What triggers sales tax obligations for small businesses

Sales tax obligations begin when a business establishes nexus, a connection that can come from having physical presence in a state, reaching certain sales thresholds in a state, or other ties. Once your business has nexus with a state, you generally need to register with the tax authority, collect tax from customers, and file and remit taxes as required. Failure to fulfill your sales tax obligations can result in audits, fines, and other penalties.

Understanding nexus is the first step to becoming sales tax compliant. 

• Sales tax obligations are triggered by nexus, which is a connection with a state or other tax jurisdiction.
• Failing to comply with sales tax obligations can be costly, leading to audits, fines, and reputational risk.
• Sales tax software for small businesses helps simplify compliance by tracking nexus obligations.

Sales tax is a tax on the transfer of taxable goods or services, usually based on a percentage of the retail sales price. Retailers collect sales tax from customers at the point of sale and remit it to the appropriate tax authorities. If a seller doesn’t collect sales tax at checkout, the consumer may be responsible for remitting the equivalent use tax.

There are more than 12,000 sales and use tax jurisdictions in the United States, making sales tax compliance challenging for small businesses.

Nexus is another word for connection. Sales tax nexus is a connection that creates a sales tax obligation.

Here’s how it works: If your business has sales tax nexus with a state, you’re required to obtain a sales tax permit in that state; collect sales tax, remit sales tax, and file sales tax returns; and comply with all other applicable tax requirements. You aren’t required to collect or remit sales tax in states where you don’t have nexus.

For the most part, sales tax laws are governed by states. However, individual cities and/or counties may enforce local sales tax obligations in the handful of states that allow home rule — notably Alabama, Alaska, Colorado, and Louisiana.

Businesses can establish nexus through:

• Physical presence (physical nexus)
• Sales activity or revenue (economic nexus)
• Relationships to in-state affiliates (affiliate nexus)
• Online referrals or links from in-state entities (click-through nexus)

Physical presence and economic activity are the most common nexus triggers.

Activities that trigger physical nexus 

If you have inventory, operations, or people in a state, you likely have physical presence nexus for sales tax. According to the Washington State Department of Revenue, “Physical presence is a nexus standard that requires only more than the slightest presence.”

You can create physical nexus if you:

• Have employees or contractors in the state (including remote staff)
• Have real or tangible property in the state (including inventory in a marketplace fulfillment center)
• Make deliveries using your own vehicles or staff in the state (not by mail or common carrier)
• Participate in business events or trade shows in the state

It’s important to note that nexus requirements vary by state. For instance, while marketplace inventory generally doesn’t establish nexus in New York or Texas, inventory can create nexus in California and New Jersey. Though marketplace facilitators are generally required to collect and remit sales tax on behalf of third-party sellers, marketplace sellers can have other sales tax obligations.

Activities that trigger economic nexus 

Economic nexus is created when a company with no physical tie to a state reaches a certain level of economic activity in that state. It’s a common nexus trigger for online sellers, mail-order businesses, and other companies that make remote sales.

The U.S. Supreme Court authorized states to tax remote sales in 2018 with its decision in South Dakota v. Wayfair, Inc., and today, all states with a general sales tax have an economic nexus law. In Alaska, one of the states with no statewide sales tax, many cities and boroughs enforce economic nexus for local sales tax.

Every state’s economic nexus law provides an exception for businesses with sales in the state that are beneath a certain economic nexus threshold. Nevertheless, economic nexus laws can impact small businesses because the thresholds used by many states are relatively low. The most common state economic nexus thresholds are $100,000 in sales, and $100,000 in sales or 200 transactions.

Bear in mind that economic nexus laws are subject to change. For instance, numerous states have dropped their 200-transactions threshold.

Affiliate nexus

Affiliate nexus is created when an out-of-state business has certain ties to in-state entities that help the remote seller establish or maintain business in the state. As with economic nexus, a business usually needs to generate a certain amount of sales in the state through their affiliates for affiliate nexus to apply.

Click-through nexus

Click-through nexus is created when an out-of-state business 1) receives referrals from a third-party seller or other agent located in the state, and 2) makes a certain volume of sales from such referrals. About 15 states have click-through nexus laws.

Exempt sales don’t exempt you from tax compliance

Sales tax nexus laws can affect any business selling taxable goods or services in a state with a sales tax, including small businesses that primarily make exempt sales.

You shouldn’t collect sales tax on transactions that are exempt from sales tax. However, where you have nexus, you may be required to register for a sales tax permit, validate exempt transactions, and file sales tax returns even if all your transactions in that state are exempt. Most states include exempt sales in their economic nexus thresholds.

And, of course, you’re required to register for sales tax if you sell taxable goods or services in a state where you have a physical presence. 

You need to learn about the nexus laws in effect in the states where you make sales. Then you need to figure out where you’ve triggered nexus and established an obligation to collect sales tax.

States typically have a lot of good information on their department of revenue websites. Depending on your business and level of audit risk, it may be worth your while to consult with a professional tax advisor or undertake a sales tax nexus study.

There are three options for an Avalara Sales Tax Risk Assessment: free, standard, and premium.

If you trigger nexus with a state, you’ll need to:

1. Register for a sales tax permit with the tax authorities.
2. Calculate and collect sales tax on taxable transactions.
3. Validate exempt transactions with the appropriate exemption or resale certificates.
4. File sales tax returns by the due date (you may get a discount for filing on time).
5. Remit the sales taxes you collected by the due date.
6. Comply with all other applicable tax requirements.

It’s generally in a business’s best interest to register sooner rather than later. In fact, some states require a business to register immediately after reaching the economic nexus threshold.

But, there are some things you’ll need to consider before you register. For instance, it’s critical to determine when you first established sales tax nexus. If it was years ago, and you didn't know you had nexus, you could end up with a hefty bill for back taxes.

If your business fails to comply with its sales tax obligations and is selected for an audit, you could end up responsible for paying years of back taxes, plus penalties and interest. You also risk damaging your company’s reputation.

The most effective and efficient way for a small business to manage the complicated process of sales tax compliance is to use cloud-based sales tax software.

With Avalara AvaTax, small businesses can automate rate calculations, track changing tax rules, and file returns more accurately — all from one platform. Whether you’re selling in one state or many, Avalara helps reduce manual work and risk so you can stay focused on growing your business.

Learn how Avalara can help small businesses simplify sales tax compliance.

What triggers sales tax obligations for small businesses?

Sales tax obligations are triggered when your business establishes nexus with a state, primarily through physical presence or economic activity. Sales tax nexus can impact your business regardless of its size. Check out our Know Your Nexus guide or sales tax nexus FAQ for more useful information.

Do I need to collect sales tax if all my sales are exempt?

Some states require you to register and file returns once nexus is established, even if your products or customers qualify for exemptions.

What happens if I ignore sales tax nexus?

Failure to fulfill your sales tax obligations can result in audits, fines, and other penalties. You also risk damaging your company’s reputation.

How can small businesses manage sales tax compliance efficiently?

Small businesses use sales tax software to help ensure accuracy and avoid costly surprises while reducing risk and saving time.

What if my small business is struggling to manage invoices, bill payments, and cash flow? 

Avalara provides more than sales and use tax compliance, it also gives businesses a powerful solution to manage invoicing, bill pay, and cash flow in one place. With Hopscotch by Avalara, businesses can create and send invoices, collect payments, and avoid transaction fees with fee-free bank transfers. Hopscotch integrates with accounting software like QuickBooks to automatically reconcile payments. You can even use it to skip net invoice terms altogether and get paid instantly. 

This post has been updated; it was originally published January 13, 2023.