With looming deficits and shrinking taxes, most states are facing the need to raise more revenue. One of the most successful ways to do that, at least from the viewpoint of the state, is to find new people to tax. And if the state can find residents and businesses in other states to tax, it can be a windfall for the state. That’s where nexus comes into play.
Nexus means connection. If you have nexus with a state, that means you have a connection with them, under that state’s definition. And that nexus can mean taxes. We call it the cross-border tax grab.
Each state and the District of Columbia is able to set up their own rules for what constitutes nexus. There can be up to 51 different rules for nexus. For example, if you spend even just one day working a trade show or presenting at a seminar in Michigan, you have Michigan nexus.
It gets even more complicated when we look at the three different types of nexus that can be created: sales tax nexus, income tax nexus, and ‘other tax’ nexus.
If you have sales tax nexus in a state, you are then liable to collect and remit sales tax on sales made to residents in that state. As an example, 17 taxing districts now claim that website hosting is enough to create sales tax nexus. If your website is hosted in Maine, then you have sales tax nexus for Maine. Better start collecting sales tax from sales to residents in Maine!
An Oregon retailer found out about sales tax nexus the hard way in 2011. Mattress World, an Oregon mattress seller with seven stores, closed up because of unpaid sales tax to a neighboring state. Oregon doesn’t have a sales tax, but Washington does. Washington residents frequently buy items in Oregon to get around paying sales tax. They flocked to Mattress World to place their orders.
The owner arranged with a third party to deliver and set up the mattresses. Washington took the position that the act of setting up the mattresses meant that there was work being done in the state. Therefore, Mattress World should have collected sales tax. They added it all up and the unpaid sales tax came to about $800,000, but by the time penalties and interest were added in, it was closer to $2 million. The company didn’t have that money, and just coming out of this recession, had no way to raise it. They shut down all seven stores. Sales tax nexus put them out of business.
Income tax nexus is generally a little harder to establish. In California, if 25% of your sales are made to California residents, then you need to file a California return, in addition to your home state. That’s just one example of what can constitute income tax nexus.
And finally, ‘other’ state nexus can create difficulties for small businesses. These are the taxes that aren’t income or sales taxes such as the Texas Franchise Tax, Ohio CAT, Washington B & O, Hawaii Excise and a handful of other state taxes that aren’t quite income tax or sales tax. If Ohio determines you have one business that is subject to their CAT, they often take the position that every other business and investment you have is also subject to it.
States are looking for more money. With 51 different taxing agencies and three different kinds of nexus, it can get complicated for the small business owner. The U.S. Supreme Court has declined to hear cases of conflicting state nexus definitions, saying it is the responsibility of Congress to deal with it, and Congress seems pretty busy with other issues these days.
Your next steps should be to contact a firm that specializes in nexus evaluation and have one performed to determine if you have past liability, and what current responsibilities you have. If there is past liability, you can hire a nexus negotiator to negotiate a voluntary disclosure agreement (VDA) to minimize tax, penalty, and interest in exchange for voluntarily coming forward. If you get a nexus questionnaire from a state, talk to a specialist before you complete it. These can be taken as an admission of guilt, and negate any possibility of a VDA.
As with all tax matters, get the best advice you can afford and stay one step ahead of the tax authority with good records and a strategic plan.