Accounting professionals with clients who sell goods outside their state will want to know more about “economic nexus” and its impact on sales tax compliance. This article will give you a baseline understanding of the decades-long legislative path that has led to economic nexus, which will in turn allow you to inform your clients more accurately about potential compliance risks affecting their business.
The Road from Nexus to Economic Nexus
To explain economic nexus, it helps to understand the current law. A 1967 court decision stated that before a state can impose a tax collection obligation on a business, the business must have a substantial physical presence (nexus) in that state.
Nexus is the word used to define a connection between a taxing jurisdiction and a business or person. There are two types of connection: due process and commerce clause.
Due process nexus, as interpreted by the US Supreme Court, simply prohibits a state from taxing a business unless there is a “minimal connection” between that business and the state in which it operates. Under the 1967 and 1992 court decisions, a business or person has commerce clause nexus by having a place of business in a state – either permanently or temporarily. That place of business could be an office, warehouse, property in storage, or just about any other type of physical place. Nexus could also be created by people, such as a salesperson, whether directly employed or a representative or agent.
So far in 2017, 30 states have debated dozens and dozens of pieces of legislation to expand or redefine the definition of nexus, which is the requirement for companies doing business in a state to collect and pay tax on sales in that state.
In 1992, the states lost their second attempt before the Supreme Court (Quill Corp. v. North Dakota) to gain the power to require every seller to collect sales tax. Subsequently, states and business made several attempts to negotiate a package of simplification and uniformity that would result in businesses collecting everywhere. This negotiation culminated in the creation of the Streamlined Sales Tax Project in 2000, followed by the introduction of authorizing legislation in Congress.
Those years of trying to negotiate a solution are over. As states engage in a full assault on the court’s physical presence decision in Quill with the hope that the Supreme Court has changed its position, we are now dealing with new and challenging rules.
For the last few years, many states passed legislation hoping to nibble around the edges of the Quill decision. They did this with ideas on how new business activity can be squeezed into the old definition of nexus. The most commonly adopted idea is called click-through nexus, classifying certain in-state activity to be that of an agent for the out-of-state business. States passed laws prohibiting sellers from advertising that Internet sales were tax-free.
In addition, Colorado won a case before the Supreme Court (Direct Marketing Association v. Brohl) on a law that requires sellers who don’t collect the Colorado tax to send their Colorado sales information to the state, in order for the state to collect use tax from the consumer.
The most recent state idea is an outright attack on Quill and is called economic nexus. This idea starts with the state assumption that everything from retailing to consumption to technology, today, is different than 1992.
Removing Barriers to Taxation via Economic Nexus
The current assault on Quill’s physical presence requirement is economic nexus, or as some laws say, “substantial economic presence.” These laws claim that because everything is different today, a sale, alone, is all that is necessary for a state to require a seller to collect their sales tax.
This latest idea was first presented in 2015 and the debate continued into 2017. At the end of 2015, the Alabama Department of Revenue enacted the first economic nexus requirement. That was followed in 2016 by a law from the South Dakota Legislature, an administrative regulation by the Tennessee Department of Revenue, and, so far in 2017, by law from the Indiana and Wyoming legislatures.
Whether by administrative regulation or by law, these laws have several things in common:
1. They define substantial economic presence to be a function of either gross sales or number of sales. A seller meets the definition of having substantial economic presence by exceeding one of the following two thresholds:
- Gross revenue/sales of taxable property or services delivered into the state exceeds $100,000 in South Dakota, $250,000 in Alabama, and $500,000 in Tennessee; or
- Having more than some specified number of separate taxable transactions delivered into the state (200 in South Dakota).
2. They are written in a way to facilitate a quick route through the state and federal court systems. South Dakota’s law instructs their circuit court to “act … as expeditiously as possible and … proceed with priority over any other action presenting the same question in any other venue.” In addition, the law requires that an “appeal … may only be made to the state Supreme Court.”
3. They eliminate any potential collection burden by any business other than the business involved in the court case. South Dakota did that by declaring that the initiation of a lawsuit “operates as an injunction during the pendency of the action, applicable to each state entity, prohibiting any state entity from enforcing the obligation” to “remit the sales tax.”
4. Probably most importantly, they make the collection obligation a future event. South Dakota’s law says “no obligation to remit the sales tax required by this Act may be applied retroactively.” By eliminating the possibility that a business will owe back taxes, the states eliminate forcing the courts to worry about that financial impact on any impacted business.
Now, all the states require is a business to agree to be sued all the way to the Supreme Court. Alabama, South Dakota, and Tennessee have all been sued, but no one knows how those cases will turn out.