If one word is closely associated with the US tax regulations and pops up in every second conversation, it's nexus. But what exactly is nexus?
Simply put, it's a connection that qualifies you as a taxpayer in a particular jurisdiction. Traditionally, there was only physical nexus-if you have an office or other type of physical presence in a jurisdiction, you're liable to pay tax there.
Post-Wayfair, it's become a lot more complex. You can trigger economic nexus in a jurisdiction even if you don't have a presence there as long as you hit a certain transaction threshold or physical nexus if you've hired remote employees or contractors in a particular jurisdiction. Even more complicated, all states have different qualifiers and thresholds for physical and economic nexus.
Types of nexus and when they're triggered
Physical nexus
As mentioned above, a physical nexus is triggered when a business has any physical presence in a jurisdiction.
Triggers:
- Having a physical office (even if it's just your house)
- Hiring an employee or contractor
- Participating in an event like a tradeshow or pop-up that brings you sales
Economic nexus
An economic nexus is triggered when a business has a certain financial threshold in a jurisdiction. These thresholds vary from jurisdiction to jurisdiction.
Triggers:
- Crossing a specific “transaction” threshold in a year (commonly 200 transactions)
- Crossing a specific “revenue” threshold in a year (commonly USD 100,000)
Affiliate nexus
It's a subtype of economic nexus and is triggered when an out-of-state business has a relationship with an in-state business. More than 30 states in the US have affiliate nexus. However, the conditions vary from state to state.
Triggers:
- Having a subsidiary registered in a different state
- Having a partnership with a company in a different state from where your company is registered
Click-through nexus
Click-through nexus, or "click-through advertising" nexus, occurs when an out-of-state seller has a relationship with in-state businesses or individuals who refer customers to the seller's website through online links (e.g., banner ads or affiliate links).
Triggers:
- Having an affiliate, partner, or reseller in a different state
- Selling via banner ads and other forms of advertising in a different state
Now that we've explored the different types of nexus, the next step is determining what nexus your company has triggered. This can be done with a nexus study.
What is a nexus study?
A nexus study, also known as a nexus review or analysis, is a comprehensive examination conducted by a business or organization to determine whether it has a tax obligation in a particular jurisdiction. Nexus studies are typically performed to ensure compliance with tax laws and to assess potential tax liabilities.
Businesses must conduct nexus studies regularly, especially if they expand into new states or experience significant changes in their operations. All states have a “nexus questionnaire” that can be used as your baseline to answer questions regarding sales tax nexus in that jurisdiction. For example, here's Texas's Nexus Questionnaire.
However, as nexus laws keep evolving, manually reviewing your nexus obligations across jurisdictions can get tedious and time-consuming. An easy way to determine your company's nexus is by using a free tool like Galvix's nexus checker that can give you a full overview of your business's sales tax obligations across all jurisdictions and nexus types-in minutes.
What is the difference between a nexus questionnaire and a voluntary disclosure agreement?
A nexus questionnaire and a voluntary disclosure agreement (VDA) are two distinct tools businesses use to address their tax compliance obligations, particularly in the context of state and local taxes in the United States.
A nexus questionnaire is typically initiated by the state tax authority to assess a business's tax nexus. In contrast, a VDA is initiated by the business itself to voluntarily address past tax noncompliance and negotiate a resolution with the tax authority. Both tools are essential for businesses to comply with state and local tax laws and manage potential tax liabilities.
Nexus Questionnaire
Purpose: A nexus questionnaire is a document or survey typically provided by a state tax authority to businesses that may have tax obligations in that state. It gathers information about the business's activities, operations, and connections within the state to determine if a tax nexus exists.
Content: The questionnaire usually asks detailed questions about the business's physical presence, sales activities, employees, property, and other factors within the state. The business is expected to complete the questionnaire honestly and accurately.
Outcome: After reviewing the completed questionnaire, the state tax authority will assess whether the business has a tax nexus in the state based on the information provided. If nexus is established, the state may require the business to register for tax permits, collect and remit taxes, and file tax returns.
Timing: Nexus questionnaires are typically sent by tax authorities proactively to businesses they suspect may have a tax presence in the state. However, businesses can also voluntarily contact tax authorities and request a questionnaire to assess their potential tax obligations.
Voluntary Disclosure Agreement (VDA)
Purpose: A voluntary disclosure agreement is a formal arrangement between a business and a state tax authority. The business typically initiates it to voluntarily come forward and address any past or potential tax liabilities in a state where it previously had unmet tax obligations.
Content: In a VDA, the business typically contacts the state tax authority, acknowledges its past noncompliance, and negotiates the terms for resolving outstanding tax issues. This often involves paying any back taxes, interest, and penalties owed.
Outcome: Upon reaching an agreement, the state tax authority may grant the business certain concessions, such as waiving penalties or reducing interest charges. The business agrees to become fully compliant with tax laws in the state moving forward.
Timing: A VDA is initiated by the business when it discovers or realizes it has not complied with a state's tax laws. It is a proactive step to correct non-compliance and prevent future tax liabilities.
Some frequently asked questions answered
How do refunds impact my business's nexus?
Refunds are not transactions, so they will not increase your tax liability in a particular jurisdiction. So, it's essential to keep track of refunds to calculate the correct number of transactions and ensure your threshold is accurate.
What should I do if I triggered an economic nexus without realizing it?
While previously, ignorance of the law has been a good defense against not filing sales tax, it's no longer the case. Here's what you can do to rectify the situation-perform a nexus study to determine your tax exposure and past liabilities. Make sure you add any late fees and penalties to the final amount. You can pay it to the jurisdiction immediately if it's small.
However, if you cannot pay the amount, you can file a VDA and negotiate with the state to bring down the total amount and other fees.
What should I do if I no longer have nexus in a particular jurisdiction?
You have to formally notify the state or local tax authority in writing about the change in your nexus status, providing specific details and the effective date of the cessation. Be sure to file any final tax returns or reports the jurisdiction requires, indicating that your activities have ceased.