What Exactly Is An Economic Nexus?
Economic nexus is a new concept for sales tax, although it has been around for a while now for income tax and other types of taxes. There are two relevant Supreme Court rulings on sales tax here: in one case, they said you had to have some sort of physical presence in order to create a link with a state and that state could then require you to collect or pay its taxes. The other said that there's no need for physical presence for the state to require you to collect its sales tax, bringing up the concept of economic nexus.
So what exactly is an economic nexus? Michael Fleming has all the answers.
Michael is the founder of Sales Tax and More and is one of the country's leading authorities for sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers. He is a writer, speaker, and regularly presents on webinars, and he also hosts his own podcast where he shares his wisdom and learnings to his audience in order to help them navigate the tricky world of taxes.
In this episode, Michael Fleming is flipping the script as he answers questions posed by Dr. Jeremy Weisz, a seasoned podcast host himself, as they talk about the concept of economic nexus, its impact in different states, and the cost of non-compliance for businesses.
Here’s a glimpse of what you’ll learn:
What is an economic nexus?
The impact of the South Dakota case on other states
The cost of compliance vs the cost of being pursued by the state
What's included in taxable state thresholds?
Resources Mentioned in This Episode
Connect with Michael
Sponsor for This Episode
Sales Tax and More assists companies and their trusted advisors like CPAs with sales tax needs. They offer consulting and research, registrations, returns, and so much more. Over the years they have assisted thousands of sellers both foreign and domestic with their tax issues in the United States and in Canada.
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's your host, Michael Fleming.
[0:26] Mike: Hi, I'm Mike Fleming, founder of Sales Tax and More. I’m today's host of the Sales Tax and More Podcast, where we talk about everyone's favorite subject, which is, of course, sales tax. And I've got Jeremy Weiss with us here today. And he's interviewed, you know, thousands of entrepreneurs, very successful entrepreneurs, and CEOs and other you know, high-level officers of companies. And today we flip the scripts and Jeremy is actually going to be interviewing me.
[0:58] Jeremy: Michael, thank you for having me, a bit about you, I mean, myself, and I know many people in the CPA world and business world consider you one of the top in the USA leading authorities when it comes to sales tax. And the episode is brought to you by Sales Tax and More. And they assist companies that are trusted advisors with their sales tax needs. So they offer consulting and research, registrations, returns, and much, much more. And over the years, they've assisted thousands of sellers, both foreign and domestic, with their tax issues in the United States and Canada, because this is complex stuff when you get to know it, so go to salestaxandmore.com. For more information, check out other episodes of the podcast, which you know, he goes in-depth in the most frequently asked questions. And today, you know, we kind of polled people and asked them what are your most pressing questions when it comes to sales tax and one of them is, what exactly is economic nexus? So let's, let's explore that. Mike, I know you get that question a lot.
[1:58] Mike: Oh, yeah. And this is a great question because it's really a new concept for sales tax. It's been around for a while for income tax and other types of tax. But for sales tax it, you know, there were two Supreme Court cases that said you had to have some sort of physical presence in order to create a link with a state that we call nexus, that the state could then require you to collect its taxes or pay its taxes. And on June 21, 2018, the Supreme Court weighed in on the Wayfair case. The big famous case, but tremendously important sales tax case. Because they come back in and they say we made a mistake, we should have never, you know, talked about physical presence in these other cases. So, we're overturning these cases. So, it's like they never happened. So there isn’t . . . there's no need for physical presence in order to for the state to require you to collect sales tax. So what that means is that just having a certain level of sales into a state, or a certain number of transactions into a state can create nexus. And we call this type of nexus, economic nexus. And by the way, nexus, fancy word, just means link or connection. So your sales into a state can actually create this link or connection for you.
[3:34] Jeremy: That's a big deal. Because I mean, on the other hand, it's obvious what, I mean, it's actually a more obvious physical presence. Obviously, there are other things that you've talked about in other episodes where there's more than just you're located in the state if you have independent contractors or things, but the economic nexus is not what people are thinking about.
[3:53] Mike: No, and they haven't thought about it for the last 50 some odd years because everyone always you know, talks about Quill, which says, “Hey, you have to have a physical presence before you can force me to collect your taxes.” So, you know, sometimes, you know, our salespeople call on these companies and they're like, “Oh, we checked into this five years ago, and we're fine.” Unfortunately, the world has been stood on its head. I mean, this is, this is unbelievably a game-changer. Yeah, you can't say this is big enough. I mean, it's tremendous, because it literally can affect everybody. I mean, some people think of this as an internet tax. It's not. It impacts every company that sells into multiple states. If you have sales in multiple states and are not registered everywhere, then this impacts you, this economic nexus, because whether you sell by phone, whether you sell by an infomercial, whether you sell by catalogs, when you sell by referrals, maybe people are just sending you referrals. If you're selling into multiple states, this economic nexus can impact you. So a lot of people say, “Well, Mike, you know, you keep mentioning economic nexus, well, what is it?” Well, South Dakota, that was the state that, you know, was suing Wayfair. And they . . . or pursuing Wayfair. They believe that was $100,000 or 200 transactions. Now $100,000, that's pretty, you know, okay. You got to be a pretty big seller to have $100,000 of sales inside of South Dakota. But 200 transactions, you know, that's not a lot. Not a lot at all. That's a pretty low number. So a lot of states just jumped on the bandwagon. And once the Supreme Court said, “You don't need a physical presence,” they all said, “Well, we're going to do exactly what South Dakota did and our new rules are 100 thousand dollars or 200 transactions.” And, you know, the Supreme Court didn't say explicitly that, “Hey, we're okay with this.” They, you know, sort of implied that it was okay for South Dakota, but they did send it back to the lower court in South Dakota and said, “You guys hash this out. And unfortunately, they settled the case without coming to a conclusion on that. So we may see more litigation in the future, but states have started to modify what they're doing. So this is rapidly changing as we speak. States like Washington, who originally came out with $100,000 and 200 transactions, are now saying, “You know what, at 200 transactions is kind of low.” So six months later, they come out and change the rules. California did the same thing. They were at $100,000 and 200 transactions, and people started saying, “Hey, you're a lot bigger than South Dakota. I mean, you can't have the same guidelines as South Dakota.” So they listened and they came back, they did away with their transactions, and they raised their sales threshold to $500,000. So, which creates problems because a lot of people went out and got registered because they were over the 200 transactions.
[7:24] Jeremy: Right. It seems I mean, I don't know. I'm curious what your opinion is, why don't they just get rid of the transactions? It seems pretty arbitrary. You know, it's all about the dollar amount someone’s bringing in. Why do they even have transactions there? And what do you think they should do?
[7:40] Mike: I think they want the transactions because they want to capture all sellers. Yeah, pretty much.
[7:45] Jeremy: Yeah, pretty much. So yeah. Five transactions or a million dollars. I mean, it's, it's like at that point, it's everyone.
[7:53] Mike: Well, the trend is moving away from transactions. So there are quite a number of states that when they issued what their thresholds are, there were no transactions, and there are six or so states that have reversed themselves. But be careful, because there are still a lot of states out there, like Illinois, that have a 200 transaction threshold and appear like they're going to stick with it. So until it's challenged in the courts, and a lot of sellers out there say, “Well, I'm going to wait until this is challenged in the courts.” I never think waiting is a good idea, because the cost of compliance is going to be pennies, compared to you know, if the state decides to pull you, pursue you, and this may take, you know, 5-10 years for it to come to fruition in the Supreme Court. And even if your argument, your side wins by that point, you're out of business. So I think we, for most sellers, we need to approach this as it is today. And yes, there is a cost to compliance. However, here's one of the things, and I'm going to relate this to Amazon sellers. I've been talking to Amazon sellers forever - eight to nine years, and I've been talking till I'm blue in the face with a lot of these people saying,”You got exposure, you got exposure, you got exposure.” Recently, people said, “If I only knew, if I only knew that I was supposed to collect sales tax, I would have done it from the beginning. And then I wouldn't have any this past exposure and I'd be compliant.” Well, these same people who told me that when this economic nexus began, you didn't have any past exposure. It was only going forward. But, they're in that same pattern right now, because some of these effective dates are a year old, and some states are now coming back and making you prove you didn't have nexus on July 1 of 2018. States like Maine, and they're going after that back-tax. So here we are. We're seeing history repeat itself because everyone was saying, “I'm waiting for Congress to step in and do something. I'm waiting for the Supreme Court to make another ruling.” And unfortunately, Congress can't even decide what to have for lunch, let alone do anything substantive, like an attack on this. I sort of joke we think, you know, we have to do nothing Congress today. In 1959, there was a nexus case involving income tax. And the U.S. Supreme Court pretty much said that states can tax whatever they want, whenever they want. And the business at that point said, “Oh, my, this is horrible. We're going to go into a depression.” You know, that's how bad this is. That's how confusing this is. We're not going to be able to, you know, figure out what nexus even is, let alone comply with it. And they got Congress involved. And you know, Congress is the one who gets businesses, the one who gets Congress elected. So Congress moves very swiftly. And within seven months, they passed a law that pretty much nullified this Supreme Court decision. And the difference between then and now, is no one's saying that the country is going into depression, back then everyone seriously thought the country's going into depression. But Congress said, “Nexus is so confusing and so complex, we gotta form panels and committees, and we got to study this. So this is just a temporary solution. And we're going to come back, and after we figure this out, we're going to make a permanent solution that that really works.” Well. That was 60 years ago. And we still have this antiquated, temporary solution. And the Supreme Court, in 1992, came back and said, “Hey, Congress, you really got to do something on this in the Quill case,” you know, I'm paraphrasing, obviously, and they still have done nothing. So, you know, on some issues. . . Maybe our great-grandchildren will have something from Congress that makes things easy. But if you waiting on Congress for a solution today, I just don't think it's gonna happen. And nexus is, of course, much more complex today than it's ever been before. So do I think it should happen? Yes. I'm not holding my breath waiting for it to happen. I'll tell you that.
[12:20] Jeremy: Waiting is not the solution.
[12:21] Mike: Yeah. Maybe our great-grandchildren will you know, have something from Congress that makes things easy. But if you waiting on, on Congress for a solution today, I just don't think it's gonna happen. And nexus is, of course, much more complex today than it's ever been before. So do I think it should happen? Yes. I'm not holding my breath waiting for it to happen. I'll tell you that.
[12:40] Jeremy: So what you're saying, let's say I'm a business based in Wisconsin, and I sell, you know, widgets, and I sell, you know, a million dollars of which into California, I have economic nexus, and I should be registered in California for that particular case. So people need to really keep track of where they're, you know, each of the states that they're selling into and what they're selling, and how much?
[13:06] Mike: Absolutely. And, and it gets confusing because a lot of people are saying - okay, well I sell widgets and I install them, but installation services in California are not generally going to be taxable. So, therefore, I'm not going to include that. Well, unfortunately, what's included in those thresholds is very different states to state. Remember, states don't make anything easy. If anything, they go out of the way to make it confusing and tough on you. And some states are going to include all sales, gross sales, you know, services, even if the state doesn't tax services, they're going to include your exempt sales that are going to literally every sale that you make is included in that threshold. So, you know, figuring out what's even included is tough because some states exclude sales for resale, but they include other exempt sales. Some states only taxable sales, some states only taxable sales of tangible personal property. So it is greatly different across the board. And now we've got 40 states that say the marketplaces should collect the tax. That makes it even more confusing because some states say, include the marketplace sales, other states say exclude the marketplace sales. So staying on top of it is tough. It's one of the things that we actually do here and provide a free resource to anybody. It's on our website, you know, salestaxandmore.com under the resources, you go to charts and matrix. . . matrices, and it's economic nexus. And you can use it for your clients and figure out when they're crossing thresholds, what's included in the threshold. Now, some states, not that much detail there, because when a state first comes out, says, “Here's what our thresholds are,” that's it. They don't give you a lot of information. But we're updating this continuously on a weekly basis because the states are continuously updating their positions.
[15:13] Jeremy: Thank you for shedding some light on that. And like Michael said, salestaxandmore.com, if you have questions, contact them. And they have a lot of free resources as well. Check out past episodes where he goes in detail on some of these other factors and some interesting case studies. Michael, thank you for having me.
[15:32] Mike: Thank you, Jeremy.
[15:34] Outro: Thanks for listening. Be sure to click subscribe and check out all of the resources we have out on the web.