Is the Time Right for a Sales Tax Nexus Review?

Sales tax nexus is not static. As your company grows, expands and evolves, your nexus footprint will likely change as well. All too often, companies will not realize the compliance impact of those changes until they receive an unfriendly inquiry from a sales tax auditor.

As tax compliance professionals emerge from the barrage of requirements hitting them in the months of December and January, the time may be right to consider whether your company might benefit from instituting a nexus review protocol; something it could utilize periodically, ensuring that you identify new compliance obligations as they emerge rather than several months or years after the fact. In setting up a nexus review process, consider the following critical steps:

Step 1: Consider your physical nexus footprint

A company becomes obligated to collect and remit sales tax in any jurisdiction where it has a physical presence. Physical nexus can be loosely described as having people (e.g., employees, contractors) or property (e.g., buildings, inventory, equipment, delivery vehicles). For example, if your organization opened a new office, a new warehouse or began housing inventory in a third-party facilitation center in a new state, that could expand your physical presence nexus. Likewise, in a world of “work from anywhere,” having an employee in a new state may expand your physical nexus, even if that employee is not directly involved in your sales process.

Step 2: Consider your economic nexus footprint

As of January 1, 2023, every state with a sales tax has a rule in place that looks not only to physical presence but also economic presence. While the details vary from state to state, economic nexus presence standards look at your total sales into a given state (sometimes defined as gross sales, sales of tangible property or sales of taxable tangible property) and/or the number of independent transactions into a state. If you need a quick guide for economic nexus thresholds, please feel free to use the chart located here. The implications of incurring economic nexus are largely the same as they would be with respect to physical presence nexus; meaning you become obligated to register to collect and remit sales tax and in many states, that obligation technically occurs in the very next transaction after you cross the threshold. Although, some states give you a little time to get your house in order. In a handful of states, such as Alabama and Texas, economic nexus sellers can request and receive permission to collect and remit under a simplified scheme that allows you to disregard local tax rates and apply tax at a simplified combined state and “local” rate.

Also, remember that Missouri is adopting an economic nexus standard effective January 1, 2023. The state applies a $100,000 threshold based on cumulative annual gross receipts from the sale of tangible personal property measured in the current or previous calendar year.

Step 3: Has your economic nexus footprint evolved into physical presence?

If your company, as an economic nexus seller, opted to advantage the simplifications in states like Alabama and Texas, but it subsequently created physical presence in either of those states, you would likely no longer qualify for the simplification and will need to begin collecting tax using standard local rates. Likewise, under the Illinois “Leveling the Playing Field” rules, the requirements change depending on your physical presence. A fully “remote retailer” charges retailers occupation tax (ROT) based on the customer’s location, meaning that both state and local tax rates apply. However, a seller with an Illinois location (physical presence) is only obligated to charge the 6.25% state sellers use tax when the sale originates from an out-of-state location.

Step 4: Have you lost nexus anywhere?

If your company changes its business model in a way that eliminates your physical and/or economic nexus footprint, it’s possible to de-register with a particular state and end your compliance obligations. With respect to physical presence nexus, there are well established “trailing nexus” rules that detail when a seller may opt to end its registration. With respect to economic nexus, the decision to de-register may be more complex and a little less certain. If a state, for example, changes its threshold from $100,000 in gross sales to $500,000 and your company does not come close to the new sales volume, de-registration may be appropriate. Conversely, if in a given year your sales drop slightly below a threshold, you may wisely choose to nonetheless stay registered and continue to collect, rather than undertake the obligation to track sales volumes and re-register if sales pick up.

Step 5: What’s next?

Once a company creates nexus, it must 1) register for sales tax, 2) collect tax from its customers based on appropriate rates and rules, 3) remit tax on the proper tax return, 4) collect and retain exemption certificates from any non-taxable customers, and 5) keep everything up to date. In an upcoming blog, we will discuss how you might go about setting up a process to keep things current.