State Tax Nexus in the Digital Age: Learn the New Rules

In the rapidly evolving landscape of state taxation, nexus plays a pivotal role in determining tax obligations across the states. Nexus — the minimal connection between a business and a state allowing a state to impose state tax filing requirements and tax obligations on a business, its employees (and potentially its owners) — is now greatly influenced by internet activities and remote workforces.

While the landmark Wayfair decision expanded the scope of nexus to include economic activities in addition to the traditional physical presence rule, the technological advancements in the provision of digital goods and services are causing states to reevaluate the scope of its nexus rules.

Understanding state nexus can help you make informed decisions about the state tax implications of expanding operations, and how to potentially reduce your state tax liability.

What is tax nexus?

State tax nexus is the basis for determining a state’s ability to impose its taxes on a business entity. Nexus is defined by reference to the amount or level of business activity occurring in the state.

Historically, nexus was established through physical presence, such as having employees, independent representatives, property, or business operations within the state. Now, many states have expanded nexus definitions to include economic and digital presences with the rise of remote sales and e-commerce.

The tax implications of physical presence nexus

Physical presence nexus is traditionally established when a business has a tangible presence in a state. Physical nexus activities within a state may include:

• Employee travel
• Property ownership
• Independent representatives working on behalf of the company
• Company-owned vehicles making deliveries
• Attendance at trade shows
• Warranty or repair services
• Storage of inventory by third-party retailers, such as Amazon

Having a physical presence in a state can trigger the requirement for businesses to register for and remit various types of taxes, including income tax, sales tax, net worth taxes, franchise taxes, and payroll taxes. Most U.S. states enforce strict regulations regarding physical presence nexus.

Economic nexus and how it affects taxes

States are increasingly adopting and updating economic nexus statutes as a strategy to capture tax revenue from remote sellers and digital businesses.

Economic nexus is triggered by a business’s economic activity within a state — such as reaching a sales or transaction threshold (e.g., $100,000 sales or 200 transactions)— rather than its physical presence.

Most states now include some form of economic nexus language in their tax statutes for state income tax, and all states with a sales tax have economic nexus provisions. Some states have clear, bright-line rules, while others use broader, more ambiguous criteria — making the rules complex in many cases.

Economic nexus is an alternative to physical nexus. That is, a business with physical nexus that is under the economic activity threshold in a state, is still considered to have nexus and may be subjected to a state’s taxing regimes.

How Public Law 86-272 affects out-of-state businesses

The Interstate Tax Limitation Act, also known as Public Law 86-272, limits the ability of states to tax income from out-of-state businesses, specifically when their only in-state business activity is soliciting orders for tangible personal property that are approved and fulfilled from a location outside of the state.

Public Law 86-272 doesn’t extend to services or intangible goods and only applies to income derived from interstate commerce involving tangible goods. Importantly, Public Law 86-272 doesn’t protect businesses from other state taxes not based on income (e.g., sales and use tax, gross receipts tax, or non-income-based franchise tax).

Many states are now narrowing these protections, especially as they adapt to the evolving digital economy. Recent interpretations by the Multistate Tax Commission and subsequent state adaptations have introduced new guidelines on what constitutes protected and unprotected activities under this law, particularly concerning internet activities. Certain online interactions — such as electronic chat or the use of cookies for gathering customer data — may now create tax obligations overriding protections previously available under Public Law 86-272.

In addition, state tax authorities are challenging businesses claiming P.L. 86-272 protection through audits and litigation, often digging deep into a business’s activities within their state and finding nuggets of unprotected activities. With evolving interpretations and the uptick of state tax authority scrutiny, businesses should monitor their nexus profiles and current nexus rules.

How the Wayfair decision affects sales tax and income tax

The pivotal 2018 Supreme Court South Dakota v. Wayfair, Inc. decision allowed states to require out-of-state sellers to collect and remit sales tax based on economic activity within the state, rather than physical presence.

As of January 1, 2023, all states with a sales tax have implemented Wayfair bright line economic nexus laws whereby any company that exceeds the bright line threshold (typically $100,000), are required to register and collect sales tax.

Even with the adoption of these bright line rules, there remains great variety among the state adaptations, creating a complex regulatory environment for interstate businesses operations. This new era of sales tax collection underscores the need for robust systems and processes adaptable to the dynamic tax landscape, allowing businesses to efficiently meet their tax obligations across multiple jurisdictions.

The Wayfair decision has emboldened states to enact laws, regulations and administrative positions that incorporate similar economic thresholds for income, franchise, and gross receipts taxation. As a result, business need to be cognizant of not only complying with a state’s sales tax rules but also complying with other tax types.

The tax nexus rules for remote employees

The COVID-19 pandemic increased the number of remote employees and in response, many states changed their nexus rules to capture more taxes.

Remote employees can trigger nexus for income taxes, sales and use taxes, payroll taxes, and other business-related taxes, depending on state-specific regulations.

Organizations should review state nexus rules on remote employees and maintain up-to-date records for compliance purposes.

How we can help

A lack of uniform standards for tax nexus across states presents ongoing compliance challenges. Also, many states use broad and ambiguous definitions to extend their reach in taxing entities’ activities.

CLA’s state and local tax professionals can help you determine if your activities meet the nexus threshold for taxation in different states. They’ll work closely with you to identify potential tax planning opportunities and ways to enhance your organization’s tax position.

Contact us

Kathleen Thies - https://www.claconnect.com/en/directory/t/thies-kathleen

Jack Feltham - https://www.claconnect.com/en/directory/f/feltham-jack