in another state who resold it to a third party. If the customer goes out of business and you can’t document that the transaction was for resale, and therefore not taxable, you could end up being liable for the sales tax.
Sharon R. Paxton is Vice Chair of McNees Wallace & Nurick LLC’s State and Local Tax Group. She has more than 20 years of experience representing companies of all sizes in a broad range of state and local tax matters. She can be reached at 717-237-5393 or firstname.lastname@example.org