What is a Tax Nexus?
Outlining Nexus in Income Taxes and Sales Taxes
In discussions of sales taxes, you may hear the term "tax nexus" or just "nexus" mentioned. Nexus 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.
Nexus 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/remit sales taxes in that state and pay income tax on income generated in that state.
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.
Tax Nexus in 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 sales taxes on applicable products and services in each state, and (b) pay state income tax on any income generated within that state. For this reason, many businesses set up separate profit centers in each state in which they do business.
Sales Tax Nexus and Online Businesses
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. The issue is the difficulty of monitoring collections and enforcing them.
Congress has considered several bills (including the Mainstreet Fairness Act) to remedy the mess, but none have passed so far.
Affiliate Nexus vs. Click-Through Nexus
Two types of nexus exist for online sales: click-through nexus and affiliate nexus. Click-through nexus is a direct connection between the buyer and the seller, while affiliate nexus includes the presence of an affiliate between the buyer and seller.
Many states have enacted laws requiring sales tax to be collected for online sales or they have required affiliates with a tax nexus in their state to collect and pay sales taxes. 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.
Of course, Amazon is the biggest elephant in the room in this continuing saga of online sales taxes. Amazon is adding more distribution centers, which are clearly tax nexus points, in most states, so even Amazon is collecting sales taxes for its online sales.