Sales Tax FAQs #3: Physical Presence
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 answer some of your frequently asked questions about sales tax.
Here’s a glimpse of what you’ll learn:
The basics of determining physical presence when it comes to sales tax.
Does physical presence matter for sales tax?
What should someone do once they’ve determined they have physical presence for sales tax?
Webinar: Does a Physical Presence for Sales Tax Even Matter Anymore?
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, Mike Fleming here, founder of Sales Tax and More and today's co-host of the Sales Tax and More Podcast where we talk about everybody's favorite topic, which is of course sales tax. And today we're gonna be answering some frequently asked questions. These frequently asked questions all revolve around physical presence.
So this is gonna be a physical presence centered podcast. But before we get into the questions, let's introduce you to my co-host, Ellie Moffat. [00:01:00]
Ellie Moffat: Hi everyone. Mike, it's really great to be here. You don't know if we are physically present because our cameras are off, but we are, and we're gonna be talking about physical presence when it comes to sales tax anyway, but I'll go ahead and do, I don't know if that joke made any sense, but if everyone could give me a courtesy laugh that's, that would be great.
Thank you. But I'll do a quick introduction for Sales Tax and More. So we are a full service consulting and solutions firm, and we have a really great team here of experienced tax professionals who are very dedicated to fulfilling any of your state tax or related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, 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 would love to hear from you and please like and subscribe to this podcast. It really helps us out. We love having you as a listener and we're so glad you're here today. And with all that being said, [00:02:00] no more cheesy jokes.
But Mike, can you go over the basics of determining physical presence when it comes to sales tax?
Michael Fleming: Yeah, absolutely. And Ellie, I, before I forget, let's bring this up. We just did a whole webinar, a 60 minute webinar on physical presence nexus. So if these questions get you thinking a little bit more about physical presence, I invite you to go and see the webinar and Ellie will provide links to get you there.
All right, but I am ready for these these questions.
Ellie Moffat: Yeah, absolutely. So yeah. Mike, can you go over the basics of determining physical presence when it comes to sales tax?
Michael Fleming: Yeah, absolutely. Let's start with the definition of nexus. Nexus just means a link or connection. And when we're talking about sales tax, it's the link or connection that must be present before a state can make you do anything.
For example, before it can make you collect [00:03:00] its sales tax or vendors use tax or pay its taxes, like an income tax, a franchise tax, or a consumer use tax. You have to have this link or connection with the state. And we call this link or connection nexus. So when we're talking about determining a physical presence nexus, this link has to have some sort of physical component, not all the time 'cause we have economic nexus too, but when we're talking about physical nexus, there's gotta be some physical component of the nexus. Now some of it's gonna be very obvious, some of it not so obvious. Some of it is going to be, common sense. Some of it is gonna make you scratch your head and say, oh wow, I never thought of that. So there's a lot of things that goes into determining physical presence. Some of them pretty easy, fairly obvious, very common. For example, if you rent an office somewhere, [00:04:00] I think that or own an office or own real estate, I think we can all agree that creates some sort of link or connection with the state.
And very common just about all the states out there are gonna consider that to be a physical presence. However, if you have a virtual office, a lot of people tell me "Mike I don't have any of these links that you're talking about. I do everything in the cloud and therefore I don't have a physical presence anywhere".
And unfortunately, the states don't look at that, that way. Wherever you live wherever you operate your business from, the state is going to say that you are creating a link with that state. Very common, all of the states out there are gonna take that as to be a nexus creating activity. But it's not so obvious.
A lot of people tell me, "I don't have this this link or connection". Another one, not so obvious, is third parties. There's actually two US Supreme Court [00:05:00] cases that say that third parties, if they're helping you to establish or maintain a market, can actually create nexus for you. So independent contractors, subcontractors, heck you don't even have to give it a name, if you have a company out there performing services on your behalf, if they're interacting with the public or your clients that's generally going to be nexus creating and that is an area to me just doesn't make common sense. If I'm thinking about what activities I have that are gonna create a link or connection with the state, I don't very often think of the activities that third parties have with the state that can give me nexus by extension. So if you have someone out there doing installations for you or implementations, if you have someone doing repair work on your behalf, if they're collecting bad debts, if they are doing credit repair work. There's a whole list of [00:06:00] activities out there that can be under the umbrella of helping to establish or maintain a market.
So those are the tougher ones to recognize. But because this has been the subject of two US Supreme Court cases very common. What state's not going to say this creates nexus if the Supreme Court has said it creates nexus twice. Now, not all third party relationships are going to create nexus.
For example, if you hire someone on a 1099 basis to develop software for you, they're not interacting with the general public. They're generally not interacting with your customers. So in general, that's not going to be a nexus creating activity. It's gotta be something like the implementations or the installations something along those types of lines.
Like I said, some things are fairly obvious, some things are not so obvious, so this is something you have to [00:07:00] delve into a little bit deeper. There's no quick and easy answer here. If you think something could possibly create some sort of link or connection between the state and you, look into it.
Chances are it's gonna be creating nexus for you. And it's a lot easier to create a physical nexus than most people realize. Just sending an employee into the state if they're there for greater than 48 hours in a state like Michigan or Arizona, and that's 48 hours cumulatively throughout the year that can create nexus. Attending trade shows as an exhibitor can create nexus in some states. So there's lots of ways to do this. Basic rule of thumb, expand your thinking. Try to think outside the box. Could the state say that I am creating a link or connection with the state by having these activities there?
And if they are, follow up on it. Call someone like us. Go out and do the research [00:08:00] yourself. But this is a lot more dangerous in my opinion than economic nexus, because economic nexus has only been around since 2018. And the states are coming hard after that. But you may have had independent contractors doing installations for you in estates for the last 20 years.
There's greater exposure or potential exposure from that physical nexus than there is for that economic nexus. No, no easy way to determine it. You have to actually know the types of things, and some of this is state specific. Some of it is very common and just about all the states look at it the same way, if not all of the states.
Ellie Moffat: All right. So Mike, I really think you went over this, but I'm gonna just reiterate a small part. So does physical presence matter for sales tax?
Michael Fleming: Absolutely does matter. And we get people calling us all the time saying, "Hey Mike, I want to de-register". And I say, "Why?"
And they say "The state got rid [00:09:00] of their, transaction threshold and I'm underneath the $500,000". And I'll ask them , "Last time we spoke you had inventory in the state". "I still do". This is California. California thinks inventory in an Amazon warehouse creates a physical presence. They say, "I still have that, but I'm underneath the $500,000".
Yeah, you still have that physical presence nexus, and that's always going to when it comes to sales tax trump and economic nexus. The states know that somewhere between 40 and 60% of companies are not compliant when it comes to economic nexus. And they are gearing up to track down these companies.
And while they're tracking down these companies, they're gonna stumble across all types of nexus. I think not only does physical presence nexus matter for sales tax today, I think it matters more than ever because of what I was saying earlier. You may have had, independent contractors [00:10:00] for 20 years and six and a half years for the economic nexus.
That's my summary. Yes, it does matter. Short story long.
Ellie Moffat: Yes. Okay, Mike, can you summarize what someone should do once they've determined they have physical presence for a sales tax? They understand this is an issue. If they understand it matters, it applies to them. What do they do?
Michael Fleming: I think you have to quantify the potential exposure. You're gonna hear something from me that you're not going to hear from anyone else. So maybe technically you have nexus in a state, but you only have a thousand dollars worth of sales. And the average sales tax rate in the state is 8%.
So you would owe $80. It's gonna cost you a heck of a lot more to get registered. Even if you do it on your own. There's opportunity costs. Time is money. It's gonna take you more than $80 worth of time to get registered. And now once you're registered, maybe it's a [00:11:00] state like Georgia, where you're automatically a monthly filer for at least the first 12 months.
Now, someone's gotta take the time to do all those returns. So whether you're doing them yourself or you're hiring someone like us, there's a cost involved. So if you don't pay the sales tax, if you don't get registered, the penalty and interest is not gonna be a 100%, but let's say that it is.
So you owe $80, add another $80 to it for penalty and interest, you would owe potentially $160 per year. You can't possibly get registered and file returns every month for less than $160. So to me, that doesn't make sense. And I think that we need to use common sense. We gotta look at the materiality when we do this.
Just because the state says you need to do this doesn't mean it makes good business sense. Now, that is my opinion. That's not the state's opinion. The states think that once you have nexus, you should be [00:12:00] collecting sales tax from dollar number one. So the first thing we need to do is quantify what our potential exposure is.
So if it's minimal, maybe we do nothing. If it's substantial, maybe we look at some mitigation programs like a voluntary disclosure agreement or an amnesty or some other type of program out there. Where as a reward for stepping forward and saying, "Hey, I want to become compliant". The state will limit the lookback period.
In California, they find you, they're going back eight years and they want the back tax plus penalty and interest. If you step forward, they only want the last three years worth of back tax and interest. They'll even waive the penalty. So you saving five years of back tax and penalty plus the 10% penalty for the three years in the VDA period where you gotta pay the back taxes. [00:13:00] Once again, it depends. The first step you gotta do is figure out. What your potential exposure is, you gotta quantify it. And once you quantify it, then you determine how to move forward.
Do I just do a perspective registration, which means that I'm gonna register on a going forward basis? Now, the states may not want you to do this if you've had nexus for a while, but if the numbers are small. Some of our clients say, "Hey, I wanna stop the bleeding. I don't wanna do one of these voluntary disclosure agreements. I don't wanna step forward and tell them. I just wanna tell 'em I'm gonna start collecting tax going forward. You can do that. However, if the state ever finds out that you had nexus prior to the date you tell them, they're gonna want all those back taxes plus penalty and interest. The statute of limitations does not apply if you've never been registered and never filed a return.
So in theory, [00:14:00] those periods that you didn't fix could be open forever. In reality after 2, 3, 4 years, the likelihood of a state finding you is virtually zero. Every year that goes by it gets less and less likely that a state's gonna find you unless you have someone internally who rats you out to the state, which I have seen done.
I've seen partnerships break up. I've seen husband and wifes get into nasty divorces and one of them wants to penalize the other. It's not impossible, but it gets less and less likely to be found the longer you get away from the date that you actually get registered.
Maybe you gotta do nothing, but before you decide to do nothing, you gotta quantify what your potential exposure is, and it's very minimal.
Maybe you do nothing. If it's somewhere minimal, maybe you just register prospectively. In other words, on a going forward basis, or maybe it's substantial and you need to take care of [00:15:00] some of that past exposure through a mitigation program, like a voluntary disclosure agreement.
Ellie Moffat: Thank you so much, Mike. Is there anything else you wanna add in about physical presence?
Michael Fleming: No, I think we covered it. Again, if you have any more questions, I suggest you go to the the webinar that I referenced earlier. Ellie will give you a link to it. And also, send in some questions and we'll answer them on the next frequently asked questions type episode.
Ellie Moffat: Yes, please always send your questions and you know you have reign to ask questions at those webinars as well. We do answer questions at the end of those live webinars. And, if you have any sales tax needs, we offer a lot of solutions and services. You can reach out to me directly at emoffat, that's E-M-O-F-F-A-T at salestaxandmore.com, or visit our website salestaxmore.com.
And thank you so much for listening today. We appreciate you being here.
Michael Fleming: [00:16:00] Thank you for joining us today, and I hope that we see everybody on the next installment of the Sales Tax and More Podcast