Economic nexus: How to keep up with changing sales and use tax requirements

For retailers and remote sellers, keeping up in today’s sales and use tax world is increasingly difficult. Internally, you’re working on repetitive, time-consuming sales tax compliance and audit work with little time for strategic, value-added activities. You may struggle to plan responses to market disruptors like changing economic nexus rules and tax regulations. Maybe your neighboring business units, like finance and marketing, are investing in technology to keep up and stay current. But is your sales and use tax department making the same investment?

What is economic nexus?

The South Dakota v. Wayfair Supreme Court ruling marked a drastic shift in tax law precedent and established a new definition of nexus. Before Wayfair, nexus depended on a company’s “physical presence” in the state. But in a post-Wayfair world, if your business sells goods in any state — even if you don’t have a physical presence in that state and the transaction is online only — you may be obligated to register in that state and collect sales tax if you exceed the “economic nexus” threshold.

With economic nexus now defined by different thresholds across jurisdictions, retailers must follow nexus laws in all 50 states, not just where they have physical operations. Add in the widespread use of drop-shipping post-Wayfair, and the situation becomes even more complex. For retailers operating digitally, indirect tax software tools are essential for maintaining compliance with economic nexus laws and meeting states’ varied sales tax requirements.

Key questions for understanding economic nexus

To navigate sales and use tax requirements, retailers and online sellers should start by addressing these critical questions:

• Where are you selling?
• Where are your products shipped from?
• Who collects sales tax?
• Where is the sales tax due?
• Where does my company have nexus?
• Where does my drop-shipper have nexus?
• Where is the customer located?
• Can an exemption certificate be applied?

Economic nexus: Even simple transactions aren’t simple

To better understand how the answers to these questions are interrelated, consider a relatively simple sales transaction involving a retailer, a customer, and a drop-shipper.

If the retailer, drop-shipper, and customer are all located in the same state or all have economic nexus in that state, the tax treatment is relatively straightforward. If neither the retailer nor the drop-shipper has economic nexus in the state, the tax treatment may also be simple. In that case, neither the retailer nor the drop-shipper is responsible for collecting tax on the sale. The customer is subject to use tax on the purchase unless a tax exemption applies.

However, a drop shipment can involve multiple states, creating complex sales tax obligations. For example:

Scenario — a customer in California places an order with an online retailer based in Colorado, and the retailer uses a drop shipper based in Texas.

Complications — the participants must determine where they have nexus, where tax exemptions apply, where tax is charged, and how each party is responsible.

From the retailer’s perspective, if your drop shipper has nexus in a ship-to state where you do not have nexus, you may need to register in that state to collect sales tax. Currently, nine states do not accept home state retail certificates, requiring registration if you cannot provide an exemption certificate.

The absence of a valid tax exemption certificate can create challenges for the drop shipper. If this retailer has economic nexus in the customer’s state but lacks an exemption certificate, it may need to administer sales tax on the transaction.

Drop-shipped transactions often lead to additional nexus requirements, such as managing multiple exemption certificates with different durations and expiration dates. Not all tax software can effectively track and manage certificates for multistate sales transactions, further complicating compliance.

Managing state-by-state economic nexus requirements

In addition, each state has passed varying provisions for remote seller nexus. These provisions place a burden on the retailer to track their transaction activities in detail. Once the remote seller nexus threshold is reached in a given state, the retailer may need to start collecting sales tax immediately. For example, if the nexus threshold is $100,000 on gross receipts, the state may expect a retailer to be able to automatically turn on collections at the click of a button. 

Using automated sales tax software for economic nexus compliance

Staying on top of evolving nexus requirements and understanding their implications for your business can be daunting. Indirect tax software can significantly reduce the burden. These tools help businesses:

• Manage changing nexus requirements.
• Track exemption certificates.
• Navigate state-by-state economic nexus laws.
• Handle state registrations.
• Assess whether remote seller nexus thresholds are met.

Effective software should also address local jurisdictions, as some areas have their own rules even when the state itself doesn’t impose sales tax.

A valuable solution is using cloud-based tax calculation software. These tools help businesses remain compliant amidst multiplying sales tax challenges. By leveraging automation, retailers and online sellers can ensure tax accuracy and dedicate more resources to building a smarter, more resilient business.