A Beginner’s Guide to Economic Nexus

Navigating multistate sales tax? Economic nexus now affects how and where you pay, changing tax obligations based on your sales volume, not just your business’s location. Our focused guide sheds light on the critical aspects of economic nexus, from what triggers it to managing state-specific sales tax rules. 

Key takeaways

• Economic nexus is determined by the amount of business activity, such as sales, within a state, and not the physical presence of a business.

• Non-compliance with economic nexus laws can result in severe financial and legal consequences, including liability for unpaid sales tax, fines, interest, and possible criminal penalties for tax evasion.

• Businesses can leverage tools such as tax automation software to manage compliance with various state-specific economic nexus thresholds and requirements.

What is economic nexus?

If you conduct business across multiple states, you might have encountered the term ‘economic nexus.’ But what does it mean? In simple terms, economic nexus is the connection between a business entity and a taxing jurisdiction, such as a state. This connection is determined by the volume of a business’s sales within the state, not the physical presence of the business.

If a business’s sales surpass a specific economic threshold in a state, it may be required to collect sales tax on those sales according to the statewide sales tax rules. This has significant implications for online and remote sellers, who can be subject to state tax obligations regardless of their physical presence.

Physical vs. economic nexus

Prior to the advent of online commerce, the focus was on physical presence nexus, which was established by a business having a tangible presence in a state, such as owning property or employing individuals. The distinction between physical nexus and economic nexus lies in their tax obligations. While a physical nexus requires a tangible presence, an economic nexus is triggered by meeting specific sales or transaction thresholds in a state.

It's also important to note that a business might have both a physical and economic nexus in the same state, potentially escalating state tax obligations.

Evolution of economic nexus

The emergence of ecommerce and its impact on interstate commerce is closely linked to the evolution of economic nexus. As online sales have become a significant part of the economy, states have sought ways to tap into this revenue source, leading to changes in sales tax compliance.

The decisive moment was the Supreme Court’s verdict in the Wayfair vs. South Dakota case. This ruling overturned the ‘physical presence’ requirement, allowing states to enforce sales tax collection obligations on remote sellers using economic thresholds based on the number of sales transactions. The Wayfair decision significantly broadened the concept of economic nexus, marking a new era in sales tax law.

The Wayfair decision

Background and ruling

The Wayfair case, officially known as South Dakota v. Wayfair, began when South Dakota sought to improve its ability to collect sales taxes from ecommerce and remote transactions. In a landmark decision, the Supreme Court ruled that states can require out-of-state sellers to collect and remit sales tax based on economic nexus, even if they lack a physical presence in the state.

Implications for businesses

The Wayfair decision has had far-reaching implications for businesses, especially those with online sales and operations in multiple states. The ruling has led to:

• Widespread adoption of economic nexus laws.
• Increased complexity due to lack of uniformity in economic nexus thresholds.
• The introduction of marketplace facilitator rules.

Steps that businesses have had to take in response include registering with appropriate jurisdictions and tracking sales thresholds in each state where they operate.

State-by-state economic nexus thresholds

The economic nexus thresholds for sales tax purposes vary across U.S. states. Here's a rundown of the thresholds for individual states as of 2024 (Delaware, New Hampshire, Oregon, and Montana do not impose sales taxes and therefore have no economic nexus):

Alabama: $250,000 in sales.

Alaska: $100,000 in sales or 200 transactions.

Arizona: $100,000 in sales.

Arkansas: $100,000 in sales or 200 transactions.

California: $500,000 in sales.

Colorado: $100,000 in sales.

Connecticut: $100,000 in sales and 200 transactions.

Florida: $100,000 in sales.

Georgia: $100,000 in sales or 200 transactions.

Hawaii: $100,000 in sales or 200 transactions.

Idaho: $100,000 in sales.

Illinois: $100,000 in sales or 200 transactions.

Indiana: $100,000 in sales or 200 transactions.

Iowa: $100,000 in sales.

Kansas: $100,000 in sales.

Kentucky: $100,000 in sales or 200 transactions.

Louisiana: $100,000 in sales.

Maine: $100,000 in sales.

Maryland: $100,000 in sales or 200 transactions.

Massachusetts: $100,000 in sales.

Michigan: $100,000 in sales or 200 transactions.

Minnesota: $100,000 in sales or 200 transactions.

Mississippi: $250,000 in sales.

Missouri: $100,000 in sales.

Nebraska: $100,000 in sales or 200 transactions.

Nevada: $100,000 in sales or 200 transactions.

New Jersey: $100,000 in sales or 200 transactions.

New Mexico: $100,000 in sales.

New York: $500,000 in sales and 100 transactions.

North Carolina: $100,000 in sales or 200 transactions.

North Dakota: $100,000 in sales.

Ohio: $100,000 in sales or 200 transactions.

Oklahoma: $100,000 in sales.

Pennsylvania: $100,000 in sales.

Rhode Island: $100,000 in sales or 200 transactions.

South Carolina: $100,000 in sales.

South Dakota: $100,000 in sales or 200 transactions.

Tennessee: $100,000 in sales.

Texas: $500,000 in sales.

Utah: $100,000 in sales or 200 transactions.

Vermont: $100,000 in sales or 200 transactions.

Virginia: $100,000 in sales or 200 transactions.

Washington: $100,000 in sales.

West Virginia: $100,000 in sales or 200 transactions.

Wisconsin: $100,000 in sales.

Wyoming: $100,000 in sales or 200 transactions.

District of Columbia: $100,000 in sales or 200 transactions.

Complying with economic nexus laws

To comply with economic nexus laws, businesses must ensure they do the following:

• Register for sales tax permits in each state where the business has economic nexus.
• Apply the relevant sales tax rate according to the customer’s location and the type of product sold.
• Collect and remit sales tax from customers within any state where the business reaches the economic nexus threshold.

Alongside these responsibilities, businesses must maintain comprehensive records of their transactions, including collected taxes, to ensure accurate sales tax reporting.

Registering for sales tax permits

Obtaining a sales tax permit is a vital step toward complying with economic nexus laws. Businesses must:

• Collect important information such as the Employer Identification Number (EIN) and other business identifying details.

• Proceed to the state’s Department of Revenue website.
• Locate the ‘Sales and Use Tax’ section.
• Follow the provided instructions to finalize the registration procedure.

While registration is typically free, some states may impose a nominal fee, usually less than $20. The registration process can take between 2 to 6 weeks from the date of submission in most states.

Collecting and remitting sales tax

Once registration is complete, the focus should be on collecting and remitting the sales tax. The tax rates are typically determined based on the customer’s location, using the 5-digit US zip code. The product type also impacts the sales tax amounts, with unique state laws dictating which products are subject to taxation and which are exempt.

To ensure accuracy and compliance, businesses are advised to keep detailed records of all property or service purchases, including purchase records, and maintain these records for the necessary duration to substantiate the income or deductions on a tax return.

Record-keeping and reporting

Keeping detailed records is essential for businesses to ensure compliance with economic nexus laws. These records include details of transactions and collected taxes, which help in preparing precise and comprehensive sales tax returns. Businesses need to track sales thresholds in each state where they operate and monitor changes in sales volume to assess compliance.

Businesses can utilize tax automation tools to effectively manage and track taxable income for multi-state corporations.

Impact of non-compliance

The consequences of not complying with economic nexus laws can include:

Back taxes and interest: Businesses may be liable for the taxes that should have been collected during the period of non-compliance, along with interest. This can amount to a significant sum, especially if non-compliance extends over a long period.

Penalties and fines: States may impose penalties and fines for failure to comply with economic nexus laws. These penalties can be a fixed amount or a percentage of the unpaid taxes and can increase with the duration of non-compliance.

Audit and legal costs: Non-compliance can lead to audits by state tax authorities. Audits can be time-consuming, disruptive, and expensive, particularly if legal representation is needed.

Reputation damage: Being found non-compliant can damage a business's reputation, particularly if the non-compliance is publicized. Customers and partners may view the business as unreliable or untrustworthy.

Licensing issues: Some states may link tax compliance with the ability to hold certain business licenses or permits. Non-compliance with tax laws can jeopardize these licenses.

It's important for businesses to understand the specific requirements of each state where they have economic nexus and ensure compliance to avoid these consequences. Legal advice and consultation with tax professionals are often necessary to navigate these complexities effectively.

Tax automation software

Adhering to economic nexus laws can be challenging, particularly for businesses operating across various states. Fortunately, tax automation software can help businesses manage their economic nexus obligations.

Tax automation software is a technological tool designed to simplify and automate tax-related tasks. It can support businesses in managing economic nexus by:

• Monitoring economic nexus thresholds.
• Identifying when a business surpasses these thresholds in any state.
• Ensuring compliance through automated tax computation and collection.

LumaTax offers tax automation software for economic nexus management. It has a variety of functionalities such as calculating tax rates, preparing returns, managing documents, monitoring changes in sales tax laws and rates, and applying tax exemptions when needed.

Conclusion

Navigating the complexities of economic nexus can be challenging, especially for small businesses and those new to ecommerce. However, by understanding the basics, regularly monitoring sales activities, and seeking professional advice, businesses can successfully manage their tax obligations and avoid costly penalties. As the digital economy continues to evolve, staying informed and compliant with these laws is more important than ever.

Do you need help understanding your physical and economic nexus exposure? Contact LumaTax and let us get your sales tax compliance on track with our automated data analysis and expert review.

Frequently Asked Questions

What is an example of economic nexus?

An example of economic nexus is when a company has $99,000 in online sales in South Dakota and 300 transactions, requiring them to collect and remit sales tax in South Dakota.

What triggers economic nexus?

Economic nexus can be triggered by reaching a certain amount of sales (e.g. $100,000) and/or a specific number of sales transactions (e.g. 200 transactions) in another state. This can create a tax obligation for out-of-state corporations.

What does it mean to have nexus?

Having nexus means there is a necessary connection between a taxpayer and a state, allowing the state to impose taxes on the taxpayer. It is typically created when a business has a significant presence or connection, triggering a sales tax collection obligation.

How does a business establish an economic nexus in a state?

A business establishes economic nexus in a state by surpassing a specific economic threshold in terms of sales volume or transactions. This can vary by state and should be carefully monitored to ensure compliance.

What are the consequences of non-compliance with economic nexus laws?

Failure to comply with economic nexus laws can result in severe financial and legal repercussions, such as unpaid sales tax liability, penalties, interest, audits, and harm to a company's reputation.

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