What do retailers need to know about the changing dynamics in how states tax sales?

According to federal law, a state may not impose a tax based on net income on a retailer that limits its in-state activity to solicitation of sales of goods, orders are sent outside the state for approval, and, if approved, are filled by shipment or delivery from a point outside the state. However, this law does not provide protection against state taxes not based on net income, such as franchise taxes based on capital, gross receipts taxes, and sales and use taxes.

A retailer is generally required to report and pay taxes to a state where it has sufficient contact to establish “nexus.” Nexus is the minimum connection between a taxpayer and a state which allows the state to tax the company. Nexus thresholds vary by state and by type of tax.

A physical presence in a state, such as a store, distribution facility, or employee, has historically been the standard for nexus. However, nexus standards have evolved over the years, and—at least with respect to income, gross receipts, and franchise-type taxes—many states have taken the position that something less than a physical presence creates nexus.

Retailers should be aware of and consider the following nexus standards:
• Agency nexus. A retailer’s use of an agent or an independent contractor (i.e., a non-employee), may create nexus where the agent or independent contractor performs an in-state activity that helps the company establish or maintain a marketplace. In essence, a retailer generally may not avoid nexus by transferring responsibility for the activity to another party.

• Affiliate nexus. An affiliate may create nexus for a retailer if they engage in activities that help the retailer establish or maintain a marketplace in the state. This type of nexus is generally applied for sales taxes and often arises when a retailer’s brick-and-mortar store establishes and maintains an in-state marketplace on behalf of its online store.

• Click-through nexus. This is a recent trend among states due to the growth of e-commerce and the resulting loss of sales tax revenue. Click-through nexus typically creates a rebuttable presumption that an out-of-state retailer has nexus for sales tax if it enters into a commission-based agreement with an in-state resident to implement referral links on the resident’s website. These links help drive customers to the retailer’s site and can cause in-state sales to exceed some dollar threshold amount. If an out-of-state retailer has click-thru nexus, it would be required to charge sales tax on products shipped into the state.

• Economic and factor presence nexus. A handful of states have enacted laws under which a retailer may have income, gross receipts, or franchise tax nexus where the retailer’s in-state property, payroll, or sales exceed a threshold amount as represented by the apportionment factor. The threshold amounts may not be very high. For example, in Ohio, a retailer may have nexus for Commercial Activity Tax purposes when its in-state sales exceed $500,000.

Amid an evolving retail landscape—marked by increased consumer demand for a consistent, integrated shopping experience across platforms and locations—it behooves retailers working in multiple different tax jurisdictions to understand the full scope of their tax liabilities. Doing so may help these businesses avoid onerous tax penalties, and may even produce potential opportunities for tax savings down the line.