A nexus must exist before a taxing authority can impose a tax on the enterprise, and it requires that there be a substantial link between the jurisdiction and the business. The concept of a nexus has become a complicated issue with the advent of online sales businesses that serve numerous states and countries. Learn more about what it means for you.
What Is a Tax Nexus?
The term “nexus” is used in tax law to describe a situation in which a business has a tax presence in a particular state. A nexus is basically a connection between the taxing authority and an entity that must collect or pay the tax. Two clauses of the U.S. Constitution form the origin of a tax nexus:
The due process clause, which requires a connectionThe commerce clause, which “requires substantial presence"
Having a nexus can also describe the amount and degree of business activity that must be present before a state can tax an entity’s income or sales within its jurisdiction. The taxpaying entity must pay and collect sales taxes in that state if it has a nexus there, and it must pay income tax on income generated there.
How a Tax Nexus Works
Although the definition of nexus can vary by jurisdiction, it generally requires that a business must commit to a certain type of action in the jurisdiction. Your business might be considered to have a nexus in a location, for example, if it’s a place where your business:
Maintains an officeEmploys workersStore products or supplies in a warehouse
This would require that you establish a sales tax rate for that location and collect it from any resident of that location who buys products from you. You would most likely also have to pay income tax to that state.
Types of Tax Nexuses
Nexus can be determined differently for income taxes and for sales tax purposes.
Nexus for Income Tax Purposes
Nexus is typically created for income tax purposes if an entity:
Derives income from sources within the stateOwns or leases property thereHas employees there who are engaged in activities that exceed “mere solicitation"Has capital assets or property located there
Nexus for Sales Tax Purposes
Nexus is determined more loosely for sales tax purposes. A business might have sales tax nexus in a state if it has:
A physical location in the stateResident employees working in the stateProperty, including intangible property, within the stateEmployees who regularly solicit business there, such as salespeople
Requirements for a Nexus in Online Transactions
A nexus for sales tax purposes has historically required that a business have a physical presence in that state, but the advent of the internet has driven states to more closely consider online businesses and their non-payment of sales taxes. The Supreme Court finally ruled on the issue of online nexus in the case of S. Dakota v. Wayfair in June 2018, stating that older ways of determining tax nexus were artificial and anachronistic. The Court indicated that states have a right to require online sellers to charge and collect sales tax from all online buyers, not just those who are physically located in that state. The various states that charged sales taxes scrambled to set up regulations and procedures that would allow sales tax collection for online sales. To avoid harming smaller sellers, many states have set a minimum number of transactions or annual amounts of sales below which no sales tax is charged for online transactions.
Types of Nexuses in Online Sales
States have come up with several ways to determine a nexus for online transactions.
