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Understanding Nexus: A Guide for Growing Companies

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For new companies and those in growth mode, it can be easy to forget about tax planning. There are many other challenges to tackle, and many people assume they don’t need to worry about taxes until it’s time to file annual returns.  

Nexus, however, is important to monitor because every state has different requirements and overlooking it could cost you more money in the form of penalties and interest. Becoming familiar with nexus is the first step to avoiding some of the common pitfalls that lead to added tax bills. 

What is Nexus and Why is it Important for Your Company? 

Nexus is a connection to a state that creates a tax obligation. It’s a threshold, or a level of business activity, that once reached, means a company must collect and pay sales tax. Some states also use nexus to determine other tax liabilities such as pay income, franchise or gross receipts taxes. A state can impose penalties and interest on a business that fails to register and collect and pay taxes after reaching nexus.  

Operations are already lean for most startups and growing businesses, so it can be difficult to find the resources to cover unexpected expenses. While paying additional taxes can be a challenge, the challenge is greater if you’re required to pay penalties and interest on top of taxes owed. 

Even new companies just establishing their first sales can quickly reach nexus in multiple states. Let’s look at how that happens. 

How is Nexus Determined?

There are a few ways that a company can meet nexus, but they all depend on the laws in each state. 

One common way to create nexus is by having a physical presence in a state.  Physical presence can be defined as hiring an employee (even one who works remotely), traveling salespeople, use of independent contractors or storing inventory in a third-party warehouse, such as Fulfillment by Amazon (FBA). 

The 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. expanded nexus definitions to include economic activity, even without physical presence. It was a reflection of the explosive growth seen in e-commerce, and the decision allowed states and local governments to collect sales tax revenue from out-of-state sellers. That growth continued and was amplified during 2020 and 2021 during the COVID-19 pandemic.  

Each state has a different threshold when sales tax must be collected and paid. For example, Georgia’s nexus threshold is $100,000 in sales or 200 transactions. A company could sell 200 books for $20 each, which gives it $4,000 in sales. Although that total is far less than $100,000, the company has reached nexus with 200 transactions. In contrast, the same company would need to sell 25,000 books in order to reach nexus in California, where the threshold is $500,000 in sales. 

States also differ in the time periods they use to establish nexus. Some states use the current or previous calendar year, while others use a 12-month period ending any quarter. 

There are other ways nexus can be met, and it’s easy for some of them to go unconsidered. For example, if a company attends a trade show in another state and sells products or services at that trade show, those sales could count toward creating nexus in the state where the trade show was held. 

Some states also consider related companies or entities with shared control to be affiliates that contribute to nexus, but the definition of an affiliate varies from state to state. 

Click-through nexus is another way some states determine tax obligations. It’s typically defined as when a third party is paid or rewarded for referring customers to a company. For example, sales through social media influencer links or discount codes could contribute to nexus in a state where a company doesn’t have a physical presence. 

The Challenge of Keeping Up with Nexus Changes

For quickly growing companies, it can be difficult to keep up with demand and increased sales while also knowing where they stand regarding nexus in various states, and every legislative session brings the possibility of changes to nexus laws.  

For example, in recent years some states have eliminated their number of transaction requirements. A business used to reach nexus in California when it had completed 200 transactions in the state, but in 2019, that requirement was eliminated. Now California law sets the nexus threshold at $500,000 in sales. 

Many startups or even middle-market companies don’t have the bandwidth or expertise in-house to stay informed of all the changes in tax laws and complete necessary state registrations and tax filings throughout the year to remain in compliance. 

Simple Steps for Companies to Stay Compliant 

Here are a few steps that can help your company adhere to all the legal requirements in various states as you grow. 

1. Track Your Growth.

Monitor where you have employees, particularly if you have remote employees in states other than the one where your company is based. You will also want to track where your company stores inventory and where you have significant sales. You should know, for example, if you have a 200 percent increase in sales in Kentucky, month over month. 

2. Become Familiar with Nexus Rules.

Knowing nexus laws in each state where you have either a physical or economic presence is key. When you’re familiar with the rules while also tracking your company’s growth, you’ll know when sales are approaching a nexus threshold. You will be in a better position to take action once nexus is reached. Many states specify a timeframe for completing tax registration after achieving nexus.  

3. Conduct Regular Nexus Reviews.

Regularly reviewing a company’s tax obligations is a good way to ensure compliance. As your business scales operations, you could reach nexus in a state more quickly than you anticipated. If your company pivots or changes sales strategies, that also could affect when nexus is met. 

4. Partner with Experts.

Consider outsourcing state tax consulting and compliance matters to professionals like Frazier & Deeter. Experts who specialize in multistate tax will be aware of all the latest changes in state laws and can advise your company on best practices, based on their experience.  

Conclusion

Nexus is a challenge that can affect startups and mid-market companies as they grow. Proactively becoming more familiar with nexus and managing your company’s tax compliance can help you avoid surprise bills for additional taxes, penalties and interest later.  

Connect with our State & Local Tax (SALT) experts today to ensure your company is on the right track with regards to nexus.  

Contributors

Brian Strahle, Partner and National SALT Practice Leader

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