Creating a Sales Tax Nexus Versus a Nexus for State Income Tax
When I began this series, I explained what a Nexus was and when you need to create one, but do you know the difference between a nexus created for sales tax and a nexus for state income tax?
Let’s say that your client’s business sells mattresses in New York and have salespeople who travel to Connecticut, New Jersey, and Pennsylvania to sell mattresses. The mattresses are shipped from New York to those states. What kind of nexus have you created?
Because their salespeople entered the states of Connecticut, New Jersey, and Pennsylvania, they have created a sales tax nexus. The question then becomes, do they have to register as a foreign company in those states, and are they responsible for income tax in those states? The simple answer is no.
Most states do not require you to register as a foreign corporation unless you have a “substantial presence” in that state. A substantial presence would be created if you had property, equipment, or the like in that state. Just because you had the oddball sale in Connecticut doesn’t mean you have to register in that state, nor does it mean you have to pay state income tax.
If you don’t have to pay state income tax, why do you have to pay sales tax? Very simply, you had salespeople enter those states and they made sales. If you had employees in that state, and your business was subject to sales tax, then you would have to pay sales tax on the sales, but not necessarily state income tax.
For instance, I have offices in Florida, Delaware, and Nevada. I have a nexus in those states. However, I have clients all over the country and I enter a lot of states to meet with those clients.
Sometimes, I make a sale in those states. But I provide a professional service, so I am not subject to sales tax.
If I was in a business where I was subject to sales tax, I would have to pay that tax in those states. But because I just happen to be in that state doesn’t mean I have to register in that state, and I am not subject to income tax in that state.
If I had employees working in another state, I would then be required to register as a foreign corporation in that state, be subject to sales tax on the sales in that state, and also be subject to income tax in that state.
Why? Because I have created a substantial presence in that state by having employees working there. The same would be true if I had subcontractors in that state.
A sales tax nexus is created in a foreign state when the seller creates any type of physical connection with the state. The physical connection that is created can be either direct or indirect.
A direct physical connection involves sending employees into a state, having property in a state, or performing services in a state. An indirect physical connection includes sending subcontractors into a state.
In 1959, Congress passed Public Law 86-272 which stated that a company could perform the following activities in a state without creating a state income tax nexus:
• Soliciting sales of tangible personal property (directly or indirectly).
• Providing services that are ancillary to the sales of property.
• Having samples for display in the state and having other property used for sale in the state (cars, computers, etc.).
• Accepting and fulfilling orders outside of the state.
The following activities will create a nexus for state income tax:
• Selling services and not personal property.
• Providing services in the state.
• Accepting orders in the state.
• Delivering property into the state in company vehicles.
• Accepting deposits in the state.
• Repossessing property in the state.
• Having inventory in the state.
As you can see, creating a nexus for state income tax and state sales tax are two different things. In my next article, we will discuss creating a nexus for other taxes, like state franchise taxes.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...