A blog post

State Nexus and Sales Tax

Posted on the 05 March, 2010 at 10:30 am Written by in Taxes

As CPAs we are seeing the incremental creep of state taxes on our clients. A key concept here is “nexus” and – if you got it – you owe state tax. Today let’s talk sales tax.

Nexus is Latin for connection or link. The Due Process Clause of the US constitution requires a minimum link or connection between you and a state before the state can exert its taxing power. Granted, this was a whole lot easier many decades ago when doing business meant a storefront or office, mostly likely staffed by agents or employees who lived in the state. You were physically present. Easy to understand.

Not so much today.  Are you doing trade shows? It takes 16 days of trade shows to establish nexus with California. How about Texas?  Well, Texas requires only one day. Have you got an employee living in the state? That will clinch nexus in all 50 states. Did you send an employee into the state to do installation? You have probably just created nexus.

The preceding of course is tempered with the economic impact of your activities. If you sent one employee for one installation in one state, you may well decide that it is not worth the trouble to register with the state. If you are sending your trucks across the bridge daily into an adjoining state (think Cincinnati and northern Kentucky), then you should probably hurry up and register.

You also have to evaluate what percentage of your sales are taxable. You have to be careful here though, as you may need to get exemption certificates from your customers. Do not rely on getting them later, when a state audit has begun. Not all states allow that. You should find out if the state requires a separate line on the invoice for exempt items. Some states will tax an otherwise exempt item if it is not separately stated.

How are states identifying potential taxpayers? A common way is the sales tax questionnaire. Some states periodically send out mass mailings. Don’t ignore it if you receive one. Sometimes doing so may eliminate certain settlement options with the state. States park people at truck weigh stations, trade shows, construction projects. You may have even been picked up during someone else’s audit. During the audit, the state could have reviewed vendor invoices and sent questionnaires to the companies identified. If they saw your invoice with installation charges – well, you may just have an audit appointment.

Remember that – if you do not file – there is no statute of limitations. Hypothetically a state can go back indefinitely. Let’s say that you are contacted and the state finds nexus (there’s a surprise). They now want $XXXX of back sales taxes, with interest and possibly penalties. It’s a bit late to collect this from your customers. It’s coming out of your hide. You have just reduced your bottom line dollar-for-dollar.

And we are only talking about sales tax. If you send employees into other states as a routine part of your business, you may also be looking at payroll withholding taxes, unemployment taxes, corporate income taxes.

Hey, the point here is not to frighten. The rules are what the rules are. When you get to the point that are you are regularly crossing state lines, contact a tax pro. Find out the ropes. We have seen back state taxes in the hundreds of thousands of dollars. This is real money folks, and the kind of money that – if it catches you wrong – could endanger your business.