Sales Tax Nexus: Physical Presence And Your Business

The concept of physical presence is an important consideration for businesses when determining their sales tax obligations. In the United States, the Supreme Court's decision in South Dakota v. Wayfair in 2018 significantly impacted the sales tax landscape by introducing the concept of “economic presence” as a factor in establishing a state's right to collect sales tax from a business. While the definition of physical presence varies from state to state, it generally includes having a retail store, warehouse, inventory, or a regular presence of travelling salespeople or representatives in a state. Additionally, owning or leasing an office, storing property, or even briefly sending employees to another state may also establish a physical presence. With the rise of e-commerce, understanding the evolving sales tax requirements and their impact on remote sellers is crucial for businesses operating across multiple states.

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Physical presence nexus

The definition of physical presence varies from state to state. Generally, things like an office, an employee, a warehouse, or affiliates create physical presence. For example, owning or leasing an office in another state will give a business a physical presence and an obligation to collect and remit sales tax. Similarly, in National Geographic Society v. California Board of Equalization, the National Geographic Society maintained offices in California for the purpose of soliciting advertising for the society's magazine. Although this function was not related to taxable sales, the court found that the offices themselves established enough of a physical presence to create nexus.

Other ways to establish a physical presence include owning or leasing a warehouse or other facility, storing property in a facility in another state, or sending employees or agents to another state, even if they're only there briefly. For example, in Time, Inc. v. Massachusetts Commissioner of Revenue, the court determined that nexus was established by the taxpayer's maintenance of a small news bureau in Massachusetts, coupled with the company's employment of in-state personnel who solicited advertising for its publications.

Some states are now arguing that putting apps or software (e.g. web cookies) on an in-state computer or device gives a business physical presence nexus in that state as well. Additionally, businesses that provide out-of-state services or occasionally conduct business out-of-state may want to reevaluate their activities in light of the South Dakota v. Wayfair decision, which ruled that states can collect sales tax from businesses that do not have a "physical presence" in the state but do have an "economic presence".

While the physical presence standard for sales tax has not been eliminated, it is important to note that economic nexus obligations kick in after a business tops a set level of sales in terms of quantity or dollar amounts, or both.

Economic nexus

In 2018, the United States Supreme Court ruled in South Dakota v. Wayfair that states could collect sales tax from businesses that have an "economic presence" in the state, even if they do not have a "physical presence" there. This decision has had a significant impact on online retailers and any business that conducts remote sales to out-of-state customers.

For example, a business may be required to collect and remit sales tax in a particular state if it exceeds a certain dollar amount in sales, such as $100,000, or a certain number of transactions, such as 200 transactions. Some states, like Connecticut and New York, require both sales dollar amount and sales transaction thresholds to be reached to establish an economic nexus.

It is important to note that economic nexus laws do not replace physical nexus laws. Physical presence still matters when it comes to triggering sales tax nexus, and businesses with a physical presence in a state, such as a retail store, warehouse, or employees, may have an obligation to collect and remit sales tax. However, the Wayfair decision has broadened the criteria for tax collection, and businesses must now carefully navigate the evolving sales tax landscape, especially if they operate in multiple states.

To ensure compliance with economic nexus laws, businesses should track their sales and transactions in each state, stay updated with state-specific guidance and legislation, and consult with tax experts to understand their specific obligations.

State-specific thresholds

For example, in New York, a business with no physical presence must register as a sales tax vendor and collect sales tax if, in the preceding four sales tax quarters, its gross receipts from sales in the state exceeded $500,000, and it made more than 100 sales transactions.

Similarly, Virginia law requires a Maryland business selling to Virginia customers to register, collect, and remit sales tax if they have either more than $100,000 in annual gross revenue from sales in Virginia or at least 200 annual sales transactions in the state.

Other states, like California, have removed the transaction threshold and solely focus on sales revenue. As of April 25, 2019, California businesses with more than $500,000 in sales in the current or previous calendar year are required to collect sales tax.

In contrast, Colorado has a lower revenue threshold, with businesses clearing more than $100,000 in sales in any given year qualifying for sales tax nexus.

These state-specific thresholds are essential for businesses to understand, especially those operating in multiple states, to ensure they comply with their sales tax obligations.

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Employees and contractors

The definition of physical presence varies from state to state in the US. However, the general consensus is that having an employee or contractor in a state constitutes a physical presence. This includes sending employees or contractors to another state, even if they are only there briefly. For example, an employee or contractor attending a trade show or making sales in another state may establish a physical presence.

In some states, the physical presence of an employee or contractor triggers a sales tax collection obligation. This means that the business is required to register with the state's tax authority and charge, collect, and remit the appropriate sales tax. For example, in Arizona, having an employee present in the state for more than two days per year establishes a physical presence and triggers sales tax obligations.

It's important to note that the physical presence of employees or contractors is just one factor in determining a business's tax obligations. Other factors include the presence of an office, warehouse, inventory, or other physical assets in a state. Additionally, since the 2018 Supreme Court ruling in South Dakota vs Wayfair, states can also consider "economic and virtual contacts" when determining tax obligations. This means that a business may have an economic presence in a state, even without a physical presence, if it makes sales or provides services to customers in that state.

The concept of physical presence nexus is evolving, and each state may have its own specific criteria. Businesses with employees or contractors working in multiple states should carefully review the tax laws and regulations in each state to understand their tax obligations. Seeking professional advice can help businesses navigate the complex landscape of physical presence and sales tax obligations.

Inventory and warehousing

However, the presence of inventory in a warehouse can create a physical nexus, which refers to a business's obligation to collect and remit sales tax based on its physical presence within a state. This means that storing goods or inventory in a state, even briefly, can trigger sales tax nexus and the requirement to register and collect sales tax in that state. For example, if a business stores inventory in a warehouse in Texas, it establishes a physical nexus in Texas and becomes subject to Texas sales tax laws.

It is important to note that each state defines "physical presence" differently, and the rules vary significantly. Some states consider any presence, no matter how slight, as sufficient to establish nexus. In contrast, others have more lenient standards, and a few states, like Iowa, Kansas, and Nebraska, generally treat businesses with inventory stored in third-party warehouses as remote sellers, exempting them from sales tax obligations.

Additionally, businesses should be aware that even if they do not have a physical presence in a state, they may still be subject to economic nexus laws, which are based on the volume or value of sales made into that state. The Supreme Court's decision in South Dakota vs. Wayfair in 2018 clarified that states can collect sales tax from businesses with an "economic presence" even if they lack a physical presence.

To summarize, inventory and warehousing are critical considerations for businesses to determine their physical presence and sales tax obligations. Storing inventory in a state can create a physical nexus, triggering sales tax requirements, but the specific rules and thresholds vary across states. With the evolving sales tax landscape, businesses operating in multiple states must stay informed to ensure compliance with applicable laws.

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