Almost every conversation in and around state tax consulting begins with nexus. Why? Because it’s still of utmost importance to companies to know whether they have nexus, or taxable presence, in a state such that the state can require them to register to collect and remit sales tax and/or to pay income based or franchise taxes. If a company doesn’t have taxable presence, then they are not obligated to file in a particular state. I’ve been practicing in state tax for longer than I care to admit, and I still have this conversation daily with existing clients and new clients as we talk about their potential exposure to taxes in multiple states. It doesn’t help that states are getting more aggressive and creative (maybe a little too aggressive and creative) in defining what constitutes nexus.
Since the infamous 1992 Supreme Court case, Quill Corp. v. North Dakota, 504 U.S. 298 (1992), we’ve been talking about nexus as it relates to substantial physical presence in a state. What sorts of things create that physical presence? I often tell clients that it is like having “boots on the ground”. While “substantial” is also a subjective term, it includes the following activities engaged in within a state. Most of them seem fairly straightforward, so I’ve included some examples of specific items we often encounter with clients.
Employees located in a state
Generally, when companies think of creating nexus by virtue of employees located in a state, they’re thinking of employees physically residing in the state, or coming to work in a company office in the state. However, other employee activities in the state can also create nexus. Consider the following scenarios:
- A company salesman works from his home in Texas. But his territory, which he travels into regularly to generate sales, includes the neighboring states of New Mexico, Arizona, Oklahoma and Louisiana. Depending on the number of days spent in each state, he likely has created nexus for the company, not just in Texas, but in the other states as well.
- A different company employee engaged in operations, travels to every jobsite of the company and assists with the installation of the company product, confirmation that it functions correctly and other initial troubleshooting. This employee has likely also created nexus for the company in most states he visits.
Owning or renting property in a state
When companies rent office space or warehouse space in a state, it’s generally fairly clear that that activity creates nexus. The same is true for property purchased in a state. But there are other nuances of property ownership that may seem less obvious, particularly if the items owned in a state are smaller!
- A company leases a very small office space in a strip-mall. Only one employee works there. Nexus has been created. It’s not the size of the office that matters!
- A company leases space in a server facility or data center in a state. Nexus has generally been created.
- A company sells a cloud based software solution (software as a service) that relies on the customer also having a reader or other device which enables the application. (This is especially relevant in a medical device type of scenario.) The company doesn’t sell the device to the end consumer. Instead, they lease it to the customer for a monthly fee of $10. The presence of the device in a state, owned by the company, creates nexus in every state in which they own these readers. (Better just to give them away or sell them – certainly from a sales tax compliance standpoint!)
- Does your company use a fulfillment service, like Amazon’s FBA? Guess what? You now likely own inventory in multiple states!
The above are true examples of client situations we’ve recently encountered. Unfortunately, the next question, once the activity for nexus creation has been established, is often “How long have you been doing that?” Depending on the answer, the company may have some significant exposure for sales tax.
Stay tuned for a follow-up article about whether the activities of third party contractors give you nexus, AND some recent revelations about economic nexus, which doesn’t really require “boots on the ground” at all! It’s a quickly changing environment out there. Let us know how we can help navigate these issues and keep your company compliant!
Monika Miles is President of Miles Consulting Group, a firm specializing in multi-state tax consulting for middle market businesses. Clients include technology, manufacturing, software and SaaS based companies doing businesses across state lines. Miles Consulting Group assists them in determining the sales tax and income tax ramifications of creating a taxable presence in a state and how to address these issues with the various states.