Physical Presence 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 talk 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, I thought it would be a good subject to do a series of podcasts about. Today we are going to discuss physical presence nexus for sales tax.
Here’s a glimpse of what you’ll learn:
What is nexus?
Is nexus the same for sales and income tax?
Does physical presence nexus even matter anymore?
Physical presence nexus-creating activities
State-specific nexus-creating activities
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.
[0:28] Mike: Hi, Mike Fleming here, Founder of Sales Tax, and More and today's co-host of the Sales Tax and More podcast where we talk about everybody's favorite topic, which is of course sales tax. Now one of the topics that we discuss a lot is nexus and we discuss it in virtually all of our webinars, we write articles about it, we write blog posts about it yet, it continues to be one of the topics that we get the most questions about. So I thought it would be a good subject to do a series of podcasts on and today we're going to discuss the physical presence nexus for sales tax. Our next episode, we will cover economic nexus for sales tax and in the third episode, we will talk about income tax nexus because that's different than sales tax nexus. But before we get started, I'd like to introduce you to my cohost Ellie Moffat.
[1:24] Ellie: Hi, everyone. Mike, great to be here. I think this is going to be a really great series and cover a lot of information that we're asked about all the time. But before we get started, I do want to do a quick 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 or would like to work with us, please reach out and ask. We would love to hear from you and we'd love to work with you as well. So Mike, let's start real basic. What is nexus and nobody wants to hear that nexus is some kind of shampoo. Please don't tell us that's what it is.
[2:19] Mike: But it is a shampoo. I think I was in a pet store the other day and I saw something for horsehair. It actually is a type of shampoo, but on a more serious note, when used in relation to taxes, it's really just a fancy word that means link or connection. And before a state can require you to do anything, there must be some sort of link or connection with that state. And we called that link or connection, nexus. Now, for example, a state cannot require you to collect its taxes. It cannot require you to pay its income taxes. If you don't have this link or connection, now there are a number of different ways that this link or connection can be created. And we're going to cover some of them in our discussion today.
[3:13] Ellie: All right. So before, we get into that discussion Mike, and I know we're going to dive a lot deeper into this in the following episodes, but is nexus the same for both sales and income tax?
[3:26] Mike: Great question and as I alluded to earlier, no it's not. And we've got a great webinar out there. It's called “Sales Tax Versus Income Tax Nexus”. So it compares and contrasts the two, but I just want to point that you can have nexus for one type of tax and not the other type of tax or vice versa, or have nexus for both. So sales tax and income tax are different. And I want to clear up one very common misconception. A lot of people seem to believe that once you registered for sales tax, this creates income tax nexus, and it does not. And that goes for the opposite, registering for an income tax doesn't create sales tax nexus. Now the same activities that required a sales tax registration may require an income tax registration, but the mere act of registering for sales tax does not create an income tax nexus creating activity. Now, if you registered with the secretary of state that can in some states, but registering for sales tax or income tax does not create nexus, it's the underlying activities that we have to look at. So today, we're going to concentrate on physical presence for sales tax, we'll go deeper into the economic nexus and the income tax nexus in the following episodes.
[5:05] Ellie: Thank you, Mike. So we said, we're going to talk about physical presence, nexus for sales tax. Before you do, can you discuss one of the more common questions that we get, so common in fact that we created an entire webinar with this title, but the question is, does physical presence nexus even matter anymore?
[5:29] Mike: Great place to start, Ellie. We seem to be mentioning our webinars a lot today.
[5:34] Ellie: Come to our webinars that we did we say that yet?
[5:38] Mike: We haven’t said that yet, haha. But yes we get into these subjects a little bit deeper, but we get so many variations of that question, for example, people will call us or email us about Texas or California and they say, “Hey, Mike I want to, deregister in the state of California and I have a follow-up question and I asked them why do you want to deregister in California? And they say I'm underneath the $500,000 threshold. And there is no transaction threshold, so I don't need to be registered anymore or in Texas, the same scenario. My follow-up question will be well, what about the independent contractors you have traveling into the state of Texas. What about, in California, that inventory you had there and they said yeah, we still have that, but we're underneath the thresholds. And unfortunately, I've got to break it to them. It doesn't work that way. This economic nexus doesn't protect you from any other type of nexus. As a matter of fact, physical presence is always going to supersede an economic nexus, economic nexus doesn't protect you from anything. What it does is it just gives the states one more bite at the apple. It's one more way that they can get you to do what they want you to do, which is registered to collect their tax or pay their tax. So yes, physical presence, nexus still matters and perhaps more than ever.
[7:24] Ellie: More than ever? Fairly bold statement there. Do you want to elaborate?
[7:30] Mike: Yes, Ellie, it sounds like there was a little bit of sarcasm in that statement. There are you beginning to question me a little bit?
[7:38] Ellie: Absolutely not, just general shock over here.
[7:43] Mike: I truly think it matters more than ever. And here's why let's start by saying that if a state finds an unregistered company, They can go back to the date that the nexus began, that this link or connection first began with the state. And they're going to want their back. They're going to want their back penalty there. Excuse me, the penalty on the back tax. They're going to want the interest on the back tax. And in theory, they can go back, 12, 15, 20 years now, generally they don't go back that far, depends on the state. But they're generally only, and I say that tongue in cheek only go back seven, eight, or ten years. I don't know of any states that go back nine years. Why? I don't know, but a state like Texas is going to go back seven years. A state like California is going to go back eight years state like Hawaii is going to go back 10 years. Now I say, generally because we had Texas go after a seller for 12 years and a seller reached out to us. And one of the first things we did is beat the state back down to its normal seven years. So when I say generally, that's what it means. It means generally, in theory, they can go back 20 years if they so choose in most states. Now this has always been the case, why do I say it matters more than ever at this time? Well, it has to do with economic nexus and there are two surveys out there, one survey said that one in two companies, 50% of all companies out there are not compliant for economic nexus, the other survey, and in our own practice here, we find the second one to be more accurate. 60% of all companies or six out of ten companies don't know what their requirements are when it comes to economic nexus. So the states know that. And we're three years into this economic nexus now. June of 2018 is when the Wayfair case was decided by the Supreme court, which ushered in economic nexus last year, before the pandemic, the states started gearing up. They said, Hey, we've been trying to, go after this remote income since, the Quill case back in 1992, now we can, and nobody is paying attention to this. Or one out of two people is not paying attention to this. So we're going to get very aggressive and we're going to start, tracking down companies. And a lot of states hired extra people and they were really gearing up states like Utah purchased lead lists where the targets were companies that they believed were over their economic thresholds, which are a hundred thousand dollars or a hundred transactions and they started pursuing companies. Then the pandemic happens and everybody, all the states turns into nice guys at this point, they put everything on hold, but now the pandemic is starting to end, and to make matters worse. All of these states have huge holes or most of the states have huge holes in their revenue because they weren't able to collect the same amount of income tax or sales tax. The country was virtually shut down for, more than a year and this has really hurt the states. And whenever states are heard, whenever they're coming out of recessions, they step up their discovery efforts. They step up their compliance efforts. They step up their collection efforts because they have to feel their coffers back up. So States are always, super-aggressive coming out of a recession. So now, we've got really a perfect storm. We had states coming after companies before the recession. Now, excuse me, before the pandemic, now the pandemic is opening up. The states are going to start that effort again, but that effort is going to be turbocharged now because of this other, having to refill their coffers. The states are going to primarily be looking for economic nexus, but they're going to stumble across all types of nexus and it's bad enough if a state finds you for economic nexus. You got three years’ worth of exposure in a state like New York, maybe a year and a half in a state like Texas, that's bad enough, but what happens if you've had physical presence in a state for 10 years, 15 years, 20 years and they stumble across that. So we know the states are coming. We know the states are going to be aggressive. We know they're going to find physical presence nexus in addition to the economic nexus and that's where the real exposure lies, the real exposure lies, where you've had the most exposure for the greatest amount of time, and that's going to be physical presence, nexus.
[12:50] Ellie: All right, now that everyone's really scared, do you want to share some examples?
[13:00] Mike: Yes I do. But before we do, I want to say, my previous statements are scary, but I'm not saying them just to be scary. The states are coming, the states have to fill their revenues. All we have to do is look at the past to see what the states are going to do now. So I'm not trying to be scary just for the sake of being scary. I think that it's going to be very ugly for a lot of companies, and what I'm trying to do is alert you to this issue because if you're being proactive, you do have options. There are ways to limit some of your past exposure and once the state contacts you in general, those options are off the table. So I don't want anyone to be blindsided. I don't want anyone to say - Oh, I wish I knew this, six months ago or a year ago. So yes, this is scary, but I'm not saying it to scare anybody. I'm saying it to make you aware of the issues so that you can take action if you so choose.
[14:31] Ellie: All right. So just to summarize that for everyone’s fear, this fear is like a public service announcement. Something like scared straight, I guess we could say.
[14:46] Mike: Okay, I'll go with that. Hopefully. Yeah.
[14:50] Ellie: Okay. Is now the time to share some physical presence, nexus creating activities?
[14:55] Mike: Almost, but not quite. We want to start with some terms I use to help group activities that create nexus. So I have two sets of terms. The first set of terms are common nexus, creating activities versus state-specific nexus creating activities. And the second set of terms are, obvious nexus creating activities versus less obvious nexus creating activities. Now you may be scratching your head and say, what the heck is he talking about? When we talk about common nexus-creating activities, these are the activities that most, if not all of the states are going to look at the same way and say, okay, these create nexus. And less common or state-specific, excuse me, state-specific nexus, creating activities. Those are viewed widely different between the states and sometimes, maybe only a handful of states may consider them to be nexus creating. But each state is going to look at those activities a little bit differently. So we have common versus state-specific. Then we have an obvious nexus creating activities. These are the ones that, okay that makes sense. We're all going to look at it and agree that yeah, I can see how that activity creates a link or connection with the state. Then we have less obvious and those are the ones that have a scratching our head and say, wow, I didn't realize that, or I never thought of it that way. But it doesn't matter if it's obvious or less obvious if you've got it. And the state finds you then it’s going to be a problem. So those are the big picture terms I wanted to introduce and at this point, Ellie, you want to get onto some actual nexus-creating activities? Did I postpone that long enough?
[17:00] Ellie: Yeah, that sounds great. Mike, let's go over those.
[17:06] Mike: Okay. So one of the obvious, and in a very common, I think is owning or renting real property in a state. So if you own a warehouse, if you own an office building, if you rent office space, any type of real property. Owning or renting, I think we can all agree that yeah that's pretty substantial that creates some sort of link or connection with the state. And just about every state out there is going to say that yes, that is nexus creating. So it's obvious and it is common. Now, here's one that's not so obvious. A lot of people nowadays tell me Mike, everything's in the cloud. I have a virtual office. I don't have this link or connection that you talking about anywhere. And unfortunately, the states don't look at it that way. The states say someone's got to be operating that business. So wherever you live. Wherever you operate your business from the state is usually going to say, Hey, that creates a link or connection. And I think once we think that through say, okay, it wasn't very obvious, but it makes sense. And it's very common just about all the states are going to say that. So where you live or where you operate your business from creates this link or connection that we're talking about. Now, along those lines, another fairly obvious activity is having an employee in a state. If you've got someone, you hired them, they live in another state. They work in another state. I think we can agree that creates some type of link or connection with that state. And it's also very common. Some states say, Hey, if you've got an employee in our state or greater than, 48 hours cumulatively over a 12 month period, then that's nexus creating. And if you've got someone living in a state they're there for greater than 24 hours. Now they're not doing any work and they just live in that state. That's generally not nexus creating, but if they're performing work in that state and that's truly a remote employee, the COVID pandemic rules aside, that's generally nexus creating. All right now taking that one step further, and we touched on this when I said states like Arizona and Michigan greater than 48 hours, pretty much for any reason is going to be nexus creating travel employee travel. So not so obvious, but anywhere those employees are going on your behalf with a few exceptions, that's going to create this link or connection, especially if they're going for sales purposes, there are some carve-outs if they're going, on a purchasing trip or if they're going to, trade shows that still create nexus, but there are different sets of rules for that. But having employees traveling to the state to do business very common across most of the states there. Now, perhaps one of the least obvious, but this is extremely important. This is where I see the most exposure when it comes to physical presence for companies out there. Because it just doesn't make common sense. And that's third-party nexus. So if you're hiring independent contractors or subcontractors, or don't even put a label on it, you're just hiring a company to perform services for you in another state. Two U.S Supreme court cases cover this and the second case, the Tyler pipe case from 1987, perhaps most important. And what they say it doesn't matter, what you call someone doesn't matter how you pay them. Doesn’t matter if they, work for you exclusively or they represent multiple parties? Doesn't matter if they do it on a full-time or part-time basis. Here's what's important. Are they helping you to establish or maintain a market? And if they're helping you to establish or maintain a market, then yes, that is nexus creating. That really has become umbrella language. And there are all sorts of activities that can fall under this umbrella. Activities like doing training, doing installations, doing implementations any type of collections work, credit check work the list goes on and on. And what we generally tell our clients is, rather than going through all of these, here's the test. If someone is going into a state on your behalf, and they're interacting with either your customers or the public there's a good chance that's going to be nexus creating. Where you could be hiring an accountant, or you could be hiring a software developer and you may be hiring them on a contract basis and paying them with a 1099, but they're not interacting with the public. They're not helping you to establish or maintain a marketplace. So, therefore, They do not create nexus. So it's not all third-party relationships that create this link or connection. It's only those that help you to establish or maintain a market, and again, this is the area I see the most exposure because it just doesn't make common sense. How can someone who you have no control over who it's a true arms-length transaction and it's not just companies that overlook this. I see a lot of smart CPAs out there. A lot of attorneys out there, these trusted advisors who they're thinking, just like you, they're thinking, how can a third party create nexus? But you gotta remember two supreme court cases. So that's where some of the greatest exposure lies. And that's what I'm afraid is going to be found by these states while they're out there looking for other types of nexus. Now, one other area is owning tangible personal property in another state in two major ways that this happens. If you're in the business of leasing or renting tangible personal property, you now own property in another state and owning property in another state, just about all the states out there. This is very common. They're going to say that is nexus creating and. The other one is having inventory. Inventory is tangible personal property. So if a state says, Hey, if you own tangible personal property in our state, the inventory usually fits that bill. Now the states don't say if you are the one who moved it into our states for the Amazon sellers out there, do you still own the property? It doesn't matter who moved it there. So I know you don't like to hear that, but inventory, most states will look at it as generally nexus creating. So fairly common been around forever. I know I'm reading this stuff, but the online merchant’s scale, then they're trying to say that the states are violating. Like California is violating, Wayfair because they're trying to go backward. That's a bunch of hogwash. California has always considered inventory to be nexus creating and they've been pursuing sellers for long before the Wayfair case. You can't believe everything these attorneys are telling you it's a dangerous situation, especially if you're, they're telling you to ignore these states. On that line some states even though Amazon's collecting now, if you're selling on other platforms, you've got to worry about that inventory, state like Pennsylvania just came out and said, Hey, we want to remind you. Even though Amazon's collecting the taxes. We want to remind you that your inventory in that warehouse, you still own it. And it's creating nexus for your Shopify for your own website, for your big commerce, for any platform that's not a marketplace. It still creates nexus is number one. And number two, it creates income tax nexus. And, We think that you should step forward. They gave a voluntary compliance program. It's almost the same as a voluntary disclosure agreement. Very favorable terms. And they said, if you don't take advantage of this, we're coming after you and we're coming after you for all of the years. So if you got one of these letters from the state of Pennsylvania, today's the last day, you can do anything about it. But I strongly suggest you do. These online merchants Guild filed a court case in the federal courts trying to get this stopped and the federal courts threw it out and they dismissed the case. So inventory does create nexus, even if it's in an Amazon warehouse. Now, there are some exceptions, since the marketplaces have started collecting tax states like Illinois and Texas and Arizona have said if you're only using these. Fulfillment by Amazon, these warehouses where you store inventory. If it's only being used to fulfill Amazon sales, then that's no longer nexus creating. Pre-collection it was nexus creating post collection, no longer nexus creating. If you're using those warehouses to fulfill sales outside of Amazon, then that is generally going to be nexus creating. Very common. Most states still believe that having inventory, even if it's in an Amazon warehouse is nexus creating one last thing I want to talk about, not so obvious, but very common delivery in your own trucks. So if you're actually, making deliveries, one of the ways states find you is they have people on the border and as you cross the border, they look at the name on the side of the truck. Next thing you know, you're on a list and the discussion, and the discovery unit are following up to try to track you down. We have had calls, I've been involved in situations where trucks got impounded in these weigh stations and they needed a sales tax bond. Now what's happening also is in the ports. And the state of Pennsylvania has told us that, they're even going after foreign sellers and foreign sellers say, Hey, good luck I'm overseas. You ship things into the U.S through the ports, and there's a lot of reciprocity agreements going around right now where they're going to allow other states to seize goods at their ports. So that's number one, number two, most sellers have some sort of money at these marketplaces. That is money that can be found by these states and the states can go after that. They can also if you've got inventory in Pennsylvania, Pennsylvania can go after that inventory. So even if you're a foreign seller, These rules apply to you in the states are getting very aggressive. They've shared this with us. Pennsylvania was very detailed in what they're going to do on a going-forward basis. So anyway, those are some of the bigger, common nexus-creating activities. Some of the more common common nexus-creating activities.
[28:18] Ellie: Mike really great examples here, again, of those common nexus creating activities Do you have any state-specific examples?
[28:28] Mike: Of course, Ellie you know that I can talk about nexus for weeks at a time here.
[28:33] Ellie: Oh I know.
[28:36] Mike: So let's look at some of the common state-specific. One of the first ones that come to mind is trade shows and every state looks at trade shows very differently. And a lot of people out there talk about diminimous. And unfortunately, States really don't define what's diminimous or not. And sometimes they actually don't pay attention to it. Except when it comes to trade shows, some states are very good about explaining what their diminimous activities are. For example, Georgia says that if you're there for less than two weeks, a year, and less than a hundred thousand dollars is generated from those trade shows then that is not nexus creating. Some states say, if you're here less than three days, some states, if you're here less than two weeks, so each state's going to be a little bit different as to what they allow. Now, some states they don't have any diminimous activities at all. If you come here, then it could create nexus. Now there are some states who go as far as saying, if you come here as a consumer, That is nexus creating. They've answered this on a lot of the surveys out there, put out by research companies like Wolters Kluwer's CCH, Bloomberg. The states take that position or at least they say they do. I've never seen it happen. And I think that a state would be hard-pressed to make that stick just showed up somewhere as a consumer. We generally, when we're guiding our clients, tell them to ignore that, but. The states say they can do it. So you've got to take that with a grain of salt. Now the next level many states say, okay, you can come as a consumer that doesn't bother us. But if you're exhibiting, then that is going to be nexus creating. And the third group of state says you can exhibit you just can't actively solicit. Now to me, that's a pretty fine line there. How do you make that distinction? A lot of times, but the states do so active solicitation is something that can trigger trade show nexus. Then the next group says you can actually solicit. So long as you don't accept any orders and make any deliveries while you're here. And then you've got, Nevada, they've got Las Vegas, the trade show and convention center of the universe. They want everyone to go there. So they say, you can do everything. You can even, make sales while you're here. We want you to collect the sales tax, but you can turn it into the show’s promoter. And so long as you're not doing that more than once a year, it's not nexus creating. You do it twice a year. It is nexus creating. If the trade show promoter, you can't find them. You're in a hurry, got to catch a plane. Then when you get home, you just call the state and email the money in, and again, not nexus creating so long as you don't do that more than once a year. Another one and this one is one that's a misconception. A lot of it's a misconception in a couple of different ways. A lot of people out there believe that in order to register for sales tax, you have to get registered with the secretary of state. And unfortunately, it's just not true. There may be certain circumstances where you have to get registered with the secretary of state, but if you're doing a remote registration, I don't know of any circumstances where you would need to get registered with the secretary of state, however, In some states getting like Florida, if you do get registered with the secretary of state, then that is going to be nexus creating. A lot of states. but in a handful of states out there, if you get registered with the secretary of state, if you subject yourself to the laws of that state, then that is going to be nexus creating. Advertising on a national basis is not nexus creating, but if you advertise in local media, the states look at that as targeting their citizens, and that is going to be nexus creating. So right now we're talking about all the state-specific and if they're state-specific then that, can't be common. Some of them make sense and some of them, are less obvious, so obvious, and less obvious. Related entities, remember if a third party can actually create nexus for you, how much easier is it for a related entity? Now, some states are very aggressive when it comes to this. If they say that, Hey, if you're selling similar products and you have a similar name and you have common ownership, you've got nexus. That’s you know what the state says generally the one entity has to be either co-mingling the business with the other entity, or they have to be performing services for the other entity, but not all the time. So you gotta be very careful with related entity nexus. Now we actually have a list of 12 state specific activities, and Ellie's going to post it when we post this podcast. And it's up on our website. And we have a list of 10 common nexus-creating activities on our website and Ellie also going to be posting that with this podcast episode and you can always find it on our website also.
[34:28] Ellie: Yeah, I absolutely will make sure that's up there and on our website and on the podcast show notes. But Mike, this is, this has been so much great information. Do you have anything else that you'd like to share?
[34:39] Mike: Something I'd like to reshare, figuring out your nexus footprint is not something that you want to procrastinate about. You do have options if you're being proactive. I also want people to know our next episode, remind them that it's going to be about economic nexus for sales tax and then the one after that, we're going to be talking about income tax nexus which will wrap up our nexus series for now.
[35:07] Ellie: Thank you so much, Mike, and for anyone out there who needs help figuring out their nexus, we offer a number of different services that can help you do so arranging from consultations or a data review at about $495 to more involved and formal nexus studies for income or sales tax. If you have interest, please let us know. And if you have. Other sales tax needs. We do offer many solutions and services for those as well. You can reach out to me directly at emoffat@salestaxandmore.com or visit our website salestaxandmore.com to get in touch with us. Thank you everyone for listening.
[35:50] Mike: Thank you everyone, and hope to see you on our next episode of the Sales Tax and More podcast.
[36:00] Outro: Thanks for listening. Be sure to click, subscribe, and check out all of the resources we have out on the web.