What to Do if You Have Economic Nexus in Another State
February 19, 2021 - If your company does business in states outside of your primary location, you may already know that you're required to collect and remit sales tax there. After Wayfair vs. South Dakota, a 2018 Supreme Court ruling, most states adopted new legislation to establish new guidelines requiring companies doing interstate business to file taxes in those states even though they did not have a physical presence.
"Traditionally, we all looked at nexus as some form of physical presence," says Teri Grahn, Senior Tax Manager, Sales and Use Tax at Redpath. "But then states started to realize they were missing out on a lot of revenue" due to increasing remote business and internet sales from companies that have absolutely no physical presence in their state. New laws, called economic nexus laws, arose to address that revenue.
Even more challenging, the requirements differ from state to state, depending on the amount of sales and number of transactions. Let's go over a few key terms and considerations to help you figure out if, when, and where you should file taxes in accordance with economic nexus laws.
What is Economic Nexus?
Nexus is a threshold of business activity a company must be doing in a state before that state can require the company to collect and remit sales tax there. "If you have an office, inventory, sales activity, or even an employee traveling into that state, that means you may have nexus in that state," Teri says.
Economic nexus, on the other hand, doesn't require any physical presence at all; in fact, it was established in South Dakota vs. Wayfair (2018) specifically to address companies that weren't required to collect sales tax in states where consumers were buying products and services.
Unlike traditional nexus, economic nexus carries thresholds that a company must hit before it's considered to "have" economic nexus in a certain state. Economic nexus thresholds differ by state, from $100,000 to $500,000 in sales, the type of sale (gross, retail, or taxable), and some have transaction thresholds.
What to Do if You Have Economic Nexus in Another State
43 states have passed economic nexus legislation; the remaining seven either don't collect any sales tax or haven't passed laws addressing economic nexus (yet). TaxJar has a current, thorough rundown of each state's economic nexus thresholds. A sales analysis can help you figure out if you have economic nexus in another state, what if any sales tax you should be collecting, and how you should be filing taxes in that state.
Additionally, a few key questions can help you address filing taxes out-of-state in light of South Dakota vs. Wayfair:
- In which states have you exceeded the sales or transaction thresholds? If your analysis finds that you do business with a number of states that have economic nexus laws, consider how many are states in which you meet the minimum thresholds. Once this is done, determine if those sales are taxable by collecting and reviewing exemption certificates you have from your customers to make sure they are valid and up-to-date (while exemption certificates may not expire in every state, we recommend updating them every three to five years regardless).
- What is your past and current liability? If you have any tax liability in a state, you need to analyze this liability to determine if you should register and start collecting sales tax as of a current date, or if a Voluntary Disclosure Agreement (VDA) with a state makes more sense. If you're audited and found owing on a previous year's liability, you'd owe the back taxes, penalty, and interest. By choosing to file a VDA, a state usually will abate a penalty and will reduce the number of years that need to be filed. That's important because failing to file past returns means the statute of limitations never starts and a state can audit any and all periods that were never filed.
- Do you have the capability to collect the correct amount of sales tax in all state and local jurisdictions? There are over 12,000 local jurisdictions in the United States. You need to make sure you're charging the correct amount of sales tax in all of them. Some states do not have local taxes, and some (like Alabama and Texas) have a single rate for remote sellers (if applied for), but most states' rates differ between counties, cities and special districts. Software like Avalara, Vertex, and TaxJar can help compile the jurisdictions in which you're responsible for collecting sales tax.
Don't Be Caught By Surprise
No matter what states you do business in, Teri says that “companies should conduct a nexus analysis to make sure they're in compliance and collecting the sales tax necessary in each state.” If any nexus exposure is found, companies need to implement a strategy to register and collect sales tax or file Voluntary Disclosures Agreements with states. Just as important, companies should put sales tax procedures in place and document their processes to prepare for future decisions on filing requirements, any changes in business revenue, or employee turnover.
To learn more about the best ways to file taxes in other states to be in compliance with economic nexus legislation, watch Teri's "Wayfair and Marketplace Nexus" webcast on demand at the link below.
Redpath and Company
Redpath and Company help clients make more informed decisions that contribute to their financial well-being by providing proactive, innovative, and value-driven CPA and advisory services for closely-held businesses, private equity, government entities, and nonprofit organizations. Core commercial industries served include retail, manufacturing, distribution, construction, real estate, engineering, and technology. Areas of service expertise include audit and assurance; personal, business, and international tax; state and local tax; sales and use tax; and succession and estate planning. Redpath also guides clients throughout the entire business life cycle with M&A advisory services (corporate and deal strategy, transaction support, and integration); accounting and financial management outsourcing; and valuation services. The firm was founded in 1971 and is employee owned (ESOP). With offices located in St. Paul and White Bear Lake, Minnesota, the firm ranks as one of the top CPA and advisory firms in Minnesota and is a top 120 firm nationally. Redpath is a member of HLB International, a global network of independent advisory and accounting firms. For more information, visit www.redpathcpas.com.
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