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 regulation. 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 for 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 physical presence in that state and the transaction is online only — you may now be obligated to register in that state and collect sales tax if you exceed the “economic nexus” threshold.
With nexus decided by different thresholds in different jurisdictions, retailers now must follow nexus laws across all 50 states, rather than only those in which they have physical operations. Add in retailers’ widespread use of drop shipping post-Wayfair, and the situation becomes even more complicated. For retailers that do business digitally, indirect tax software tools are essential to staying in compliance with economic nexus laws and with states’ various sales tax requirements.
To begin to understand the relevant sales and use tax requirements, retailers and online sellers should start by asking a host of 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 inter-related, consider a relatively simple sales transaction between 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, multiple retailers, and can easily create a complex sales tax obligation in more than one state. The nexus obligations of the various parties depend on the specific details. Say a customer in California places an order with an online retailer based in Colorado, and the retailer uses a drop shipper based in Texas. In this situation, the participants need to know where they have nexus, where they qualify for a tax exemption, where tax is charged, and how they are responsible.
Let’s start with the online retailer’s perspective. If, as a retailer, your drop-shipper has nexus in a ship-to state where you do not have nexus, you may need to register in the state where your customer resides. That’s because, currently, nine states do not accept home state retail certificates. In those cases – if you can’t provide an exemption certificate to your drop shipper – you may need to register in that state.
From the drop-shipper point of view, the lack of a valid tax exemption certificate can also create headaches. If the drop-shipper has nexus in the state where the customer resides – but doesn’t have an exemption certificate – then it may be required to administer sales tax on the transaction.
Drop-shipped transactions can be far more complicated than this. Even a relatively simple sales transaction, of the sort outlined above, leads to additional nexus requirements for managing tax compliance, such as the management of multiple exemption certificates. Each certificate may have different durations and different expiration dates. Not all tax software can handle and track the certificates associated with multi-state sales transactions properly.
In addition, each state has passed varying provisions for remote seller nexus. This places 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 to manage nexus requirements
Staying on top of the many changing nexus requirements and determining how they affect one’s ever-evolving business can be a cumbersome and onerous task. The right technology package can remove a substantial part of the burden. Indirect tax software will help you effectively manage changing nexus requirements, exemption certificate management, state-by-state economic nexus laws, state registrations, and how likely your own business is to meet remote seller nexus requirements in any particular state. Although it is simplest to talk about nexus on the state level, your software should also reach down to the local level, where multiple jurisdictions have enacted their own rules, even when the state itself doesn’t impose a sales tax.
Cloud-based tax calculation software can help businesses stay compliant in the face of these multiplying corporate sales tax challenges. Leveraging technology allows retailers and online sellers to get tax right and spend more of their time, energy, and ingenuity building a stronger, smarter business.