What you need to know before you register for sales tax
With ecommerce thriving and economic nexus laws in force in most of the country, many businesses are at risk of developing a sales tax obligation (aka, sales tax nexus) outside their home state. But before rushing to register in a new state, it’s important to consider whether you have any prior tax exposure with that state, which could put you at risk of owing back taxes.
Activities that can establish sales tax nexus in a state
There are several ways a business can establish sales tax nexus, or an obligation to collect, including:
- Economic activity in a state (economic nexus)
- Physical presence in a state (physical nexus)
- Referrals from businesses or individuals in the state (click-through nexus)
- Ties to affiliates in a state (affiliate nexus)
Which of these activities can establish sales tax nexus in the states where you sell? Depending on the state, any or all of them.
Economic activity in a state can give you sales tax nexus
Economic nexus is established when an out-of-state company’s sales into a state exceed the state’s economic nexus threshold. It’s a simple enough concept that’s complicated by the fact that no two thresholds are exactly alike. For example:
California: $500,000 in total combined sales of tangible personal property (TPP) in the state in the preceding or calendar year, including exempt sales and sales by affiliates
Illinois: 200 transactions or $100,000 in cumulative gross receipts from sales of TPP in the state in the preceding 12 months, including exempt sales of TPP transferred incident to the sale of a service
New York: 100 separate transactions and $500,000 in cumulative gross receipts from sales of TPP in the state in the previous four sales tax quarters, including exempt sales as well as sales of SaaS and canned software
Any business that meets or exceeds a state’s economic nexus threshold is required to register with the state tax department and collect and remit sales and use tax per the law. Some states require businesses to register with the tax department as soon as they cross the economic nexus threshold and to start collecting sales tax on the very next transaction. Other states give businesses a bit more time: Remote retailers now have “at the most 60 days” to register in Kentucky. Yet even 60 days isn’t much time to determine whether you have past liability with a state — and some businesses do.
Physical presence in a state can give you sales tax nexus
Physical presence in a state used to be the sole requisite for sales tax nexus: States couldn’t require a business with no physical tie to the state to register. That changed when the Supreme Court of the United States ruled in favor of the state in South Dakota v. Wayfair, Inc. (June 21, 2018), the decision that granted states the right to enforce economic nexus.
Although no longer the only way to establish sales tax nexus, physical presence in a state remains one of the primary nexus triggers because it includes:
Leasing, renting, or owning property in the state. Having a temporary or permanent display, kiosk, office, or warehouse in a state can establish physical presence nexus. Having servers in a state can do the same.
Sending employees into the state. Having permanent or temporary employees or contractors in a state typically establishes sales tax nexus. For example, participating in a trade show in a state can trigger nexus, as can visiting a client to maintain or promote business or making a delivery to another state in your own vehicle.
Storing inventory in the state. Having inventory for sale in a state establishes nexus in most states, even if the inventory is housed in a facility owned or operated by a third party (such as a marketplace facilitator) and handled only by the marketplace.
Online referrals can give you sales tax nexus
Click-through nexus laws establish a sales tax obligation for remote retailers that reward persons in the state for directly or indirectly referring potential purchasers through links on a website. They first emerged around 2008, and by the time Wayfair was decided in June 2018, 24 states had click-through nexus laws on the books.
Some states repealed their click-through nexus laws after Wayfair, but 17 others kept their policies intact. Connecticut amended its click-through nexus law after it started enforcing economic nexus but didn’t abolish it. Illinois repealed click-through nexus then reinstated it six months later. Missouri won’t eliminate click-through nexus until it starts enforcing economic nexus on January 1, 2023.
Like economic nexus laws, click-through nexus laws typically include a threshold, and each state’s threshold is unique. In Georgia, referral sales must exceed $50,000 in gross receipts during the preceding 12 months to establish click-through nexus; in Idaho, the threshold is $10,000. Both are much lower thresholds than either state’s economic nexus threshold.
Ties to in-state affiliates can give you sales tax nexus
Like click-through nexus, affiliate nexus was initially an attempt to work around the physical presence restriction. These laws base a sales tax collection obligation on the relationship an out-of-state entity has with an in-state entity. The particulars of affiliate nexus laws vary by state, as with all sales tax laws, but they’re all variations on the same theme.
About 36 states had affiliate nexus laws on the books prior to the Wayfair decision, and only a handful have gone to the trouble of repealing them — suggesting states find them useful.
New sales tax obligations can reveal old sales tax obligations
Economic nexus laws have gotten a lot of press since the Supreme Court issued its decision on Wayfair, and though some businesses don’t fully understand how Wayfair impacts them, many have a general understanding of the issue. They know they need to register if their sales into a state exceed that state’s economic nexus threshold.
What many businesses don’t realize is that they may already have nexus and an obligation to register in states where they develop economic nexus. They could have established physical nexus through marketplace inventory or trade show attendance. They could generate sales through referrals and have click-through nexus or have affiliates in the state. And they could owe years’ worth of back taxes.
If you have sales tax nexus, it’s in your best interest to register sooner rather than later. But it’s important to do so wisely while minimizing associated risks.
What to do if you have prior tax exposure in a state
There are several options for businesses that haven’t been collecting and remitting sales tax as they should. Below are five potential scenarios to consider as you determine your next move. While we hope you find them helpful, they’re not a substitute for tax advice.
- Option 1: File back taxes
- Option 2: Enter into a Voluntary Disclosure Agreement (VDA) with the state
- Option 3: Hold out for a tax amnesty program
- Option 4: Ignore past liability and register anyway
- Option 5: Do nothing
Option 1: File back taxes
If you owe taxes for a prior tax period and haven’t paid them, your eventual returns and payment will be delinquent, and penalties and interest charges will likely apply. Businesses whose past exposure is quite small may be able to simply back file those returns and pay the associated penalties, fines, and fees. They can also request relief from penalties, interest, and fees (see this California Request for Relief form as an example). With a valid reason, state tax authorities may waive associated penalties.
Consulting with a tax professional before filing back returns is always recommended. And remember, before you can file a return or make a payment, you must first register with the state (i.e., obtain a sales tax permit).
Option 2: Enter into a VDA with the state
Most states offer voluntary disclosure agreement (VDA) programs to encourage nonregistered businesses to self-identify and pay the taxes they owe. Among other benefits, a VDA can limit the look-back period (the amount of time a tax authority can assess overdue taxes) and reduce or waive late filing or late payment penalties for participating businesses. Because of this, VDAs are typically recommended when exposure in a state is high.
Businesses considering a VDA may be able to take the first step anonymously. According to the California Department of Tax and Fee Administration (CDTFA), “Applicants may obtain a written opinion as to whether the CDTFA would approve a voluntary disclosure request based on circumstances presented anonymously.” However, the Washington Department of Revenue encourages businesses to disclose their identity upfront and reminds, “Your application for voluntary disclosure cannot be approved until the identity of the business is disclosed.
There are many benefits to participating in a VDA. However, businesses shouldn’t initiate the process in any state without first consulting with a tax advisor.
Option 3: Hold out for a tax amnesty program
States may periodically offer temporary tax amnesty programs to encourage taxpayers with outstanding tax liability to come forward and pay the taxes they owe. The problem is, states aren’t required to offer them, and there’s no guarantee they will.
Tax amnesty programs are usually created by state legislatures, and consequently their details vary by state: They may be open to both registered and unregistered businesses or apply only to taxpayers already registered with the tax authority; they may apply to all taxes or merely some; they may waive penalties or simply reduce them. And so forth. For example, in early 2021, Pennsylvania offered limited amnesty for unregistered remote sellers with inventory in the commonwealth.
Option 4: Ignore past liability and register anyway
If you develop a tax collection obligation, it’s in your best interest to comply with it. Yet if you have prior exposure in a jurisdiction, you may put yourself at risk if you simply register without acknowledging your history in the state.
Sales tax registration forms ask businesses to provide the nexus start date in a variety of ways. Businesses are required to fill out such forms completely and honestly — misrepresenting or concealing past nexus with a state can lead to civil and criminal penalties and potential personal liability.
If you suspect you have past liability in a state — and even if you don’t — it’s always advisable to consult with a tax advisor before registering in new jurisdictions.
Option 5: Do nothing
Ignoring both past liability and new obligations to collect and remit sales tax is risky.
Now that they have the authority to tax remote sales, some states are actively seeking non-compliant businesses. For example, Connecticut, Illinois, Indiana, New York, Ohio, Oklahoma, and Pennsylvania are using data mining “to find out-of-state sellers that either aren’t aware they owe tax or are shirking collection and remittance.”
It may take states a long time to find you, but there’s a good chance they will find you eventually. If they do, and if you have a history of doing business in the state without collecting and remitting the taxes you owe, you could end up with a mighty big tax bill (plus applicable penalties and interest). In that case, you’ll likely have to pay, out of pocket, the sales tax you could have collected from your customers. It’s extremely hard to obtain sales tax from past transactions.
Think before you register
The best way to minimize liability from prior exposure is to be proactive. Before deciding your next step, we recommend you consult with a tax advisor. Our partner accountants are here to help.
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