What happens if you forget sales tax nexus?
If you have sales tax nexus with a state, you’re required to register with the tax authorities then collect and remit applicable sales and use taxes in that state. But how do you know where you have sales tax nexus? And what happens if you don’t realize you have nexus with a state in which you’re making sales?
How is sales tax nexus established?
Nexus is a connection between a business and a state that allows the state to impose a tax obligation on the business. There are several ways for a business to establish sales tax nexus with a state, but the most common are through a physical presence or economic activity in a state.
A physical presence can include having a brick-and-mortar store, employees (temporary, permanent, or remote), or inventory (including marketplace inventory) in a state. You can also have physical presence in a state through in-state affiliates or from referrals originating in the states. Specific requirements vary by state.
The amount of economic activity that establishes sales tax nexus with a state also varies, ranging from $100,000 in sales in a state in the current or previous calendar year (like in Florida), to $500,000 in sales and 100 transactions in the state during the previous four sales tax quarters (like in New York).
Many economic nexus thresholds include exempt sales, so you can have an obligation to register and file returns even in states where you don’t make taxable sales.
What does sales tax nexus mean for small businesses?
Having sales tax nexus with a state results in a sales tax obligation, no matter the size of your business. So whether you’re a mom-and-pop shop or an international enterprise, if you have sales tax nexus with a state, you need to:
- Register for a sales tax permit with the state tax authority (and perhaps even local tax departments)
- Collect sales tax on taxable sales
- Validate exempt sales with an exemption or resale certificate
- File and remit sales tax on time
When it comes to tax compliance, the main difference between small and large businesses is that small businesses often have just one person managing sales tax — in addition to everything else they do — while large businesses can devote more resources and tools to the task.
What happens if I didn’t know I had sales tax nexus?
One of the trickiest aspects of nexus is that it requires constant monitoring. Even the slightest presence in a state, like participating in one trade show or having inventory in a marketplace warehouse, can trigger nexus. Likewise, you can establish nexus by making one hefty sale or a couple hundred small transactions in a year.
It’s extremely difficult to stay on top of nexus because nexus laws are different from state to state. Unfortunately, if you establish nexus with a state and don’t realize it until months or even years after the fact, you could end up owing back taxes along with penalties and interest.
For example, if you file a return or pay sales tax late in Florida, you could be subject to a penalty of 10% of the tax owed, plus interest. The Washington State Department of Revenue imposes a 9% late penalty if sales tax isn’t paid by the due date, and the penalty jumps to 29% if it’s not paid by the last day of the second month following the return’s due date.
Public shaming is also a risk: The Minnesota Department of Revenue routinely publishes a list of businesses whose sales tax permits have been revoked because an officer of the business owes at least $500 “for other debts to the state.” And if you collect sales tax then pocket it instead of turning it in, you’ll be publicly shamed and face criminal charges.
It’s simple, really: Parents want kids to make their beds; bosses want employees to show up on time; and states expect businesses to comply with sales tax laws.
Can I be audited for sales tax?
You sure can.
States take pains to uncover noncompliant businesses. For example, California, Pennsylvania, and Washington check whether marketplace sellers 1) have inventory in the state, and 2) make direct sales in the state. Connecticut encourages taxpayers to report businesses suspected of noncompliance. New York mines data to identify businesses with a high probability of noncompliance.
And sales tax audits happen.
State tax audits are a bit like roulette or bingo: A tax department could land on you for a nexus audit at any time, but they might not. In fact, they may never call your name for a sales tax audit. Or they may call it this year, and next year, and the year after that.
Some people like to gamble, some don’t, so as in life, you basically have two options:
Do all you can to be in good standing in the event of a sales tax audit
Gamble and deal with the consequences of a sales tax audit
It can be difficult for states to identify the full scale of noncompliance, and it can take time for them to uncover noncompliant businesses, so gambling may pay off, at first. Yet once the tax authorities know you exist, at some point they’ll likely subject you to a nexus audit to see whether you’re in compliance.
So it’s in your best interest to get compliant sooner rather than later. If you’re selected for a state tax audit and found out of compliance, you’ll be liable for the unpaid sales tax plus penalties and interest. These vary by state, as noted above, but they can be significant and they’re easy enough to avoid by paying the taxes you owe.
Collecting and remitting sales tax as required is the right thing to do. But you don’t know what you don’t know, and if you don’t know how sales tax nexus is established in a state, you may not realize you’ve triggered a sales tax obligation.
What can I do if I overlook sales tax nexus?
If realize you may owe back sales tax in a state where you’re not registered for sales tax, you have a few options:
Enter into a Voluntary Disclosure Agreement (VDA) with the state
Cross your fingers and hope the state will offer a tax amnesty program soon
Ignore past liability, register, and hope for the best
Do nothing and hope for the best (not recommended)
It’s best practice to consult with a trusted tax advisor before making any decisions. They can ensure you know what you need to know before you register for sales tax.
It’s all too easy to make mistakes related to nexus — even if you’re doing your best to stay on top of it — because nexus laws, regulations, and rules can change. Also, there’s a lot to keep track of if you have customers in lots of states.
The good news is that you don’t have to handle sales tax on your own.