What is a Nexus? What Determines a Tax Nexus?
Types of Nexus and Nexus for Online Sellers
In discussions of sales taxes, you may hear the term "tax nexus" or just "nexus" mentioned. Nexus is the basis on which a becomes a common theme of discussion for online sales businesses, such as Amazon sellers, who often serve numerous states or countries. This article discusses tax nexus and its importance in both sales taxes and income taxes, particularly for online businesses.
What is a Tax Nexus?
Nexus in general means a connection. The term nexus is used in tax law to describe a situation in which a business has a "nexus" or tax presence in a particular state or states. A nexus is basically a connection between a taxing jurisdiction, like a state, and an entity like a business that must collect or pay the tax.
The Sales Tax Institute notes that the origin of tax nexus is two clauses of the U.S. Constitution, the due process clause, which requires a connection, and the commerce clause, which "requires substantial presence.
Nexus also describes the amount and degree of business activity that must be present before a state can tax an entity's income or for taxes on sales within the state. If a taxpayer has nexus in a particular state, the taxpayer must pay and collect/pay sales taxes in that state and pay income tax on income generated in that state.
Everything about nexus has to do with "presence," but that presence is defined differently for different types of taxes and within the sales tax area.
What Determines Nexus?
Nexus is determined differently for income taxes and for sales tax purposes. Each state has its own rules for determining 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 in the state, has employees in the state in activities that exceed "mere solicitation," or has capital assets or property in the state. The requirements vary from state to state.
For Sales Tax Purposes
Nexus is determined for sales tax purposes more loosely. A few cases in which a business might have a sales tax nexus in a state:
- If the business has a physical location in the state
- If there are resident employees working in the state
- If the business has property (including intangible property) in the state
- if there are employees who regularly solicit business in the state (i.e., salespeople).
The issues relating to whether a business has a nexus in a state and is thus subject to the state's taxing authority are complex and each state views the concept of nexus differently.
Recent Changes in Nexus for Online Transactions
A nexus for state sales tax purposes has, in the past, required a physical presence of the taxing business in that state. In the past 10 to 15 years, a growing concern has driven states to more closely consider online businesses and non-payment of sales taxes. The states feel that online businesses are not collecting sales taxes from online sales, and the states feel these revenues should go to them.
After years of confusion about nexus in relation to internet transactions, the Supreme Court ruled in June 2018 in the case of S. Dakota v. Wayfair. The Court said that older ways of determining tax nexus were "artificial and anachronistic" and that states have the right to require online sellers to charge and collect sales tax from all online buyers, not just buyers physically located in that state.
This new ruling has sent the various states that charge sales taxes scrambling to set up regulations and procedures to allow sales tax collection for online sales. To avoid harming smaller sellers, many states have a minimum of transactions or annual amounts of sales, below which no sales tax is charged for online sales.
Tax Nexus in the Several States
Just to be clear, if your business meets the requirements for having a tax nexus in several states, you will need to
(a) collect, report, and pay sales taxes on applicable products and services in each state, and
(b) pay state income tax on any income generated within that state.
Different Types of Nexus for Online Sales
Through the years of dealing with nexus for online transactions, the states have come up with several ways to determine nexus:
- Click-through Nexus. Click-through nexus is a direct connection between the buyer and the seller. Avalara says, "An out-of-state business establishes click-through nexus in a state when an in-state business receives a commission for referring a certain amount of sales to the out-of-state seller, as through a website link (“clicking through”).
- Affiliate Nexus. Affiliates are independent businesses selling through another business. The best example is the Amazon Affiliates program. While an affiliate is not an employee or even an independent contractor, an affiliate is actively associated with a business, so 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
- Economic Nexus. The simplest way of determining sales tax nexus is economic nexus, which is basically just sales. A business might have an economic nexus in a state if they have sales over a specific amount. Idaho, for example, has established $100,000 in annual sales as the minimum for sales tax nexus.
Which States Have Remote Seller Nexus?
The Sales Tax Institute has an updated remote seller nexus chart (as of June 2019) showing which states collect sales tax on internet transactions and how they determine nexus.
Some states use more than one type of nexus for online sellers.