What is a nexus study and does your business need one?
If you do business outside your home state, you may be liable for taxes in other states. One way to learn whether you’ve developed a tax obligation in a state is to complete a nexus study (aka, a nexus questionnaire).
What is a nexus study?
A nexus study is essentially a survey designed to determine whether a business has nexus with a taxing authority like a state.
Nexus is a connection that establishes a tax obligation. A state can’t tax a business unless that business has nexus with the state.
Keep in mind that a nexus study is typically just the first step in what can be a lengthy process. If you discover that you have nexus in one or more states where you aren’t registered, you’ll need to weigh your options carefully. More on that below.
What triggers sales tax nexus?
There are basically five ways for a business to establish sales tax nexus with a state:
- Physical presence (physical nexus)
- Economic activity (economic nexus)
- Affiliates (affiliate nexus)
- Referrals (click-through nexus)
- Cookies (cookie nexus)
Physical nexus. There are lots of ways for a business to establish physical nexus, including leasing, renting, or owning property in the state; sending employees into the state (e.g., for sales, service, or a trade show); or storing inventory in the state. Requirements differ from state to state.
For the most part, having a physical presence in a state was the only way for a business to establish nexus prior to June 21, 2018, when the Supreme Court of the United States overturned the physical presence rule in its ruling on South Dakota v. Wayfair, Inc. The Wayfair decision didn’t eliminate physical nexus, but it freed states to base nexus on other connections — like economic activity.
Economic nexus. All states with a general sales tax now have economic nexus laws that base a sales tax obligation on an out-of-state seller’s economic activity in the state. Every state provides an exception for businesses with little economic activity in the state (e.g., less than $100,000 in sales in the state in the current or previous calendar year), but each state’s economic nexus threshold is unique.
Affiliate nexus. Approximately 30 states have affiliate nexus laws. Affiliate nexus is created when an out-of-state business has a relationship with an in-state affiliate (a person, organization, business, etc.). Exactly what types of relationships establish affiliate nexus varies from state to state.
Click-through nexus. About 20 states have click-through nexus. Click-through nexus is established when an out-of-state business rewards in-state businesses or individuals for directly or indirectly referring customers through website links. As with economic nexus, click-through nexus laws typically include a threshold.
Cookie nexus. This is the rarest and perhaps the most controversial type of nexus. It’s established when an out-of-state business puts cookies on devices in the state. Only a handful of states enacted cookie nexus laws prior to the Wayfair decision (2018), and Massachusetts may be the only one still seeking to enforce it.
Where can I get a nexus study?
Certified public accountants and other tax professionals typically offer clients a nexus study to help them determine whether and where they have nexus. As noted above, this is usually the first step in what can become a lengthy process if you’re found to have nexus in one or more states.
If you don’t already work with a CPA or tax advisor, peruse Avalara’s accounting firm directory.
Alternatively, Avalara offers a free sales tax risk assessment to help you identify where you may have nexus. It can be a good first step.
I got a nexus questionnaire from a state. Now what?
Most state tax departments have a nexus questionnaire that asks a variety of questions to determine whether a business has an income tax, franchise tax, sales tax, or other tax obligation.
For example, the Arizona Department of Revenue nexus questionnaire regarding activities in Arizona asks:
- Has the company ever participated in trade shows, seminars, or lectures in Arizona?
- Does the company maintain any Arizona locations, including offices, warehouses, manufacturing facilities, etc.?
- Does the company conduct remote sales in Arizona?
- Has the company had employees, representatives, or independent contractors enter Arizona to perform work at any time?
- Does the company have any merchandise in Arizona on consignment?
The New Jersey Division of Taxation nexus audit questionnaire asks questions about whether a business:
- Solicits sales in New Jersey
- Sells any type of goods, property, or services to customers located in New Jersey
- Carries goods, merchandise inventory, etc., into New Jersey for sale to customers in New Jersey
- Enters into agreements with representatives in the state who refer customers to the business by a link on an internet website or otherwise
- Participates as an exhibitor at a trade show or take orders at a trade show in New Jersey
There’s usually no need to troll department of revenue websites for a nexus questionnaire. It’s the type of thing you’ll find one day in your inbox or mailbox if the state has reason to believe you may have nexus.
If you receive a nexus questionnaire from a taxing authority, answer it honestly and have a trusted tax advisor review it before submitting it. Providing erroneous or inaccurate information could result in a tax assessment, as this cautionary tale from the Sales Tax Institute reveals.
What’s the difference between a nexus questionnaire and a voluntary disclosure agreement?
A nexus study or questionnaire is designed to determine whether a business has a tax obligation.
A voluntary disclosure agreement, or VDA, is a binding agreement between a state and a taxpayer that has a tax obligation but hasn’t been compliant. It’s designed to encourage voluntary compliance with the state’s tax laws by limiting the look-back period — the length of time a state can reach back to hold a taxpayer liable for unpaid tax.
Most states offer VDAs for sales tax, though the specifics of each state’s program vary. You can also get a VDA from the Multistate Tax Commission. Learn more in Debunking 4 myths about voluntary disclosure agreements or in this on-demand webinar.
It’s important to know where you stand before you register for sales tax in a state. If you owe back taxes, you could open yourself up to steep fines and penalties by registering without first addressing your past liability. You may not be able to avoid back taxes, but you can at least move forward with open eyes and a plan.
The Avalara Professional Services team offers a wide range of services to help your business become compliant. Put a tax pro in your corner.
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