Understanding sales tax nexus for small businesses

The rise of mobile commerce has enabled small businesses to greatly expand their market reach beyond their local region. However, the trade-off is greater complexity for estimating taxes, especially if a business operates in or sells goods to multiple states. Each state has its own laws and separate sales tax rates to keep track of.

You must determine if you have nexus in a state to know whether you're required to collect and remit sales tax within that state. Nexus is a concept that traces its origins back to the Constitution's due process and commerce clauses. There must be a connection between the state and an entity for the state to tax that entity. A state can claim nexus with an entity in several ways.

Physical nexus

Physical nexus is one of the most straightforward nexus concepts to understand. You have physical nexus if your company has a physical presence within a state. A state may require you to collect and remit sales tax to the state when you trigger physical nexus. The exact definition of physical nexus may vary from state to state. Common ways to trigger physical nexus in a state include:

• Having the following in a state:
  • A physical business location
  • Employees
  • Warehouses
  • Inventory
  • Stores
  • Other physical business
• Attending trade shows
• Performing services

Economic nexus

The Supreme Court set a precedent in 2018 called an economic nexus, allowing states to force online sellers to collect and remit state sales taxes in certain circumstances. The Court ruled South Dakota could require sellers with more than 200 transactions or more than $100,000 in sales within South Dakota to collect and remit sales tax to the state. Many states have since adopted similar laws with different thresholds.

Affiliate nexus

Affiliate nexus is one way states creatively taxed businesses that did not meet the traditional physical nexus rules before the 2018 Supreme Court case. This type of nexus says businesses located in other states form nexus with a state if they had a physical connection through certain connections. These connections varied from state to state but often included having in-state affiliates, representatives, employees, or other affiliated entities. The exact definition of the relationships necessary to trigger affiliate nexus is dependent on the laws of the state in question.

Click-through nexus

Click-through nexus is another form of nexus used by states before the 2018 Supreme Court case allowing economic nexus. This type of nexus is formed when a business works with third parties to drive traffic and sales through website links.

This enables states to claim the companies had a physical presence in the state through the website owners. Many major companies use this practice to drive sales, including large internet retailers such as Amazon.

Marketplace nexus

Affiliate and click-through nexus had started to capture sales tax revenue from online sales. However, states realized they were leaving substantial potential taxes on the table through online marketplaces.

Some companies allow other sellers to sell items on their platform in addition to selling items themselves. These marketplaces weren't collecting sales taxes on items sold by third-party vendors even though they were collecting sales taxes on their own sales. Marketplace nexus laws began appearing to force marketplaces like Amazon or eBay to collect and remit sales tax on behalf of third-party vendors for the items sold through the marketplaces.

Sales tax compliance

Keeping track of and complying with 50 states' sales tax nexus laws can be overwhelming. Thankfully, third parties have created systems to help with sales tax compliance. These systems can automate the sales tax process and help you comply with applicable laws to save your business headache, time, and expenses. There are fees for these services, so business owners must perform a cost-benefit analysis to see if they're a good fit.