What is Nexus and Why You Should Care if Doing Business in Different States?

Key Takeaways

• Nexus determines your tax obligations in different states—it’s not just about physical presence anymore.
• Each state has its own rules for when nexus is created, and for which types of taxes.
• Economic nexus allows states to tax businesses with no physical footprint, based only on sales activity.
• Identifying where you have nexus early can save you from penalties, denied credits, and lost opportunities.
• Staying compliant protects your business and may even reduce your overall tax burden.

Defining Nexus in a Business Context

The easy part of this is understanding the definition. Nexus is a connection or series of connections linking two or more things. Within the business and state and local tax environment, nexus is the minimum connection a business or individual has to a particular state. It is significant in understanding if a business or individual is subject to filing requirements within a particular state or locality.

How Nexus Is Created: The Three Core Factors

Nexus can be established within a state in several different ways. The three general categories are payroll, property, and sales, which also are the three factors used in apportioning activities between states though many states have reduced apportionment to just the sales factor as it is generally easier to increase tax revenue by subjecting out-of-state companies to taxes.

Complications That Make Nexus Harder to Pin Down

While having retail centers or warehouses located inside the state would be quite evident that nexus is established, it is often more complicated. For instance, what about a sales team that occasionally travels into a state or what if the company has its own vehicle for product deliveries. These factors often need additional clarification such as the number of days or deliveries.  The following factors make it even more difficult:

1. Different states have different factors which establish nexus
2. Different states have different types of taxes (income, sales, payroll, property, franchise, gross receipts, etc.)
3. Some factors establish nexus for certain taxes but not for others
4. Different states have different bright line tests (minimal amounts or percentages of payroll, property, or sales)
5. Factors change depending if your revenue is either service or sales-based:
   • if sales-based, what is your product – tangible, intangible, real, etc.?
   • if service-based, what services do you provide?

The Rise of Economic Nexus and Online Business Impacts

By now, your head may be spinning and you may have already decided to not physically expand into additional states; however, you may still need to be mindful of slipping into nexus. For instance, what if you have a website? In some states, you may establish nexus even though you have never had a physical presence or performed sales activities targeting customers.

Some states are following the lead that the Wayfair Supreme Court decision provided for sales tax requirements and are starting to pass regulations or look into how to expand the economic nexus concept to other taxes. Economic nexus can be established solely based on the number of receipts or transactions with customers located in a specific state. In addition, the Multistate Tax Commission (MTC) has recently introduced amendments to PL 86-272 which could allow states to pass legislation to tax companies doing business through the internet.

Why Understanding Nexus Matters

While you may not get overly excited about being subject to taxation in other states, identifying your nexus obligations with other states is beneficial for the following reasons:

1. States and localities can deny you from doing business within their jurisdiction. Expanding into different states and localities can be an advantageous opportunity for many; however, in order to enjoy the benefits, it is important to maintain good compliance so that the opportunity stays available.
2. To avoid double taxation, you likely will be able to claim a credit for at least a portion of the taxes paid to the non-resident state against your resident state’s tax liability. The credit can be eliminated if the tax paid to the non-resident state is paid after you file your resident tax return.
3. Sales tax is collected from customers and paid to the state. If you fail to collect, you will likely be unable to collect after the sale is complete.
4. Creating nexus in some states may be able to decrease your total state tax liabilities even though you have additional reporting requirements.
5. If you discover your exposure through a tax notice, you will likely owe penalties. In addition, the state can go back to the very first date that you had activity in a particular state if the state finds you.

For these reasons, it is important to keep good records and continuously review your activities and sales in different states. For more information or assistance analyzing your nexus in different states, please feel free to contact us.

Content provided by Joe Guelda CPA, Tax Manager

Frequently Asked Questions

What is nexus in state taxation?

Nexus is the legal connection between a business and a state that gives the state authority to impose taxes on that business.

Can I have nexus without a physical location in a state?

Yes. With economic nexus, states can require tax compliance based solely on sales volume or transaction count, even without a physical presence.

What’s the difference between economic nexus and physical nexus?

Physical nexus involves tangible presence like offices, warehouses, or employees. Economic nexus is triggered by meeting sales or transaction thresholds, often online.

How do I know if I have nexus in another state?

You’ll need to analyze your business activity — where your sales go, where your people or property are located, and which state laws apply to your industry or product.

What happens if I ignore nexus requirements?

States may impose penalties, interest, and back taxes. They can also look back several years to when your activity began, not just when they discover it.

Can Nexus ever reduce my overall tax burden?

In some cases, yes. Strategic planning and spreading taxable income across states with lower rates or favorable tax rules can reduce your total liability.