What Determines Sales Tax Obligations?

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Now that you have a general understanding of what sales tax is and why it is of utmost importance to your business’s success (Why Sales Tax?), a new question arises. What determines a company’s obligation to pay sales taxes on the sale of its goods and services? Certain characteristics of your business determine whether sales tax should be collected, how much should be collected, if there are any deductions or exemptions that will be granted to your sales tax amounts, and many more factors that affect the dollar amount you must send to the government every payment period. The binding connection between your company and the state is designated “nexus.”

Nexus can be created in several different ways, but this creation of connection can be difficult to define. The types of nexuses can be broken down into four distinct categories: physical, economic/transactional, affiliate and click-through. More likely than not, your business will be establishing a physical or economical connection with the tax authority you are conducting business in, so we will not be going in-depth about the other two categories of nexus. If you happen to believe you are establishing an affiliate or click-through nexus, feel free to reach out to State Tax Advisors so we can ensure you are making the correct sales tax reporting decisions.

As we focus on the two most-prevalent forms of nexus, physical and economic/transactional, an example of each would be beneficial to you:

  • Physical Nexus:
    • Company A is a new company that is originally based in an office building in Texas. The growth of the company is happening quickly, and sales are beginning to spread across several other states. Currently, company A makes sales outside of Texas in South Dakota, Maine and Utah averaging $45,000 in each state. The company has also just recently built a new office in Utah because of the increase in sales they are experiencing. Although the company is completing sales totaling $45,000 in South Dakota, Maine, and Utah; company A has only established nexus in Texas and Utah. This is because of the company’s brick-and-mortar place of business in both states.
  • Economic/Transactional Nexus:
    • Company B conducts all its business online as an e-commerce store. The company has sales in Kansas, Minnesota and Oregon totaling $65,000, $146,000, and $21,000 per year, respectively. The three states mentioned all have a minimum threshold of $100,000 in sales to establish economic/transactional nexus. For this reason, and because there is no physical presence in any of these states, company B has only established nexus in the state of Minnesota with their total sales being $146,000 per year.

One would think, per my discussion of what sales tax is, every good and service sold to a customer would require that sales tax be collected; this is not the case. The most basic possibility to create nexus in a state is to have $100,000 in sales in said tax authority, economical nexus, or by having a physical location or employees in an authority, physical nexus; whichever comes first will create the nexus of a business’s endeavors.

Sales tax is to be collected at the state or local level, hence the phrasing of “jurisdiction” when discussing nexus establishment. For every tax authority, the U.S. Constitution determines nexus status. The Constitution describes how there is a required minimum connection necessary to establish nexus within a tax authority. In contrast, each individual tax authority has a different definition of what determines the obligation to collect sales tax. Definitions of nexus can range anywhere from, “Receives more than $100,000 in gross revenue from retail sales in the Commonwealth” to “Has made more than $500,000 in sales of tangible movable property delivered in the state”. This obligation is immediately enacted as soon as the determined threshold is met. To be clear, the state or local government that your business has created nexus within is not required to inform you that nexus has been created. Therefore, it is of utmost importance that you, as a business owner or employee, keep a close eye on all records of sales and services and begin filing your sales tax returns as soon as this threshold is met.

Since there are large spaces of “gray” area in creating nexus in a particular area, it is necessary to conduct a full-scale nexus study. This study will dive deep into state statutes and your business’s sales and credentials to determine if, when and how your company has created nexus within a specified tax authority. Trusted tax advisors conduct these studies to correctly remit your business’s taxes if necessary. Without a proper nexus study, your business may be paying unnecessary taxes or unintentionally evading tax payments.

The requirements necessary for creating nexus vary so much that it is difficult to determine nexus status unless you are well-versed in each jurisdiction’s definition of nexus. The only ways to avoid this confusion, and in turn avoid any consequences applied by the jurisdictions you are conducting business in, are by allotting a portion of your revenues to employ a part of your workforce to focus on your sales tax needs or by outsourcing all your sales tax needs to a trusted sales tax advisor. The latter is the more cost-efficient option on both your monthly payroll and your bottom line in terms of any delinquencies reported in your sales tax filings.

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