State and Local Tax Nexus: Thanks for Connecting…Now, Where’s My Money?!

There once was a time that you needed to physically go into a department store or local shop to buy all the items that were wanted or needed for work or play. You could have gotten these things via the giant 500-page department store catalog, but most of the shopping/buying was done within a physical location. In these instances, the company selling the goods from their store location is clearly doing business (has nexus) within that state. In addition, all their employees are working at that location.

Today, you can order almost anything online from your phone, tablet, or computer within minutes. We just bought a fridge online from New York last year and it eventually showed up in a large truck, then it was installed by the guys in that truck. Did not have to set foot in a store.

To add to the ability to buy from anywhere in the world, you can now work from anywhere in the world depending on the type of work that you do. The expanded network of reliable internet, enhanced communication platforms like Teams and Slack, Cloud-based Software-as-a-Service options and many other improvements have made working from home/cabin/beach/treehouse easier and, for some, more productive than being in the office.

You might be wondering “What does this have to do with tax?”. What all these changes mean to the tax world is that states are getting more and more creative with how they are determining whether a business has enough of a connection to create “substantial nexus” within their jurisdiction. Some states will say you are doing business in their state if you allow their residents to browse your inventory online or even submit a job application via their website.

The main taxes that these evolving nexus issues hit are:

1. Sales Tax
2. Income Tax
3. Payroll Tax

Below I will include key points to “trigger” whether a deeper dive should be made into a state tax nexus analysis for your company.

Sales Tax Nexus

The exposure to sales tax in today’s business world continues to expand each year. In 1992, the number of sales tax jurisdictions in the US totaled around 6,000. At this time, a court case called Quill vs. North Dakota was the standard used by companies to determine if they had a presence in a particular state. If a company did not have a physical presence within the state, besides the occasional salesperson driving through, your company did not have nexus in that state.

Fast forward to 2018, where there are now 11,000 jurisdictions, and we see a new court case come through the Supreme Court called Wayfair vs. South Dakota. In this case, the court completely changed the way states could pull various companies into their jurisdiction because they (the SCOTUS) believed that the act of doing business has changed to the point that you do not have to physically be in a state to be doing business with the residents of that state. Between the date of this decision and today, all 50 states have changed how they determine if a company is doing business within their state for sales tax purposes.

Now, there are many more factors that will pull your company into the grasps of a state, some of these (not an exclusive list) are:

1. Physical location of headquarters, office, warehouse, etc.
2. Employees are physically located within the state (including remote workers).
3. Inventory stored within state (including within Amazon, eBay, or other marketplace facilitator distribution warehouses).
4. In-state customer revenue of $100k (or more depending on specific state threshold) within the past 12 months.
5. Number of transactions with in-state customers. A common threshold has been 100 transactions, but some states are getting rid of this threshold due to the potential of forcing companies with low cost items to register to remit $5 of tax for the sale of 100 $1 items.

If any of these items raises an eyebrow for your own business, then I would suggest checking with your tax team. Each state can apply their own threshold with $100,000 in sales and/or 200 transactions being the most common. Generally, the cities, counties and special tax districts follow what the state is doing for these thresholds.

Income Tax Nexus

During the pre-Wayfair years, the income tax nexus thresholds were a little more business friendly. If you sold items in another state, but did not have any employees, offices, or other physical presence within that state, then you did not have substantial nexus for income tax purposes. There were several services and actions that were protected under Public Law 86-272, which would allow you to solicit orders to customers and give them “deminimis” services.

Now the list of “deminimis” services are basically limited to:

1. Offering your products for sale on a website
2. Having a FAQ section on your website
3. Placing cookies on computers of customers for the purposes of studying the data

Some actions that would generally cause your business to have income tax nexus (besides physical presence) would be offering post-sale assistance via a chat tool, offering employment applications on your website, sending product or code fixes via the internet, having a remote employee that is not a salesperson, and many other activities that used to generally be protected.

More states are now moving to a Factor-Based or Bright Line Nexus standard, which is based on a threshold for property, payroll or sales hitting certain amounts. The most common is $50,000 in property, $50,000 of payroll or $500,000 in revenue during a given year. Hawaii and Washington have thresholds as low as $100,000, while some states basically have no threshold and that you are doing business within the state with the first $1. If you hit one of these thresholds, then you are considered doing business in that state and should register to do business with the Secretary of State.

Payroll Tax Nexus

The final “larger” nexus area is coming into play more now that telecommuting or remote working are becoming the norm. Each state has its own rules for when a company will need to begin withholding local state taxes from the employee working from within their state. Twenty-four states, for instance, will require withholding on the first day an employee works in that state. If an employee decides to work from the cabin in Michigan one weekend, then technically Michigan could ask the company to register and withhold. On the other side of the spectrum you have Utah, which has a 60-day window before requiring withholding.

Allowing employees to telecommute from states that the company has never been registered in will open new exposures in many areas besides payroll withholding, this could include:

1. Income tax nexus
2. Sales and Use tax nexus
3. Gross receipts tax nexus
4. Unemployment Insurance

The way businesses and states are operating now are much more different than they were 30 years ago. The current pandemic has not helped in that the states are getting more and more aggressive in determining what they consider a connection to their state and their residents. Knowing what your exposure is in these areas and having a plan going forward will be beneficial on the front end of these changes, rather than down the road. Letting your tax preparer/CPA know about any new lines of business, expansions into new territories or the hiring of new employees in new states prior to it actually happening can be a great way to get these issues included in the implementation of those new items.

If you are looking for more detail or have questions on these topics, contact Nate Panning at npanning@bgm-cpa.com. You may also reach out to your BGM CPA or complete the Contact Us form and request to have one of our professionals connect with you.