How 'Economic Nexus' Might Affect Your eCommerce Business

How 'Economic Nexus' Might Affect Your eCommerce Business

The internet has created vast new opportunities for retail and service businesses that might once have been limited to a town or region. eCommerce has been around since at least the 1990’s, but the legal system — in particular, state sales tax laws — is only beginning to catch up. Every eCommerce business that sells across state lines must know which states’ sales tax laws could apply to them. Failure to collect and pay sales tax can result in serious penalties. States have developed several methods for determining when an out-of-state eCommerce business must collect and pay sales tax. “Economic nexus” is one of these methods, and it can apply to businesses almost anywhere in the country. An eCommerce accountant with knowledge of multistate sales tax laws can help your businesses understand and meet its obligations.

What Is “Economic Nexus”?

In order to require a business to collect sales tax from its customers, a state must have legal jurisdiction over that business. Most states have adopted laws establishing a minimum amount of involvement that a business must have with a state in order to owe sales tax. This is known as “nexus.” If a business has sales tax nexus in a state, that state can collect sales tax for sales made within its boundaries.

Jurisdiction to Collect Sales Tax

Perhaps the most straightforward example of nexus is “physical presence nexus.” A business that is physically located in a state must collect and pay sales tax for transactions within that state. This can include more than just having a headquarters, retail location, or other facility in a state. Storing inventory in a warehouse or regularly attending trade shows in a state, for example, can also establish physical presence nexus.

Other types of sales tax nexus include:

• Marketplace facilitator nexus: Businesses like Amazon or eBay may be required to collect and pay sales tax on behalf of out-of-state businesses that sell through their platforms.
• Affiliate nexus: A business with sufficient ties to an affiliate or other business in a state may have to collect and pay sales tax for sales in that state.

Transactions in a State Creates an Economic Nexus

Economic nexus is similar to physical presence nexus in a sense. For physical presence nexus, a business must have some minimum physical presence in a state. Economic nexus involves a minimum amount of economic ties to a state, usually measured by total amount of sales or total number of transactions. Each state’s laws can vary widely, but a fairly common standard for economic nexus is $100,000 or more in total annual sales, or two hundred or more transactions in a year.

Direct sales to consumers in a state can easily lead to economic nexus, but that is not the only way it can happen. Some states might also include wholesale sales and sales that occur through dropshipping or fulfillment by Amazon (FBA).

Which States Have Economic Nexus Laws?

Every state makes its own laws and rules regarding sales tax. To make matters more confusing, some states allow local governments like cities and counties to establish their own sales taxes. These are known as “home rule” states. eCommerce businesses need to be aware of the sales tax laws in the states where they sell products or services.

Nearly every state in the U.S. uses economic nexus in its sales tax laws to some extent. A decision issued by the U.S. Supreme Court in 2018, South Dakota v. Wayfair, made it much easier for states to enforce economic nexus against eCommerce businesses in other states. Since then, most states have amended existing sales tax laws or enacted new ones. Several states have amended their laws further to expand the scope of economic nexus, such as by lowering the minimum amount of annual sales.

It might be easier to list the states that do not have economic nexus laws, although even then, you should consult an eCommerce accountant or a state’s tax authority to confirm the current state of the law.

Four U.S. states have no general sales tax: Delaware, Montana, New Hampshire, and Oregon. Two states or territories, Missouri and Puerto Rico, have sales tax laws, but no laws regarding economic nexus for sales tax. That means that forty-five states and the District of Columbia use economic nexus.

How Does a State’s Economic Nexus Law Affect Out-of-State eCommerce Businesses?

What does all of this mean for your eCommerce business? First of all, it means that you potentially have a responsibility to learn a broad array of state sales tax laws. This is, unfortunately, a cost of doing business in an interconnected world. It also means that you should understand what can happen if you do not collect and pay sales tax in a state that requires it from you.

State and Local Sales Tax Laws

Entire books could be — and have been — written about the widely varying sales tax systems at the state and local levels in the U.S. For any state where you do business, but do not have a physical presence, you should know:

• Whether that state sets sales tax statewide or leaves it to local governments (home rule);
• Whether it uses economic nexus to determine responsibility for sales tax;
• What products and services are subject to sales tax in that state;
• Even if you are not subject to economic nexus, whether you will be required to file non-collecting seller use tax
• The minimum amount of economic activity, whether in terms or total amount of sales, total number of transactions, or some other metric, required to establish economic nexus.

This may sound like a tall order, but it is preferable to the consequences of doing nothing.

Penalties for Not Collecting and Paying Sales Tax

Some states have been quite aggressive in pursuing businesses that do not remit sales tax they are supposed to collect based on economic nexus. As with the question of whether an eCommerce business is responsible for sales tax in the first place, the consequences for failing to collect and pay sales tax vary from state to state. They can vary between cities and counties in home rule states. They can include both civil and criminal penalties, depending on the circumstances.

If a state determines that an eCommerce business was obligated to collect and remit sales tax, based on any type of sales tax nexus, the first concern will be recovering the unpaid tax. Considering how many states set economic nexus at around $100,000 or more in sales, this could be a substantial number. If a business has $150,000 in taxable sales in a state with a sales tax rate of eight percent, it will owe $12,000 in sales tax.

Suppose the business simply did not know that it was supposed to be collecting sales tax from customers in that state. The business will have to pay the full amount of unpaid sales tax itself.

A state can also assess penalties and charge interest for late payment of sales tax. The penalty could be a flat amount, or it could be a percentage of the total unpaid tax. Some states significantly increase the penalty if the unpaid tax exceeds a certain amount, such as $10,000. The interest is usually a percentage of the unpaid tax. The amount of interest will increase the longer the tax remains unpaid.

In rare cases, a state can file criminal charges against a business or certain individuals in connection with unpaid sales tax. Prosecutors would have to prove intent to defraud the state. This is unlikely in situations where a business simply did not know they owed tax, but the risk is always there. The charge could be a misdemeanor or a felony, depending in large part on the amount of the unpaid tax.

Learn More About Your Rights and Obligations

If you would like to know more about economic nexus and whether your eCommerce business should be collecting sales tax in certain states, please contact us today to learn more. Our experienced eCommerce accountants are available to help you.