Economic Nexus (#284)

In this podcast episode, we discuss economic nexus as it related to sales taxes. Key points made are noted below.

Recent Sales Tax History

Until 2018, a company could sell into another state and not have to withhold any sales taxes, as long as it had no nexus in that state. This meant that it had no facilities or employees in the state, and didn’t use its own vehicles to deliver goods there. This became a major problem for the state governments, which were losing all kinds of sales tax revenue, because so many sales were being made over the Internet, and so goods were being shipped in from out-of-state.

And then came the South Dakota vs. Wayfair decision by the Supreme Court in 2018. In that case, South Dakota claimed that an Internet store, Wayfair, had to collect sales taxes from its customers in South Dakota and remit those taxes to the South Dakota government. The Supreme Court agreed with South Dakota, partially because that state had set up a sales tax collection scheme that was quite simple, so the Court stated that it didn’t impose a burden on interstate commerce.

Economic Nexus

The Wayfair case means that the concept of economic nexus is now a major issue for anyone selling to customers located in another state. It’s created when a business generates a certain amount of sales in a particular state. Some state governments measure this figure based on the overall dollar amount of transactions generated, while others combine the concept with the total number of individual sales transactions completed.

The state governments have mostly set up economic nexus rules, though a few are still hashing out the details. At the moment, it looks like the most common threshold for having to withhold sales taxes is having $100,000 of sales into a state or 200 separate sales transactions. So, for example, you have to start collecting sales taxes if you sell $100,000 or have 200 sales transactions into the state of Ohio. That word “or” is important. For most businesses, selling 200 transactions into a state is going to come way before $100,000, so that’s the operative threshold. However, one state – Connecticut - has set up the rule differently, so that it’s $100,000 and 200 sales transactions, which is a threshold that’s quite a bit harder to reach.

And a few states have set higher thresholds – which they could change at any time. For example, the dollar threshold for Alabama is currently $250,000, while it’s $500,000 in California, New York, Tennessee, and Texas.

Applicability of Economic Nexus

So who cares about these threshold limits? Smaller business do – like mine. At the moment, AccountingTools collects sales taxes for Colorado, which is our home state, and Ohio, where we exceed the minimum threshold for economic nexus. And we’re also keeping close watch over Florida, which is getting close to passing a sales tax that will probably require us to collect sales taxes there, too. In fact, it’s reached the point where we check all of the state sales tax laws once a year, just to see if anything has changed.

Paying Sales Taxes to Other States

So, let’s say that your company exceeds one of these thresholds. What then? Ohio is a good example. They have a centralized web site where you can remit sales taxes for all locations into which you sold products during the reporting period, so it’s pretty much a case of making one payment and you’re done.

Except for one thing, which is that Ohio currently has 98 different sales tax jurisdictions, so the sales tax where one customer is located may be entirely different from the sales tax for a different buyer in the next town over. This is kind of tough if your accounting software doesn’t charge the correct sales tax based on the customer’s exact location. If the software only has a single tax rate per state, then you can only charge the portion of the sales tax that applies to the entire state – which is currently 5 ¾ percent for Ohio – and then pay any additional sales tax out of your own pocket.

And in case you think the scenario I’ve stated for Ohio isn’t good – that’s actually one of the better-run sales tax systems in the country. For a really bad one, let’s take a look at Colorado. In that state, most of the larger cities collect their own sales taxes directly, rather than having the state government collect it for them. What this means for us is that we have to pay for an annual sales tax license with each one of these cities, and make separate sales tax filings to each one. Right now, we have sales tax licenses with 20 cities in Colorado, which cost anywhere from $10 to $50 per year. Our actual sales tax payments are so small that we pay three times more for sales tax licenses than we do in actual sales taxes.

It’s so bad in Colorado that I really do recommend that if you have a choice of places to put your business, put it somewhere besides Colorado, and configure your systems to deny sales to any customers located in the state. It’s really that bad. And to make matters worse, there are currently 328 different sales taxes in Colorado, which can vary even by which side of the street you’re on, which makes it almost impossible to calculate the correct tax.

And if you think that’s bad, Colorado isn’t even in the top 10 states for the number of different sales tax jurisdictions. At the top is Texas, with 1,594. Then there’s Missouri, with 1,393, and then Iowa, with 1,002. And in case you’re curious, only eight states have imposed a single state-wide sales tax. Every other state besides those eight is going to cause trouble.

The point being that some states are accepting the new economic nexus concept pretty well, while others are so screwed up that they’re going to drive small companies crazy. I think the logical outcome is that a lot of small businesses are going to ignore it, and make the state governments come after them for payments. If a small business tries to be in compliance with the new rules, then there’s a good chance that they’ll have to pay for a portion of the sales taxes out of their own pockets, which could wipe out part of their profits.

Related Courses

Sales and Use Tax Accounting