Nexus Basics
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss and answer questions about nexus.
Here’s a glimpse of what you’ll learn:
What is the difference between physical and economic nexus?
Economic Nexus vs. Physical Nexus Details
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More your go-to resource for all things state tax related. Now here is your host, Michael Fleming.
Michael Fleming: Hi everyone. Mike Fleming, founder of Sales Tax and More, and today's co-host of the Sales Tax and More Podcast where Ellie we talk about everybody's favorite topic, which is of a course sales tax. And within that favorite topic, we're gonna talk about everybody's subtopic today, which is of course nexus.
So two favorites. Before we get into this, let me introduce you to my co-host, Ellie Moffat.
Ellie Moffat: Hi everyone. Great to be here. We love talking about nexus. It all starts with nexus. I've heard [00:01:00] Mike say it maybe a thousand times. And before we let him start talking about it some more. I'll do a quick introduction for Sales Tax and More.
We are a full service consulting and solutions firm, so we have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense, exemption certificate management, and like our name states more.
So if you have questions about our services or you'd like to work with us, please reach out. We'd love to hear what from you. We'd love to work with you, and we'd love it if you'd also like and subscribe to this podcast as well. Mike, what is the difference between physical and economic nexus?
Michael Fleming: You always ask me such great questions, Ellie. And I could probably talk about this for hours, but let's try to boil it down to its simplest. Physical, that's an activity in the [00:02:00] actual state. You are physically in the state where economic, let's call that remote for now. So physical is when you are in the state or a representative of yours is in the state, and creating that link or connection we call nexus, physically or economic means that it's being done remotely.
And it's based upon certain monetary thresholds.
Ellie Moffat: All right, so we're gonna break these two things apart because I know you could talk about them each quite extensively here, Mike. So first, can you talk more about economic nexus and highlight maybe a few important touch points that people should know about.
Michael Fleming: Yeah, absolutely. So let's go back a little bit and prior to 2018 you had to have old fashioned nexus, which sometimes physical nexus is referred to as the old fashioned nexus 'cause it's the one that's been around forever.
And in 2018, we had the [00:03:00] state of South Dakota, they wanted to try to get some of this online revenue, and the state said, it's not fair. We've got all of these sellers selling into here and it's a direct disadvantage to our local merchants. So how do we get a piece of that? So they decided that they were going to have a requirement for sellers to collect tax. If they passed these economic thresholds and they set a hundred thousand dollars or 200 transactions was enough of a economic presence in their state to create a significant nexus and therefore companies should collect and remit their tax.
And it went to the Supreme Court in June of 2018. The Supreme Court said, yes, we agree with you that we should have never introduced the concept of physical presence. We made a mistake. There were two cases one in 1967, the other in 1992 where we talked about physical presence. We should not have done that.
[00:04:00] We inadvertently created a protected class, and that was never our intent. They didn't do away with physical presence. They just said that you didn't need a physical presence in order to create this link or connection with the state that we call nexus. So that's how economic nexus came about. Now something that you need to know about economic nexus, at least for sales tax, income tax, not so much. But for sales tax, an economic nexus doesn't protect you from any other type of nexus.
As a matter of fact, an economic nexus is gonna almost always be trumped by a physical nexus when it comes to sales tax at least. In other words, if you have a physical nexus, it doesn't matter that you don't have an economic nexus. The physical nexus is more important and vice versa.
If you have an economic nexus and not a physical nexus, nexus is nexus. [00:05:00] Once you have nexus it doesn't matter what type of nexus it is. You may have a responsibility to collect and remit taxes in that state. That's probably most important about an economic nexus. Here we are, almost eight years into this economic nexus.
And a lot of smart people out there sometimes, CPAs contact us and they want to get their clients deregistered because they're underneath the thresholds of economic nexus. And unfortunately, it just doesn't work that way. It doesn't matter what type of nexus you have, one does not protect you from another.
When it comes to sales tax, income tax, sometimes it does protect you. You could have a physical nexus and be under the economic and be protected, but when it comes to sales tax, not so much. So that's a very important point there. And, the nexus thresholds for economic nexus are constantly evolving. [00:06:00] And for example, South Dakota said a hundred thousand dollars or 200 transactions.
Well, California right away said, they immediately jumped in and said a hundred thousand dollars or 200 transactions. But then they came back and they said, we're California, we're not South Dakota. We're a lot bigger than South Dakota. We don't think that's fair. It takes a lot of business to do a hundred thousand dollars or 200 transactions in South Dakota.
Heck, you sneeze at California and you'll pass those thresholds. We raised our thresholds to $500,000 and we're not even gonna have a transaction threshold. You cross $500,000 in our state, you got an economic nexus. That's enough for us. They're constantly changing. Illinois in January of this year got rid of their 200 transaction threshold, so you wanna stay on top of the changes out there because sometimes you can deregister not be registered in the state anymore. Other times as your sales continue to grow. You are gonna have to get [00:07:00] registered in more states. A lot of people, when economic nexus first came out in 2018, they all scrambled and they got registered right away and they were all compliant.
But then they never looked at it again. And their sales have continued to grow over the last eight years, and they're set up based upon what their snapshot was eight years ago, so they were compliant back then, but they're not compliant now. So every December or January, you need to be reviewing what your sales are to each of these states in light of what the current guidelines are for that state. What are the current thresholds? And I say every December or January, because some states, the look back period is based upon the previous calendar year. And the calendar year runs from January 1st to December 31st. So what better time to look at that than the month of December or the month of January.
So you're looking at the proceeding calendar year, and if you're over those thresholds, then perhaps, you need to get [00:08:00] registered. Now, the other thing to look at is what's included in a threshold. Some states never make anything easy. Some states include marketplace sales, which is sales through Amazon or eBay or Etsy. Some states exclude them. Some states exclude sales for resales. Some states include them. Some states do gross sales, which is all of your sales. Some states exempt sales for resale, but include all other exempt sales. So again, each state makes things a little bit different. We've got a great chart.
Ellie will put it in the notes when we post this podcast. And it's always up on the free portion of our website. It'll go through all of that. It'll give you all of that information and much, much more in a single chart to help you figure out your nexus footprint. And some states may be previous calendar year or current calendar year, and in that case, it's still good to check in December or [00:09:00] January.
But if your sales are exploding, you might have to check every quarter. If they're growing, just like they have every year. Then maybe you can wait until next December or January again if you weren't over it this year. But you need to be checking. This is not a set it and forget it.
And it's not all about registering in additional states. Sometimes you can deregister not have to collect and remit taxes there anymore. So Ellie, those are just a couple of the touch points. The other thing is if you don't have the time or the inclination to go through this exercise yourself, you can hire us for $795.
We'll tell you where you need to be registered, where you don't need to be registered, and what the best way to register is. Or sometimes we'll tell you to do nothing. So we call that an economic data review. That's a great service, but somebody needs to be doing it. Because if you catch these issues early, you don't have any exposure building up.
But if you don't take care [00:10:00] of 'em, you could get a year, two years, three years without realizing it, and then a state finds you and you get pay all of its back tax plus penalty and interest outta your own pocket. We call that the greatest tragedy in sales tax because this is money that could have been coming out of your customer's pockets begrudgingly, if not willingly, at the point of sale.
Most everybody pays tax at the point of sale now. So if you charge 'em tax generally not gonna impact your sale. But if you don't charge 'em tax, it could impact your pocketbook at some point down the road because now you're paying the sales tax that they would've paid. And Ellie, that's a couple of the touch points.
What else you got for me?
Ellie Moffat: I have one more question for you, but I just wanted to add in, this podcast episode will come out the end of January, maybe the beginning of February. It's still a great time to do that service that Mike is talking about you still have time to start your year off and it's better to be on it the beginning of the year.
Michael Fleming: Ellie, when's the best time to plant a tree?[00:11:00]
Ellie Moffat: Yesterday.
Michael Fleming: Yeah, absolutely. When's the second best time?
Ellie Moffat: Today.
Michael Fleming: Absolutely. Same thing with nexus.
Ellie Moffat: I guess if you're listening to this in July, it's not too late but.
Michael Fleming: It is not too late. The best time to have checked your nexus footprint was yesterday.
The second best time is today.
Ellie Moffat: Today. Alright. Okay. Last question here, Mike. Can you do the same thing for physical nexus that you just did for economic nexus? So highlight a few important touch points that people should know about. Just generally speak a little bit more on physical nexus.
Yeah a lot of the same points we talked about for economic nexus are the same for physical nexus. Nexus is nexus. However, this is something that trips up a lot of people when we're thinking about physical nexus. We think about our activities. What am I doing or what is my company doing in this state that could create a responsibility for me to collect and remit taxes?
And one of the things we often overlook, because it just doesn't make [00:12:00] common sense is the activities of third parties, independent contractors, subcontractors heck, it doesn't even have to have a name. Maybe you hired a company to do something on your behalf. And there are two US Supreme Court cases.
Scripto and Tyler Pipe. One was 1967 and one was 1992. And both of these say that the activities of third parties can create nexus for you if they're helping to establish or maintain a market. Now, it's not all third party activities. What we tell our clients is if someone's going into a state on your behalf and interacting with the public.
Then there's a good chance that's gonna be nexus creating. Now if they're developing software for you in another state, you're paying them on a 10 99 basis, or they're doing your books and you're paying them on a 1099 basis, they're not interacting with the public. They're not helping to establish or maintain a market.
So [00:13:00] that type of activities is not nexus creating generally. In all my years of doing this, the biggest problems have been created by third party nexus because it just doesn't make common sense. People don't think of what someone else is doing for them to create this linker connection with the state.
Installations, implementations a lot of companies say I don't do the installation. I have a subcontract to do that. That's what these two court cases are about and third parties, yes, they can create nexus for you. So not only do we have to check our economic nexus and see if we have crossed any threshold, but we gotta look at our physical activities, not only of ourself, but of people who are doing work on our behalf.
And it's not only where they live, it's where they're traveling on your behalf. So do you have people traveling? Do you have employees traveling? Here's another one. During the pandemic you had a lot of these states eliminate the [00:14:00] telecommuting nexus which means that if someone's working from home.
They're creating nexus for you in their home state, and they were suspended, but all of the states have reinstituted that. So maybe you let someone work from home during the pandemic. You never made 'em come back to the office and you haven't realized that you now have an expectation to be collecting and remitting tax in that state. So those are just some of the trouble points. Physical nexus, delivering in your own trucks is a big one. You're crossing a state line with your truck and if it's a non-discreet truck, sometimes it's a little bit hard unless you gotta stop at a way station and they figure out who you are.
But if you got your name plastered across the side of a state, there's someone often sitting at the border of that state writing down all the names of all the companies that are driving into their state. Lots and lots of different hidden issues. It seems simple physical nexus. But for years there's been arguments about what does and what [00:15:00] does not create some type of link or connection with the state where you might have to collect sales tax.
Err on the side of caution because as I said earlier if you don't collect the tax, and the state says you should have been collecting tax because of this. That tax is gonna come out of your pocket. With the added insult to penalty and interest where it could have been collected at the point of sale, if you had done this correctly and at that time it would've coming outta your customer's pocket with no penalty, no interest. Yeah, there's a cost of compliance, but that's minimal. That's pennies compared to the dollar amounts that they could extract from you at some point later on. Penalties and interest over time can quickly add up over 50% of the actual tax due. And that can leave a real mark, can hurt you, can even put some companies outta business. So you wanna make sure that you're taking care of this. And I was joking that number one, sales [00:16:00] tax is your favorite topic and the subtopic is nexus. Might be my favorite topics but only because I'm a sales tax nerd. And but it's so important this nexus because if you don't have this link or connection, state can't require to do anything.
So if you don't have nexus, you have no problems, no responsibility. But if you do have nexus, you could have a whole bunch of exposure building up and it doesn't need to. Ellie, anything else?
Nope, no nexus, no problems or responsibilities. One of a Mike, classic line. I just wanted to emphasize there. So I'll close this out here.
If you have sales tax needs and we have a lot of solutions and services, some of them Mike mentioned today, but please reach out. We'd love to hear from you. We'd love to work with you as well. You can contact me directly at E-M-O-F-F-A-T at salestaxandmore.com. Or visit our website at salestaxandmore.com to get in touch with us.
And [00:17:00] in addition to this podcast, we have a lot of free resources as well. So check them out and thank you so much, Mike.
Michael Fleming: Thank you everyone. We hope that you've enjoyed this episode and hope to see you on the next episode of this Sales Tax and More Podcast. Bye-bye.