If you are a small business owner, you may have heard of the term “tax nexus” and wondered what it means and how it affects you. Tax nexus is a complex and evolving concept that determines whether you have to collect and remit sales tax, income tax, or other taxes in a state or jurisdiction where you do business. It can have a significant impact on your bottom line and your compliance risk.
What is Tax Nexus and Why Does It Matter?
Tax nexus is a legal term that describes the connection or relationship between a business and a taxing authority, such as a state or local government. If you have tax nexus in a state, it means that you have enough presence or activity there to trigger the state’s taxing power over you.
Tax nexus matters because it determines your tax obligations and liabilities in different jurisdictions. If you fail to comply with the tax nexus rules you may face penalties, interest, audits, or even lawsuits from the taxing authorities. On the other hand, if you overpay taxes in states where you do not have tax nexus, you may be losing money and reducing your profitability.
Unsure if your business owes tax in Minnesota? Complete Form C101, Minnesota Business Activity Questionnaire, to find out!
How Is Tax Nexus Determined?
There is no universal definition or standard for tax nexus. Each state has its own rules and criteria for determining whether a business has tax nexus there. However, some of the major components of tax nexus include:
This is the most common and traditional way of establishing tax nexus. If you have any physical presence in a state, such as an office, warehouse, employee, inventory, or property, you generally have tax nexus there. However, some states have different thresholds or exceptions for physical presence, so you need to check the specific rules for each state.
Economic presence nexus is the result of the South Dakota vs. Wayfair supreme court decision of 2018 and requires out-of-state businesses to collect and remit sales tax if they have a certain amount of sales or transactions in the state, regardless of their physical presence. This is also known as “economic nexus” or “remote seller nexus”. The thresholds vary by state, but they typically range from $100,000 to $500,000 in annual sales or 100 to 500 transactions.
Thresholds & Small Seller Exceptions:
As discussed above, most states offer a small seller exception. You have nexus if your business activity exceeds these thresholds. Thresholds can vary by type of tax (sales tax vs income tax), type of business (retail vs service), type of product (tangible vs intangible), and type of customer (individual vs business). For example, Minnesota’s small seller exception for sales tax is 200 or more retail sales shipped to Minnesota, or more than $100,000 in retail sales shipped to Minnesota.
What Are the Consequences of Tax Nexus Errors or Omissions?
If you make mistakes or overlook your tax nexus obligations in any state where you do business, you may face serious consequences such as:
These are monetary fines imposed by the taxing authorities for failing to comply with their rules and regulations. Penalties can vary by type and severity of the violation, but they can be substantial and accrue over time.
This is the additional amount that you have to pay on top of the taxes and penalties that you owe. Interest is calculated based on the interest rate and the period of time that you are late or delinquent in paying your taxes.
These are examinations or investigations conducted by the taxing authorities to verify the accuracy and completeness of your tax returns and records. Audits can be triggered by various factors, such as discrepancies, anomalies, complaints, or random selection. Audits can be time-consuming, stressful, and costly for your business.
These are legal actions taken by the taxing authorities or other parties to enforce their claims or rights against you. Lawsuits can result from disputes, disagreements, or controversies over your tax nexus status or obligations. Lawsuits can be lengthy, complex, and expensive for your business.
How Does Tax Nexus Impact Small Business Owners?
Large corporations have dedicated staff handling nexus issues, but most small business owners just have themselves. Consider the following for your small business:
Complexity of sales tax filings:
If you have sales tax nexus in multiple states, you have to keep track of the different sales tax rates, rules, exemptions, and deadlines for each state. You also have to register with each state’s department of revenue, collect and remit sales tax from your customers, file sales tax returns, and maintain sales tax records. This can be a complicated and tedious process that requires a lot of time, organization and resources.
Complexity of income tax filing:
If you have income tax nexus in multiple states, you have to allocate and apportion your income among the states where you do business. You also have to file income tax returns and pay income tax to each state according to their rules and schedules. This can be a challenging and confusing process that requires a lot of calculations and documentation.
Complexity of payroll taxes:
If you have employees in multiple states, you have to comply with the payroll tax requirements of each state. You also have to withhold and remit payroll taxes from your employees’ wages, file payroll tax returns, allocate wages between states, and maintain payroll tax records. This can be a burdensome and costly process that requires a lot of tracking and accuracy.
Cost of Compliance:
Complying with tax nexus laws and regulations can be expensive, so plan ahead before jumping into another state. Your profitability in one state may not directly transfer to another. Consider the cost of registering with the states, collecting and remitting taxes, filing returns, keeping records, hiring staff, buying software, and more.
Working with Haworth & Company, Ltd.
As you can see, tax nexus is a complex and evolving concept that can affect your business in many ways. It is not something that you can ignore or neglect without risking serious consequences. However, it is also not something that you have to deal with alone.
At Haworth & Company, we are a certified public accounting firm that specializes in helping small business owners with their tax nexus compliance. We have the knowledge and experience to help you understand the rules and requirements of the states you do business in, help you setup systems to accurately collect, remit, and file appropriately, and plan ahead to reduce tax liabilities and maximize your profits. If you are interested in learning more about our services or how we can help you with your tax nexus compliance, please contact us today for a free consultation.