Nexus | State Tax Risk | Ohio CPA Firm

Nexus Has Evolved: Why Your Business May Be At Risk And Why It Matters

Whether your business relies on out-of-state subcontractors or independent agents, sells products or services across state lines, or employs talent outside of your state, a variety of tax implications could affect your bottom line. Staying on top of nexus and state tax risk can help keep your business compliant and safeguard you from the hidden costs of doing business outside of your state.

In its rawest form, nexus is essentially the connections that your business has with other states. This includes where your business has a presence in terms of personnel, inventory, and property, as well as states you visit for sales, installs, or support. And wherever you have nexus, you must abide by that state’s tax laws for all state-imposed taxes including sales and use tax, income/franchise/gross receipts taxes, property and payroll taxes. This may include various registrations and all applicable compliance (e.g. filing returns, collecting and remitting taxes, and managing exemption documentation).

Currently, two major considerations stand out as threats to business owners, especially businesses that have activities outside of the principal state of business:

Nearly all U.S. states have modified their standards for nexus and tax compliance, following the 2018 U.S. Supreme Court ruling, South Dakota v. Wayfair. The verdict allowed states to impose economic nexus rules. These rules triggered sales nexus for businesses purely based upon their gross sales into the states, placing a more extensive tax burden on businesses that exceed the sales/transactions thresholds imposed by the economic nexus rules across state lines. Under these standards, it is no longer essential that they have a “physical presence” in a state before the state requires that they comply with the sales tax regulations. It is important to stress that the physical nexus triggers did not go away, but that economic nexus factors have become important as well. Moreover, the case opened the door for a totally new standard of what “remote seller” means. This brings us to the second consideration …
As the legal definition of “remote seller” evolves, along with workforce changes spurred by COVID-19, more businesses than ever now fall into the category of multi-state businesses for one reason or another. This, in turn, is making them vulnerable to hidden costs and potential liabilities associated with operating across state lines – sometimes even without knowing they are now considered a multi-state business operation.

Specific Nexus Examples

As businesses venture into new frontiers or expand current practices, just about anything could place your business under the burden of out-of-state regulations and costs. If overlooked, businesses that fail to comply with tax obligations in their home state, or elsewhere, could face substantial fines and other consequences up to or including legal penalties. Obviously, the biggest change in nexus is the economic nexus rules added in response to the Wayfair case. All states have enacted these types of laws with similar yet not all the same thresholds. Florida and Missouri are the last to adapt. And, as mentioned above, physical presence factors have not been made less important when considering your nexus footprint outside your home state. As companies continue to allow and encourage remote employees and work-from-anywhere programs, it’s necessary to understand that these out-of-state employees trigger physical presence nexus for both indirect/direct state taxes.

However, there are some other examples of nexus that still could impact a business. These include:

Using third-party vendors, like Amazon. If you use third-party organizations to sell and even store your inventory, you have physical presence in other states. This rule has been around for decades, and those sellers who use Amazon’s Fulfillment By Amazon (FBA) are waking up to notices that indicate they have had nexus in unexpected states going back 10-12 years.

Generating click referrals for your business by utilizing online ads. If someone in a different state were to click on the online ads you placed to promote your business, the ad itself would be enough to establish that your business has a physical presence in another state – making you vulnerable to tax laws in that state as well. With the advent of the economic rules, some states are repealing these “clickthrough” nexus rules as redundant.

Where Potential Liabilities May Exist And How To Identify Them

Examining your business’s nexus footprint can help you understand your potential liability and will assist you in getting ahead of an issue that may cost you penalties. You might discover that your business has exposure for certain liabilities. Knowing this will allow you to make informed decisions moving forward while allowing you to maintain compliance. Knowledge is the first step in preventing your business from facing unnecessary expenses and liability, and it can also save you a lot of time – and worry!

So, what can you do to determine where your liabilities lie in this ever-increasing world of nexus?

Start by looking inward and consider doing a state and local tax (SALT) nexus and risk assessment study. Do you truly have a solid grasp on all the areas where you do business? A nexus study can help you evaluate every aspect of your tax situation and uncover areas of potential tax exposure. Rea’s SALT experts regularly perform nexus and risk assessment studies to help identify client exposure.

Keep good exemption certificate records for any transactions with wholesalers or exempt purchasers (i.e. manufacturers). Determine if your customers have an exemption for their use of your product or service in their state. If so, keep good records of those exemption certificates. Many states have rigid requirements on what constitutes a valid certificate.

Break out your invoice price to contain the risk associated with things that are actually taxable as many states fully tax mixed transactions. You should always discuss this with a SALT expert.

Make sure your software can accurately calculate sales by state, county, etc. This includes properly sourcing sales and generating the correct tax rate and determining taxable and nontaxable sales. Some types of businesses may encounter very complex taxing situations in which sales tax software is the only way to manage.

In states where your tax exposure may be high, consider whether you should register going forward and pursue a voluntary disclosure. If you choose not to take action in states where you have nexus, determine whether your audit team is required to add a disclosure to your financial statements or if you need to consider an accrual for sales tax. Additionally, if you are considering selling your business in the future, you may need to address these issues sooner rather than later. It is a hot topic under any quality due diligence process.

Consider your staff. It’s estimated that as many as 30 percent of all remote employees have worked or currently work out-of-state from their home office. If your business hired talent that works across state lines, you could face extra costs and liabilities. For example, states generally require employers to obtain workers’ compensation insurance for employees in the state where they work. Your business would need to either incur the additional fees to protect your out-of-state employees or face the penalties associated with legal noncompliance, which can be even more costly.

Examine business practices on a state-by-state basis. While nearly all U.S. states have already adopted, or plan to adopt, nexus standards for businesses that vary based upon the types of taxes, these standards are not universal. Examine which states you specifically operate within, no matter the capacity, and consider how their specific nexus standards could affect your business.

With so many considerations to examine surrounding nexus, it can be difficult to determine how they will impact your business specifically. If you believe that your business is at risk or you have concerns about the implications of out-of-state operations, our SALT team can help. Not only can we determine if nexus exists, we can recommend a strategy that will help you defend against those problems and safeguard your business for years to come.

By: Kathy LaMonica, Vertex® Certified Professional and Avalara® Certified Implementation Partner, principal, SALT
technology & consulting (Cleveland)