Economic Nexus for Sales Tax
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
We mentioned in our last episode that we talked about nexus a lot. We discuss it in virtually all our webinars, and we write articles and blog posts about it, yet it continues to be one of the topics that we get the most questions about so we thought it would be a good subject to do a series of podcasts about. Last week was the first in the series and we discussed physical presence nexus, and yes it is alive and well and perhaps more important than ever. Today we are going to discuss economic nexus for sales tax.
Here’s a glimpse of what you’ll learn:
What is nexus?
Wayfair
The cause of 1 out of 2 companies being compliant when it comes to economic nexus
Economic nexus obligations
Specifics of economic nexus
Past exposure
Connect with Michael
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here is your host, Michael Fleming.
[0:27] Mike: Hi, Mike Fleming here, founder of Sales Tax, and More and today's co-host of the Sales Tax or More podcast, where we talk about everyone's favorite topic, which is of course sales tax. In our last episode, we mentioned that we talked about nexus a lot. We discuss it in virtually all of our webinars. We write articles and blog posts about it. We've done podcasts about it. Yet it continues to be one of the topics we get the most questions about. So we thought it would be a good subject to do a series of podcasts on and last week was the first in the series. During that episode, we discussed physical presence nexus and yes, it still is alive and well, and perhaps more important than that. Today, we're going to discuss economic nexus for sales tax, which is relatively new. But before we get started, I want to introduce you to my co-host, Ellie Moffat.
[1:28] Ellie: Hey, everyone! Really great to be here, Mike. Before I jump in here, I also want to do an introduction for Sales Tax and More. Sales Tax and More is a full-service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, and like our name states more. So if you have questions about our services please reach out and ask. We'll put a lot of ways out there for you to go and do so. So Mike, let's backtrack just a little bit here for those who did not listen to last week's episode or watch it, let's start really basic. What is nexus?
[2:14] Mike: Since you didn't warn me about saying it's a shampoo. Can I say it's a shampoo?
[2:20] Ellie: Yeah, we can revisit the shampoo. People at home are like, we know it's shampoo! Haha!
[2:27] Mike: Yeah. All right. Let's get serious. Nexus is just a fancy word. That means link or connection, and when we talk about taxes, it's the link or connection you must have with the state before the state can require you to do anything. For example, before the state can make you or require you to collect and remit its sales tax or vendors use tax or pay taxes like an income tax, franchise tax, or even a consumer use tax. You must have this link or connection that we call nexus. There are a number of different ways to create this link or connection. Last week we concentrated on the physical ways to do it. Today we're going to discuss the economic nexus, which simply means that this link or connection we're talking about. Can be created just by having a certain amount of sales into a state or just by having a certain number of transactions in a state. So selling into a state as of June of 2018 can now create this link or connection.
[3:38] Ellie: Thank you so much, Mike. And I know you're going to talk more about threshold. Do you want to speak briefly about the Wayfair case so we can cover that ground?
[3:49] Mike: Yeah, absolutely. And thanks for bringing that up. Sometimes I tend to think that everybody knows about the Wayfair case because it really stood the sales tax world on its head and had major impacts on just about every company across the country. So prior to June of 2018, in order to create this link or connection, there had to be some sort of physical component to it. But in June of 2018, the Wayfair case was South Dakota versus Wayfair. The U.S. Supreme Court decided that you no longer needed a physical presence. They overturned the previous two cases, which were 1967 national Bellas Hess, and 1992, the Quill case. The court didn't say, Hey, times have changed. So we've got to change this rule about physical presence, the court did something that very rarely do they do. They came out and they said, we made a mistake. We never should have introduced the concept of physical presence, to begin with. We accidentally created a protected class and that was not our intention. So it's like the Quill and National Bellas Hess cases never happened, which in theory means that states could have gone back to 1967 retroactively enforced, this economic nexus, because the court said, Hey, there's no such thing as a physical presence space basically, or no such thing as a requirement for physical presence still creates nexus, but it's no longer required to create nexus. South Dakota was pretty smart. Because they knew that the Supreme Court would be a little bit worried if they thought the states were going to go all the way back to 1967. So South Dakota said, we're only going to do this perspectively. In other words, we're only going to do this on a going-forward basis which made the Supreme court, a little bit more comfortable and allowed South Dakota to move forward with its economic nexus.
[6:14] Ellie: Okay. So we had Wayfair three years ago this month. Yet, there was a pretty recent survey that said only one out of two companies was compliant when it comes to economic nexus. What do you think is causing this?
[6:30] Mike: Well, Ellie, that's a great point. And there was actually a second survey done that said 60% of companies are not only not compliant. But they don't even know what they're required to do and our own internal numbers trend more to that 60% number rather than the 50% number. And I think there's a couple of reasons for this. And first of all, this was so earth-shattering. Some companies only had a responsibility to register and collect taxes in one state. Some of them, if you were in one of the states that didn't even have a sales tax, maybe you weren't required to collect sales tax anywhere. Where now, some companies have to virtually collect tax in every single state that has a sales tax. There was a lot of resistance. This was disbelief and it was so much work that people said Congress is going to get involved in this. They can't let this stand. So they were just waiting for Congress to step in. The problem is that, hoping that. Any type of hope, hoping that Congress steps in or hoping that the U.S. Supreme Court revisits this hope is not a great sales tax strategy. And, if we're thinking Congress is going to step back in, I want to tell you a little bit of a story. Back in 1959 was the only time Congress passed any laws about nexus. And in 1959, they passed an income tax law concerning nexus, and it nullified the U.S. Supreme Court case, Northwestern cement. It's called the Interstate Income Act of 1959, or public law 86-272. And when Congress passed this law, they said nexus is so complex. It's so confusing that this is just a temporary stop-gap measure. We need to, empower panels and form committees and do studies before we can come out permanent solution with some permanent rule for nexus. Now, here we are 62 years later, and Congress has done absolutely nothing. We still have this antiquated temporary solution. And if anything, nexus is a lot more confusing today than it was back in 1959. The economy is totally different. Add to that, that U.S. Supreme Court in the Quill case, when they were reaffirming a physical presence, they told Congress, Hey, this is really your ballpark. You guys need to be deciding some of this stuff. So 1959 Congress tells us themselves that they're going to come out with a permanent solution. The Supreme court reminds Congress in 1992. Hey, they need to come up with a permanent solution. Again, we don't get anything. That's one of the reasons we got Wayfair to begin with because the Supreme court weighed back in and that's how we got Wayfair. Congress, for some reason, some of us think that it's been a, do nothing. Congress the last four years, eight years, twelve years, you pick a number, but on some issues like this nexus, they've been a do-nothing Congress for the last 62 years, so our grandchildren or great-grandchildren might benefit from something that Congress does, but nowadays Congress can't even decide what to order for lunch. And I just don't think that we're going to get them to give us any relief when it comes to this. There are a lot of smart people out there, who are saying, how could this be? My whole world has changed a lot of accountants out there thought that Congress has got to step in because this is so much extra work for our clients, but here we are three-year anniversary. Congress has done nothing yet. So far for the course I just don't think they're going to do anything. And now, if you had acted back three years ago in June of 2018, you had absolutely no past exposure whatsoever. Only today, in some states you get three years’ worth of past exposure and every day that goes by that exposure continues to build. So I think it's time to start being, proactive because we just can't, we can't rely on Congress to step in and protect us.
[11:19] Ellie: Okay, so Mike, so congress seems to be a big letdown here, but you said there were two issues. What's the second?
[11:29] Mike: Oh, the second one is the U.S. Supreme Court. And a lot of people thought that'd be a lot more litigation and this was going to go back to the Supreme court and, the Supreme court would overturn economic nexus. I don't think that's going to happen at all. The Supreme court solicited this case. Very rarely does the Supreme court come out and say, send us this case and we're going to revisit this issue. They made their feelings known that they don't think that physical presence is required. Now, the states were smart when they were implementing this and they didn't want to upset Congress. They didn't want to upset the Supreme court. So they all did this on a prospective basis. In other words, they were enforcing it on a going forward and most of the states did a good job. And, with the exception of an Illinois, most of them appear on their face to be constitutional. Illinois has got some real problems. The courts may strike down a single state's laws, but then that state's just going to go back and get in line with the rest of the states. I just think that economic nexus is here to stay. They're not going to overturn themselves and say, oh, no we made another mistake. We really did want a physical presence. So I think that this economic nexus is here to stay. And again, states like New York, you've got three years of past exposure and these states are gearing up and they're going to be coming, and they're going to be coming hard for a couple of reasons. Number one. The states know that one in two people at best are compliant. More like six out of ten are not compliant. So they becoming hard, to begin with. They started coming hard prior to the pandemic closures. Now that the states are opening back up, they're starting to come hard again and probably a lot harder than they would have pre-pandemic because now they have all of this revenue that they need to make up. The closures hurt a lot of businesses, but they also heard a lot of the states who are missing out on the sales tax revenue, the income tax revenue. They have to make that up somehow. And historically coming out of a recession, they make examples of people. They go out looking for people who they feel should be registered and are not.
[14:10] Ellie: Okay Mike, I want to circle back to something you mentioned. You mentioned that people, some people just don't know about Wayfair or what their obligations are?
[14:22] Mike: Yeah. And we've got a salesforce here and they reach out, they talk to companies, they talk to accountants saying in something that they report back to us all the time is, people are saying my clients aren't subject to that internet tax. We don't have people who sell on the internet. Well, a lot of that changed over the last year. Companies that never sold on the internet before started selling on the internet because those are the companies that were doing very well during the pandemic. So a lot of companies may not have had exposure before, I've got a problem when people call this the internet tax because you don't even have to have a website. For this economic nexus to apply. It's anybody who sells into multiple states. This is a multi-state tax issue. So you can sell by telephone. You could sell by referral. You could sell by catalog. You could sell by infomercial. You don't like I said, you don't even have to have a website. If you're selling into multiple states. Then this could impact you. Another reason why people don't know is that they've got their head down, they're working hard, it's been a tough environment out there. They're concentrating on, building their business or keeping the business going. And, the accountants are getting thrown all of these different curveballs on taxes. I read an article the other day that they've seen more changes in such a short period of time than any other period of time in history. So everyone's got their head down doing, they're staying in our lane, they're doing what they need to do and sales tax for most of these people has not been an issue and it just hasn't come up on their radar. We in the industry think that, of course, everyone knows about the economic nexus. Of course, everyone knows about Wayfair, but it's just not so, and that's what we're hearing when we're reaching out to people. It's like they're shocked. Even CPAs, are sometimes shocked that this does or could apply to some of their clients, especially when we hear how low some of these thresholds are.
[16:45] Ellie: I think you have everyone's attention and if not rewind because that should have gotten your attention. How about some specifics about economic nexus?
[17:00] Mike: Okay, so let's start out with South Dakota. They thought that a hundred thousand dollars or 200 transactions were fair, and the Supreme court didn't explicitly agree with that. But they sorta gave South Dakota a wink and a nod. They did send the case back to the lower court for them to hash that out. But the case was settled before that issue was addressed. So a lot of states jumped on board and they just played follow the leader. They had this hundred thousand dollars worth of sales and 200 transactions. Now in South Dakota. Not a lot of people there, a hundred thousand dollars is a big number. 200 transactions is actually a big number for a lot of companies selling into South Dakota. But California came out and they said a hundred thousand dollars worth of sales or 200 transactions. 200 transactions in California is nothing. A hundred thousand dollars is really nothing. So you had all of these states that were piling on to this hundred thousand dollars. And then we started to see a little bit of softening up of that position. Some of these states said, what's fair for South Dakota may not be fair for California. And California came out and said, okay, we're going to do away with those transactions. And we are going to go up on our dollar amount to $500,000. So California's now at $500,000, no transactions. That seems a lot fairer than a hundred thousand dollars or 200 transactions. And there are a number of states that did the same thing that California did. Now they didn't raise their thresholds, but they got rid of the transaction threshold. States like Colorado and Iowa, North Dakota, Washington, and Wisconsin. They all started out a hundred thousand dollars and 200 transactions. They all got rid of their 200 transactions and the latest state to make an announcement is Maine. This is important. The way they word this, Maine says for sales after January of 2022 then the threshold no longer applies. The transaction threshold. And you gotta be over a hundred thousand dollars. Now, the way they said that is very important because Maine right now is auditing everybody they will allow you to register perspectively, but then they're going to audit you and say, prove to us. We want to see all of your sales going back to July 1st, 2018 because that's when our economic nexus became effective, and we want to see that you really didn't have nexus as of that date. I think they're going to continue this process because of the way that's worded. It says for sales after 1/1/22 so prior to that period states often still audit companies. Massachusetts is a big one for going after companies based upon past rules, just because the rules change in the future doesn't mean the state's going to be any nicer to you today. This is the law, as it stands today, 200 transactions. So you gotta watch out for that, it's a continuation of the trends. So if you haven't crossed that 200 transactions yet after January, you don't have to worry about it anymore. Now, some states never had any transactions. They were nice guys, to begin with. So states like Alabama, Arizona the most recent additions, Florida and Kansas, Idaho, Massachusetts, New Mexico, Oklahoma, Pennsylvania, South Carolina, and all of these states came in with hundred thousand dollar thresholds. So we've got Alabama and Mississippi, actually 250,000. And then Texas came in at 500,000. Tennessee originally came in at 500,000, but they went the other way, in October of 2020 because of the pandemic, they needed more revenues. So they dropped theirs down to one hundred thousand dollars. So a lot of movement and whether the states coming in without the transaction thresholds or states eliminating them. It's a great trend. However, when people hear me talking about a trend, a lot of them start ignoring the transactions. And you really can't because half of the states out there still have a 200 transaction threshold. So some of the big states like Illinois and New York, still have these, not New York. I'm sorry, New Jersey. They still have these 200 transaction thresholds. Right now it's about half and half. I do want to talk about New York and Connecticut because all of the states that do have transactions say a hundred thousand dollars or 200 transactions. The word or is important there, Connecticut, New York don't use the word or. They used the word and. So Connecticut is a hundred thousand dollars and 200 transactions. New York is $500,000 and 100 transactions. I see a lot of people out there, not realizing that these two states are different than all the others. And you got, a hundred thousand dollars in New York, and they're getting registered. You don't need to it's $500,000 and a hundred transactions. There's a chart and Ellie's going to, link it to this that we put out. It's also up on our website. It's called the economic nexus chart, and these states are constantly changing all the time. Like I just mentioned, Tennessee and more recently, Maine and Florida and Kansas every time the state does make a change, we update this sheet and it's going to tell you what the effective dates are. It's going to tell you what the thresholds are. It's a really good chart. Software companies out there also tell you oh we can tell you what your economic nexus is, but they don't get granular enough. Beware, software company says you have nexus, maybe you do maybe you don't, but these things get very granular. So double-check it. Don't just take the word of software.
[23:49] Ellie: Yeah, I just want to second what you said there about our economic nexus shirt make us very valuable. I would definitely take a look at it. We will link it in the show notes and everywhere we possibly can on this. And it's in the free section of our website regardless, with a bunch of other handy charts, but back to this podcast, Mike. So we have an idea of the transactions. What periods do the thresholds cover?
[24:13] Mike: Let's talk about the chart again, all of this is covered on the chart and by the way, this is a free chart and we keep it updated as a service for all of you. States do this one of three ways though, there are less than a handful of states that say, we're going to look at a rolling 12 month period. Illinois and Texas are two of those states. So you've got to be constantly recalculating for these states. Some states and this is the easiest to check up on. They say, you just have to look at the previous calendar year. Some examples are Indiana or Oklahoma. So every January you need to see if you've crossed a threshold. And if not, you don't have to check until the following January. So you check once every year for this group of states. Now the third group of states, and this is the largest group of states by far. It says previous calendar year, so you need to check in January, but then it says, plus the current years. So sometimes your business may be exploding and maybe it didn't do too well last year. And you may have a responsibility to collect. I give you a good example. There was one company we do, what's called a data review. It's a service we offer. We review your data, and, make recommendations for economic nexus. And it's, relatively inexpensive, $495. There's my commercial for the entire podcast. But I was reviewing their data and they didn't send me the year-to-date information yet. It was only, mid-April, maybe it was May. They only sent me the 2020 data and I looked at this and they were like two states where they needed to register. So I did that portion first and I'm waiting on the year-to-date because I knew their sales had increased. I didn't realize how big their sales had increased. They were up like 500% in the first four months of the year. And when I looked at that year-to-date information, there were like 20 states that they had to register in up from those two states. So it can make a big difference. And some states say, once you cross the threshold, the very next sale, you need to be collecting tax on. So you can't wait, in some of these states until you. Actually, cross it because you may be missing out on a month or two or three worth of sales tax collection. So if your business is growing rapidly you're going to want to anticipate when you might be crossing one of these thresholds, the other states are more reasonable. They're going to give you 30 days or 60 days from the date, you cross a threshold in order to get registered, but there are a number of them who say very next sale. So you've got to to look out for that. So the three ways that chart's going to tell you which way the state looks at it in those three ways, again are prior 12 months. It's a rolling 12 months. Prior calendar year, you only have to check every January or prior calendar year plus the current year. And then, depending on how quickly your sales are growing is going to dictate how often you want to revisit this issue.
[27:40] Ellie: Mike, do you want to let us know what type of sales are included in the transactions?
[27:44] Mike: Okay! Let's talk about the chart again. This is covered in the chart and, my favorite answer when it comes to sales tax is it depends. You know because it really depends on the state. Each state is so different. Now, some states are going to look at gross sales, and when they say that it generally means everything. It means taxable sales, exempt sales, sales of services, sales of tangible personal property, sales for resale. Gross sales mean gross sales, literally any type of sale that you have, they're going to count. Other states say just taxable sales, other states just say sales of tangible personal property. Some states will exclude sales for resale but include all other exempt sales. Some states are going to exclude marketplace sales, marketplace is someone like Amazon or eBay or Etsy. So each state literally does it differently. And it's going to vary widely. And that's why that chart is so handy. When you're looking at these software companies, they're not taking all of that detail into place. They're just looking at a total number generally and saying you've crossed a threshold or not, but once you start backing out some of this information, then you may not have crossed a threshold. Or maybe you weren't including your sales for resale maybe, or your exempt sales, maybe you were excluding them or your non-taxable sales of services or whatever else, and you have to include them. And all of a sudden you realize that, oh yeah, I've actually got more states, but it could be very well, a lot less states once you look at what's actually included in that threshold calculation.
[29:29] Ellie: So Mike, what about past exposures? Some of these dates are three years old, right?
[29:36] Mike: Absolutely. That's a great question, Ellie. There's definitely past exposure and we see some companies. Trying to register perspectively. In other words, just going forward. They take the position that I didn't know that I was supposed to be doing this. If I'd known I was supposed to be doing this, I would have collected the tax so I can justify just registering on a going-forward basis. And yes, I know that I still have exposure and the state may find me, but I've got to stop the bleeding. I can't let this get any worse. And the states they're not okay with it. But some people say what the state doesn't know won't hurt them. You gotta be very careful because Maine and Illinois are two states that they'll let you register perspectively, but then they're going to audit you. And they're going to go back to, Maine to July 1st, 2018, and Illinois to October 1st. So when we're making recommendations nowadays, these are two states you just know if you've got a client or if you're trying to register on a going-forward basis, you cannot do it. These are states you're really want to address, through a VDA. Now South Dakota is a little bit different. They won't let you register. They're going to stop you during the registration process. So again you're either going to want to approach them with VDA or historical returns and asked for a penalty waiver. So those are the three toughest states. I expect more states to become more aggressive and follow these three states. But for now, those are the most aggressive states. The correct way to do this, the way that the states want you to do this is to use the actual date that you crossed the threshold. And then the state's going to say, thank you very much. Now please pay me all my back tax. Plus penalty and plus interest. Now we call that a historical registration. You can ask for penalty waiver states, not obligated to give it to you. Sometimes your exposure is large enough that you may want to do a VDA and a VDA is going to limit the lookback period to either three or four years. So in most of these states, you're not getting any huge benefit from the VDA except for a penalty waiver and penalty waiver can be 25% in some states. Now you gotta be careful. Because some software companies, Avalara in particular will tell you that if you owe more than $500, you have to do a VDA in one of these states, if you owe more than $500, say you just don't have any options. And oh, by the way, we do $3,500. Now let me ask you a question. Why in the world would you pay anyone $3,500 to remit $500 of back tax for you. It's ludicrous. I don't know how these guys actually, sleep at night or wake up in the morning, look themselves in the mirror, but that's, what's being done. So yeah, VDA is a great tool, but it's not a one size fits all tool. You got to look at it and see if it makes sense for you. Now, we are for VDAs. We do it a lot cheaper than $3,500. Our fee is $1,975, but the concept is still the same. Here's a simple rule of thumb. If you're not going to save at least as much money as the cost of the VDA, then don’t do the VDA, you need to do perhaps a historical registration and asked for a penalty waiver or, if your exposure is totally minimal. Maybe you just do a perspective registration. So again, each situation is going to be a little bit different. What's your exposure is going to determine which way that you want to move forward.
[33:39] Ellie: Lots of really great information here Mike, if you didn’t again, I really recommend that you listen to the first podcast in the series that we're doing on nexus. And Mike, Anything you want to add in here before we go?
[33:52] Mike: Yeah, I just want to remind people for whatever reason you're not compliant, or for whatever reason, your clients are not compliant. I urge you to take action now because the states are coming and they are going to be making examples of people. They know that the majority of people out there are not compliant and they have to be finding new sources of revenue. So they're going to be coming harder than ever. You've got options. To limit some of that past exposure if you're being proactive, but once the states contact you. A lot of these options are off the table. So you don't want to become one of the examples. You don't want to be held up by the states. The reason why they make examples of people is so that those horror stories get around. So you tell your friends, I got found by this state and all of a sudden people are coming to them. They don't have to spend as much money tracking people down. They don't have to spend as much time tracking down. So that's why they make examples of people and you just don't want to be one of those examples.
[35:02] Ellie: Thank you so much, Mike, and to anyone who needs help figuring out their nexus, we do offer a number of services that can help you do so ranging from consultations or a data review at $495 to more involved and formal nexus studies for income and sales tax. So if you have interest in that, please let us know. We would love to talk to you about our services and you can reach out to me directly at emoffat@salestaxandmore.com or visit our website SalesTaxandMore.com. In addition to the services we offer, we have a lot of free resources out there as well. We talked about our economic nexus chart. We have an entire series of free webinars, which offers CPE credit and, just like our name for our services and more. So thank you so much, everyone. Mike, anything else you wanna add?
[35:57] Mike: Oh, we appreciate everyone joining us for this episode of the Sales Tax and More podcasts. Our next episode is going to cover nexus for income tax and we hope to see you there. Bye-bye
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