What Is Tax Nexus?
Definitions and Examples of Tax Nexus
A nexus is a relationship or connection between two or more entities. In tax law, it's a relationship between a taxing authority, such as a state, and a business. A nexus must exist before a taxing authority can impose a tax on the enterprise, and it requires that there be a substantial link between the jurisdiction and the business.
The concept of a nexus has become a complicated issue with the advent of online sales businesses that serve numerous states and countries.
What Is a Tax Nexus?
The term "nexus" is used in tax law to describe a situation in which a business has a tax presence in a particular state. A nexus is basically a connection between the taxing authority and an entity that must collect or pay the tax.
Two clauses of the U.S. Constitution form the origin of a tax nexus:
- The due process clause, which requires a connection
- The commerce clause, which "requires substantial presence"
Everything about a nexus has to do with "presence," but that presence can be defined differently for different types of taxes and even within the sales tax framework. It's historically meant that a business is physically in that state in one form or another, such as by owning and maintaining property there or employing workers in the jurisdiction.
Having a nexus can also describe the amount and degree of business activity that must be present before a state can tax an entity's income or sales within its jurisdiction. The taxpaying entity must pay and collect sales taxes in that state if it has a nexus there, and it must pay income tax on income generated there.
How a Tax Nexus Works
Although the definition of nexus can vary by jurisdiction, it generally requires that a business must commit to a certain type of action in the jurisdiction. Joe's Widgets might be considered to have a nexus in Nebraska if Joe maintains an office there, if he employs workers there, or if he even stores his widgets in a warehouse there.
This requires that Joe establish Nebraska's sales tax rate and collect it from any Nebraskan who buys one or more of his widgets. He would most likely also have to pay income tax to that state.
Types of Tax Nexuses
Nexus can be determined differently for income taxes and for sales tax purposes.
Nexus for Income Tax Purposes
Nexus is typically created for income tax purposes if an entity derives income from sources within the state, owns or leases property there, has employees there who are engaged in activities that exceed "mere solicitation," or has capital assets or property located there.
Nexus for Sales Tax Purposes
Nexus is determined more loosely for sales tax purposes. A business might have sales tax nexus in a state because:
- It has a physical location in the state.
- It has resident employees working in the state.
- It has property, including intangible property, within the state.
- It has employees who regularly solicit business there, such as salespeople.
Requirements for a Nexus in Online Transactions
A nexus for sales tax purposes has historically required that a business have a physical presence in that state, but the advent of the internet has driven states to more closely consider online businesses and their non-payment of sales taxes.
The Supreme Court finally ruled on the issue of online nexus in the case of S. Dakota v. Wayfair in June 2018, stating that older ways of determining tax nexus were artificial and anachronistic. The Court indicated that states have a right to require online sellers to charge and collect sales tax from all online buyers, not just those who are physically located in that state.
The various states that charged sales taxes scrambled to set up regulations and procedures that would allow sales tax collection for online sales. To avoid harming smaller sellers, many states have set a minimum number of transactions or annual amounts of sales below which no sales tax is charged for online transactions.
If your business meets the requirements for having a tax nexus in several states, you must collect, report, and pay sales taxes on applicable products and services in each state, and pay state income tax on any income generated within that state.
Types of Nexuses in Online Sales
States have come up with several ways to determine a nexus for online transactions.
- A click-through nexus is a direct connection between the buyer and the seller. This can occur when a business within the state is paid a commission for referring sales to an out-of-state seller, such as via a link on a website.
- An affiliate nexus involves affiliates that are independent businesses that sell through other businesses. The Amazon Affiliates program is a good example. An affiliate isn't an employee or even an independent contractor, but is actively associated with a business, and states have been using this connection to capture sales taxes. This type of nexus often requires that a commission for referrals be paid by the affiliate.
- An economic nexus is the simplest way of determining a sales tax nexus. It's basically just sales. A business might have an economic nexus in a state if it sells over a specific amount or threshold. Idaho has established $100,000 in annual sales as the minimum for establishing a sales tax nexus.
- Businesses must have a nexus in a state before they’re obligated to pay income tax or collect sales taxes there.
- Nexus effectively means that the business has an active presence in the taxing jurisdiction.
- The clear-cut concept of a nexus became muddy and confused when businesses began engaging in online sales.
- The Supreme Court finally clarified and defined the issue of an internet nexus in its S. Dakota vs. Wayfair decision in 2018.