Does your business need to pay taxes in a given state? The answer depends on nexus.
- A tax concept called nexus determines whether your business has to pay sales tax, income tax or other state taxes in a state where you have a physical or economic presence.
- Nexus is determined by assessing the level of connection between your business and a particular tax-collecting jurisdiction.
- All states that impose a sales tax have now adopted a nexus standard, which means your business could have potential tax exposure that has not yet been identified.
- To learn more about your potential tax exposure under nexus and other state tax rules, talk with your tax advisor.
Does your business have to pay taxes in a particular state? While it might seem straightforward, this question can sometimes be surprisingly complicated to answer and doing so often comes down to understanding a tax concept called nexus.
What is nexus and how does it affect the taxes your business has to pay? Keep reading to find out.
What is the tax concept of nexus?
In the state and local tax (SALT) environment, nexus is the foundational concept that determines whether a state has the legal authority to impose taxes (like sales taxes) on a business. At its core, nexus refers to the level of connection between a taxpayer and a taxing jurisdiction — both in terms of the quantity and quality of activities conducted in the state.
- No nexus, no taxes: Without nexus, a state cannot constitutionally apply its tax laws; with nexus, compliance obligations are triggered.
- Physical presence matters: Businesses can establish nexus by having people or property located within a particular tax jurisdiction.
- Economic activity also establishes nexus: A certain level of economic activity (i.e., customer sales or a set number of transactions) is also enough to qualify a company for nexus, exposing your business to state tax obligations even if you do not have an office or a warehouse in the state. This is the result of the 2018 Supreme Court ruling in South Dakota v. Wayfair, which found that an out-of-state retailer that collected at least $100,000 in sales or did 200 or more transactions in a given state owed that state sales taxes regardless of physical presence.
Why is nexus important for sales tax or other state taxes?
Nexus plays a key role in establishing your business’s tax exposure. Nexus determines whether a business is required to:
- Register with a state
- Collect and remit sales and use tax
- File applicable income, franchise, gross receipts or other tax returns
- Pay state and local taxes.
Nexus is grounded in the Due Process and Commerce Clauses of the U.S. Constitution, which require a minimum or substantial connection between a taxpayer and a state before tax can be imposed.
Today, nexus extends beyond physical presence. A business may establish nexus through in-state physical activities (e.g., employees, inventory or property) or through economic thresholds — even without any physical footprint.
This means, for example, that a retailer that only operates stores and warehouses in New York but does a certain volume of online sales with customers in New Jersey could be required to collect New Jersey sales taxes, regardless of whether any of its employees ever set foot there.
All states that impose a sales tax have now adopted a nexus standard
States have expanded nexus standards to include economic thresholds, marketplace facilitator rules, affiliate relationships and remote activity. Following the South Dakota v. Wayfair decision, all states with a sales tax have adopted some form of economic nexus standard.
This has significantly increased compliance exposure for businesses operating across state lines. (Learn more about specific state nexus requirements.)
What are the tax risks if you ignore nexus?
Failing to identify and comply with nexus obligations creates significant risks. If nexus exists but returns are not filed, the statute of limitations generally remains open indefinitely. States may assess multiple years of back taxes, often including substantial penalties and interest.
Businesses may also lose access to voluntary disclosure opportunities that could otherwise limit exposure and eliminate penalties. In addition, unrecorded liabilities may require financial statement accruals under ASC 450-20, potentially impacting audits and financial reporting.
What should your business do next?
Businesses should continuously monitor their activities across states, evaluate both physical and economic nexus triggers and assess exposure across all tax types.
To get a better sense of your potential tax exposure, talk with your tax advisor. Your advisor can help you understand how tax concepts like nexus affect your business, plus implement a tax strategy to reduce your exposure.
Keep in mind that:
- Some tax advisors will only focus on performing a sales tax nexus study and ignore income, franchise or other gross receipt taxes. To protect your business against surprises, make sure your advisor considers all tax types (i.e., not just sales) when conducting a nexus study.
- Addressing historical exposure proactively through structured remediation can also significantly reduce your risk.
Nexus is the gateway to state taxation. As rules continue to evolve, proactive evaluation and compliance are essential to managing risk and avoiding costly exposure.
How Wipfli can help
Wipfli’s dedicated state and local tax specialists advise businesses on tax strategy, including how to navigate the complex web of state and local tax rules. Let’s talk about how we can help your business determine where nexus applies and how you can reduce your risks and tax exposure. Start a conversation.
How does nexus affect your business?
