The Nexus Breakdown

When launching or expanding a business, few entrepreneurs consider the complexities involved in operating in different states. Rather, they are often focused on the minutiae of day-to-day operations and depend on their accounting professionals to ensure they remain in compliance.  

To that end, a thorough understanding of nexus is warranted. Nexus refers to the connection between a state and a business. If a business is determined to have nexus in a particular state, then they are obligated to register as an entity, pay taxes, file returns, and submit other filings in that state.   

Establishing nexus can be a bit complicated at times. For starters, there’s no single definition of nexus. The rules vary from state to state, and these rules frequently change. So not only must accounting professionals familiarize themselves with the rules of each state, but they must also keep up with any changes in law.   

There are three different types of nexus to be aware of. They include the following:  

Physical nexus  

Having a presence in a state has historically been the most common way to determine physical nexus. Following are guidelines:  

• The business has an office location, brick-and-mortar store, or warehouse in the state. 

• The business has physical assets in the state, such as inventory, equipment, vehicles, or other tangible property. 

• The business has employees, independent contractors, brokers, or representatives in the state working on behalf of the company.  

Economic nexus  

Economic nexus typically involves remote sellers who have an economic presence in a state in which they are not registered as a business entity. To establish nexus in that state, a seller must reach a certain financial threshold as established by the state in question. The criteria vary from state to state, and nearly all states have a bright-line test (a clearly defined standard) to determine economic nexus.   

Some states require a certain dollar amount, others a certain number of sales. If economic nexus is established in a state, then the company is required to submit certain business filings (such as applying for a seller’s permit) and pay sales tax. In addition, several states require companies to pay and file income tax if they earn over a certain amount.  

Affiliate nexus 

Affiliate nexus refers to the obligation of companies to file and report sales tax when they have a relationship with an in-state affiliate, regardless of if they have a physical presence in that state. The affiliation can include common ownership, shared or similar branding or trademarks, or other conditions in which an in-state affiliate conducts business that benefits the out-of-state company. Each state has its own thresholds that trigger affiliate nexus.  

For example, if an online company has a brick-and-mortar store, they typically have nexus in each state. The same goes for an out-of-state company that uses in-state independent contractors to establish and maintain a market in another state. Another example is a company that pays influencers to promote their business, and sales are generated through those promotions.   

Employees and reciprocity  

If a company has employees working in a particular state, then nexus is established in that state, and the company must not only pay sales tax, but must also pay payroll taxes for those employees. This is also true with remote workers who may live in a state that differs from their employer’s state. In this case, employers must withhold and deposit both federal taxes and state taxes where the employee lives and works.   

That said, some states have reciprocity agreements, which allow employees to work in one state but live in another and only pay tax in one. To qualify for the exemption, employees must complete a non-residency certificate to the employer to have income tax withheld only for their resident state. These agreements vary from state to state.   

When it comes to temporary employees, things are a bit more complex. If a company has an employee working on a temporary basis in another state, they must abide by the guidelines set forth by that state — for example, the length of the assignment and type of assignment. Each state has its own rules regarding nexus, so it’s important to confirm with the state in question.  

Understanding nexus to serve your clients 

Helping clients determine nexus is a key component in ensuring they remain compliant. This is especially crucial in this age of global economies, online commerce, and remote work. A thorough understanding of physical, economic, and affiliate nexus ensures your clients are operating lawfully while helping them along their path toward long-term growth.

Sponsored Content: This article is generously brought to you by one of our valued sponsors. Their support enables us to continue delivering expert insights and the latest industry trends to our dedicated community of accounting professionals.