For many businesses headquartered in a single state, such as Washington, California, or New York, operations often extend far beyond their home base. Whether serving clients in other states, employing a remote workforce, or selling products nationwide, these interstate activities can trigger significant tax responsibilities in those other states. Overlooking these obligations can lead to costly penalties, back taxes, and interest. Understanding the concept of “nexus” is the first step to ensuring compliance.
What is Nexus?
“Nexus” is a legal term that describes the connection a business has with a state that is significant enough to require the business to comply with that state’s tax laws. Historically, nexus was primarily established by a physical presence, such as an office, warehouse, or employee in a state. However, the modern business landscape, driven by e-commerce and remote work, has led to a much broader definition.
Today, nexus is not just about physical location. It can also be created through economic activity, a concept solidified by the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. This ruling affirmed that states can require businesses to collect and remit sales tax even if they have no physical presence in the state, provided they meet certain economic thresholds.
When Do Tax Obligations Arise in Other States?
A variety of business activities can establish nexus in a state where your company is not headquartered. The likelihood and nature of the tax obligation can vary based on the specific activity.
| Activity | Nexus Likelihood | Explanation |
|---|---|---|
| Hiring a Remote Employee | High | Employing a worker who resides in another state typically creates nexus for payroll tax purposes and may also trigger income and sales tax obligations. |
| Selling Products to Consumers | High | Exceeding a state’s economic threshold for revenue or number of transactions will create sales tax nexus. For example, many states have a threshold of $100,000 in sales or 200 transactions. |
| Providing On-Site Services or Consulting | Medium to High | Regularly sending employees or contractors into a state for services, installations, or consulting can establish a physical presence and create nexus. |
| Selling Digital Products Online | High | Like physical goods, selling digital products or software-as-a-service (SaaS) can create economic nexus for both sales and income tax purposes. |
| Providing Telehealth Services to Patients | Medium to High | Offering medical services to patients in other states is considered revenue-generating activity and can be subject to that state’s income tax laws. |
What Types of Taxes are Involved?
Once nexus is established, your business may be responsible for several types of state taxes:
State Income Tax: If your business generates revenue from customers in another state, you may be required to file a state income tax return and pay taxes on the portion of your income earned there. For instance, a Washington-based marketing firm that provides consulting services to a client in California may need to file a California income tax return if it meets the state’s nexus criteria.
Sales Tax: If you sell goods or taxable services to customers in another state where you have nexus, you are generally required to register for a sales tax permit, and then collect and remit sales tax on those transactions. For example, a business selling over $500,000 of products annually to Texas consumers online would be required to register and collect Texas sales tax.
Payroll Tax: When you hire an employee who lives and works in a different state, you must comply with that state’s payroll tax laws. This includes registering as an employer in that state, withholding state income tax from the employee’s wages, and paying state unemployment taxes. A Seattle company hiring a remote developer in Oregon, for example, must register with Oregon and manage withholdings accordingly.
A Practical Case Study
Consider an IT company headquartered in Washington. The company has a remote employee living in Arizona and provides software services to clients in both Arizona and Texas. Although the company has no physical office outside of Washington, it has unknowingly created tax obligations in multiple states:
Arizona: The presence of a remote employee establishes nexus. The company is now required to file for and pay Arizona payroll taxes. Furthermore, revenue generated from Arizona-based clients may be subject to the state’s income tax, requiring the company to apportion its income.
Texas: By selling a significant volume of software services to Texas clients, the company has likely exceeded the state’s economic nexus threshold for sales tax. It must now register to collect and remit Texas sales tax.
This example illustrates how business activities, not just physical locations, are the determining factor for multi-state tax obligations.
How to Prepare and Stay Compliant
Navigating multi-state taxes requires a proactive approach:
- Analyze Your Footprint: Regularly review your business activities, including the location of your customers, employees, and contractors, to identify potential nexus risks.
- Track Revenue by State: Configure your accounting system to track sales on a state-by-state basis. This will help you monitor whether you are approaching economic nexus thresholds.
- Conduct Due Diligence: Before hiring a remote employee or expanding into a new market, research the tax regulations of the relevant states to understand your potential obligations.
- Leverage Automation: Utilize tax compliance software to automate the calculation, collection, and remittance of sales tax and to help manage payroll tax requirements across different states.
In an increasingly borderless economy, a business’s tax responsibilities are no longer confined to its headquarters’ location. Proactive management and a clear understanding of nexus are essential for sustainable growth and avoiding the financial and legal burdens of non-compliance. As your business expands, so too must your diligence in managing its tax obligations.
