Omar Bennett
Physical presence nexus refers to the physical connection or presence of a business in a state or jurisdiction, which triggers sales tax obligations. This can include having a brick-and-mortar store, a physical office, employees, inventory, or a warehouse within the state. While the specific criteria for determining physical nexus may vary across states, it remains a key consideration in establishing a business's tax obligations. With the rise of e-commerce, businesses must also consider how their online presence and activities, such as affiliate links and third-party sellers, can establish a pseudo-physical nexus and impact their tax compliance. Understanding the sales tax nexus is crucial for businesses to ensure compliance with state tax laws and avoid unforeseen tax obligations.
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What You'll Learn
Physical presence and nexus laws
Physical nexus, also known as physical presence nexus, is a type of nexus tax imposed by states or jurisdictions on businesses that have a sufficient connection to or presence in a state or jurisdiction, such as a physical presence or economic activity, which triggers a sales tax collection obligation. Physical nexus is created when a business has a physical presence in a state or jurisdiction, such as a store, warehouse, office, or even a mailing address. This type of nexus is the traditional standard for sales tax collection and has been established through various court cases.
Before the South Dakota v. Wayfair case, physical presence was the standard for sales tax compliance. If a business didn't have a physical presence in a state, it wasn't required to collect or remit sales tax. However, in 2018, the South Dakota v. Wayfair ruling changed this by allowing states to bring economic business activity into the sales tax compliance mix. Now, if businesses cross an annual minimum threshold of $100,000 in transactions or 200 transactions in a state, they may be required to collect and remit sales tax in that state, regardless of their physical presence. This is known as economic nexus legislation.
While economic nexus is important to consider, businesses should not overlook physical nexus requirements. Physical presence nexus remains the first consideration in determining whether a business is legally bound to collect and remit state taxes. Physical ties almost always trigger tax obligations in a state, and it can include more than just having an office. For example, inventory in a marketplace warehouse, remote employees, trade show attendance, or even attending multiple in-person sales meetings can establish a physical tie.
It's important to note that sales tax nexus rules differ in each state, and businesses should seek professional advice to ensure compliance with state tax laws. Nexus determination is primarily controlled by the U.S. Constitution, which requires a definite link or minimal connection between a state and the entity being taxed. The specific criteria for determining physical nexus may differ from state to state, and most states are careful to give themselves room to manoeuvre in their definitions.
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Inventory and warehouses
Warehouses and inventory are key components of physical nexus. Storing goods or inventory in a warehouse or fulfilment centre within a state creates a physical nexus. This applies even if the warehouse is owned or operated by a third party, such as Amazon's FBA (Fulfillment by Amazon) service, where merchants' inventory is stored in Amazon-owned warehouses. In such cases, the business would be subject to the sales tax laws of that state.
The presence of inventory or warehouses in a state indicates a definite link between the business and the state, which is a primary consideration in nexus determination according to the U.S. Constitution's Due Process Clause. This physical presence establishes a connection that triggers sales tax obligations, requiring the business to register, collect and remit sales tax on sales made within that state.
It is important to note that physical nexus rules vary from state to state, with each state setting its own thresholds and criteria for triggering nexus. For example, in Alabama, Arizona, Arkansas, and California, the presence of inventory or a warehouse in the state is sufficient to establish physical nexus and trigger sales tax collection obligations.
In summary, the storage of inventory or the use of warehouses within a state is a significant factor in establishing physical nexus and, consequently, sales tax obligations for businesses. Businesses must carefully consider the specific rules and regulations of each state to ensure compliance with their tax requirements.
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Offices and mailing addresses
Physical nexus, or physical presence nexus, is created when a business has a physical connection with a state or jurisdiction, such as an office location. This is distinct from economic nexus, which is created when a business has a certain level of economic activity in a state, even without a physical presence.
While an office is an obvious example of a physical presence, there are some less obvious activities that can also create a physical nexus. For instance, owning or leasing an office or having a mailing address can create a physical nexus. This is because a mailing address can indicate a permanent or temporary connection to a state, which is a key factor in determining nexus.
It's important to note that the definition of nexus varies across states and is constantly changing. Therefore, businesses must consider each state individually when determining sales tax nexus and stay updated on the changing regulations and interpretations.
In addition to offices and mailing addresses, other factors that can create a physical nexus include having employees in a state, storing inventory or maintaining a warehouse, and attending trade shows or having in-person sales meetings. These activities can indicate a physical connection to a state, triggering sales tax obligations.
While the physical presence rule is no longer the only standard for nexus, it is still an important consideration for businesses to ensure compliance with sales tax laws and avoid potential liabilities.
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Employees and contractors
The presence of employees or contractors in a state can trigger a sales tax collection obligation, even if the business does not have a physical office or store in that state. This is because employees are considered to benefit from the infrastructure and services provided by the state, such as police protection, public roads, and the judicial system.
In some states, even a single employee or contractor can establish physical nexus. For example, in Tennessee, a permanent employee is considered to create a physical presence, regardless of whether they are involved in sales-related activities. Other states, such as Arizona, require an employee to be present for more than two days per year to establish nexus.
It is important to note that the definition of "personnel" can vary and may include both employees and independent contractors. This means that a business with independent contractors in a state may also be subject to sales tax nexus obligations.
While physical nexus is an important consideration, it is not the only factor. Economic nexus laws, which have gained prominence following the 2018 South Dakota v. Wayfair decision, allow states to impose sales tax obligations on businesses that meet certain economic thresholds, even if they do not have a physical presence in the state.
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Affiliate, click-through, and third-party nexus
Physical nexus, or physical presence, is the traditional standard for sales tax collection and is the first consideration in whether a business is legally bound to collect and remit state taxes. It is created when a business has a physical connection to a state or jurisdiction, such as a store, warehouse, office, employees, or inventory in a state.
However, with the rise of e-commerce, states have introduced other types of nexus to ensure they can collect sales tax from businesses that may not have a physical presence in the state but still generate substantial sales. These include affiliate nexus and click-through nexus.
Affiliate Nexus
Affiliate nexus is created when a business has a relationship with another business that has a physical presence in a state. This can include having an affiliate or subsidiary in a state with a common owner or branding. Affiliate nexus can also be established through other relationships, such as using a local business to install or service its products. Affiliate nexus laws typically require the business to collect and remit sales tax if the affiliated business has a physical presence in the state. Some states have affiliate nexus thresholds as low as $10,000 or even $0, which means that even one affiliate sale from an affiliate in that state would require the business to collect sales tax on all sales in that state.
Click-Through Nexus
Click-through nexus is a type of affiliate nexus that arises from affiliate relationships in the context of e-commerce and online marketing. It occurs when a business uses in-state affiliates or third-party sellers to refer customers to its website in exchange for a commission or other compensation. Click-through nexus laws require the business to collect and remit sales tax if the third party has a physical presence in the state. States with click-through nexus laws may have thresholds for sales or transactions that trigger the requirement to collect sales tax, such as $10,000 in sales in Arkansas or $1 million in sales in California.
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Frequently asked questions
Sales tax nexus is the connection between a business and a state or jurisdiction that creates a sales tax obligation. There are different types of sales tax nexus, including physical nexus and economic nexus.
Physical nexus is when a business has a physical presence in a state or jurisdiction, such as a store, warehouse, office, or employees. This type of nexus is the traditional standard for sales tax collection.
A physical presence for sales tax nexus can include having a brick-and-mortar store, an office, a warehouse, inventory in a marketplace, or even remote employees based in a particular state. Even attending a trade show or having multiple in-person sales meetings in a state can create a physical nexus.
Economic nexus is created when a business has a certain level of economic activity in a state, even if it does not have a physical presence there. This can include reaching a certain threshold of sales revenue, transactions, or gross receipts activity within the state.
The rules for sales tax nexus vary by state, so it's important to check the specific requirements of the state or jurisdiction in which you are operating. In general, if a business has a physical presence in a state, it will likely need to register, collect, and remit sales tax to that state.
