Understanding Nexus: When Your Business Must Pay State Taxes

What Is Nexus?

Nexus is the legal term for the connection between a business and a state that gives that state the authority to impose taxes on the business. If your business has nexus in a state, that state can require you to collect and remit sales tax, pay income tax, or both. Understanding where your business has nexus is essential for multi-state tax compliance.

The concept of nexus has evolved significantly over the past several decades, and the rules expanded dramatically with the U.S. Supreme Court's landmark 2018 decision in South Dakota v. Wayfair, Inc. Today, a business can have nexus in a state even without any physical presence there.

Physical Nexus

Physical nexus is the traditional form of nexus. It is established when a business has a tangible, physical connection to a state. Common triggers for physical nexus include:

**Having an office, warehouse, or store** in the state

**Employing workers** who live or work in the state

**Storing inventory** in the state (including inventory held in third-party fulfillment centers like Amazon FBA warehouses)

**Owning or leasing property** in the state

**Having equipment or infrastructure** installed in the state

**Delivering goods using company-owned vehicles** in the state

**Attending trade shows or making in-person sales calls** on a regular basis in the state

Physical nexus has been the standard for decades and is well understood. If your business has any physical footprint in a state, you almost certainly have nexus there.

Economic Nexus: The Wayfair Revolution

The Wayfair Decision

In June 2018, the U.S. Supreme Court decided South Dakota v. Wayfair, Inc., overturning the long-standing physical presence requirement for sales tax nexus. The Court ruled that states can require businesses to collect and remit sales tax based solely on the volume of sales into the state, even if the business has no physical presence there.

This decision fundamentally changed the landscape for online sellers and service providers. Before Wayfair, a business with no physical presence in a state was not required to collect that state's sales tax. After Wayfair, virtually every state with a sales tax adopted economic nexus thresholds.

Economic Nexus Thresholds

Each state sets its own thresholds for economic nexus. The most common standard, modeled after South Dakota's law, triggers nexus when a business has:

**$100,000 or more in sales** into the state during the current or previous calendar year, OR

**200 or more separate transactions** into the state during the current or previous calendar year

However, many states have set their own thresholds. Some examples:

California - $500,000 in sales (no transaction threshold)

New York - $500,000 in sales AND more than 100 transactions

Texas - $500,000 in sales (no transaction threshold)

Washington - $100,000 in sales (no transaction threshold, removed the 200-transaction test)

It is critical to monitor your sales into each state and register for sales tax collection once you cross a state's threshold.

Income Tax Nexus

Income tax nexus determines when a state can tax your business's income. While the Wayfair decision specifically addressed sales tax, many states have also expanded their income tax nexus standards. Income tax nexus can be triggered by:

Physical presence - Having employees, property, or operations in the state

Economic activity - Earning income from customers or clients in the state

Factor presence tests - Some states apply bright-line tests based on sales, payroll, or property in the state. For example, if your sales into a state exceed a certain dollar amount or percentage of total sales, you may have income tax nexus even without a physical presence.

P.L. 86-272 Protection

Federal law (Public Law 86-272) provides limited protection from state income tax for businesses whose only activity in a state is the solicitation of sales of tangible personal property. This protection does not apply to:

Service providers - Businesses selling services rather than tangible goods

Companies with activities beyond solicitation - If employees do anything other than solicitate orders (such as providing customer support, making repairs, or collecting payments), the protection is lost

Internet-based activities - Several states have taken the position that website activities (like placing cookies on in-state computers) exceed the scope of P.L. 86-272 protection

Sales Tax Nexus

Sales tax nexus determines when a business must register to collect and remit sales tax in a state. As discussed above, sales tax nexus can be triggered by either physical presence or economic activity.

Key Sales Tax Considerations

Taxability varies by state - What is taxable in one state may be exempt in another. Software, digital products, and services have particularly inconsistent treatment across states.

Marketplace facilitator laws - Many states now require marketplace platforms (like Amazon, Etsy, and eBay) to collect and remit sales tax on behalf of third-party sellers. This may reduce your filing obligations in some states.

Exemption certificates - If you make sales to exempt organizations or for resale, you must collect and maintain valid exemption certificates.

Filing frequency - States assign filing frequencies (monthly, quarterly, or annually) based on your sales volume. Higher volume means more frequent filing.

Strategies for Multi-State Tax Compliance

Step 1: Determine Where You Have Nexus

Conduct a thorough nexus study to identify every state where your business has physical or economic nexus. Consider all employees, property, inventory, and sales data.

Step 2: Register in All Required States

Once you have identified your nexus states, register for sales tax permits, income tax accounts, and any other required tax registrations in each state. If your business also needs to foreign qualify in those states, coordinate both processes.

Step 3: Implement Tax Collection Systems

Set up your point-of-sale or e-commerce system to correctly calculate and collect the appropriate sales tax for each jurisdiction. Given that there are over 13,000 sales tax jurisdictions in the United States, automated tax calculation software is essential for most businesses.

Step 4: File and Pay on Time

Create a compliance calendar that tracks all filing deadlines across every state where you have tax obligations. Late filings and late payments trigger penalties and interest in every state.

Step 5: Monitor for Changes

Economic nexus thresholds, tax rates, and filing requirements change frequently. Monitor your sales data against each state's thresholds and stay informed about legislative changes that could affect your obligations.

Step 6: Keep Good Records

Maintain detailed records of all sales by state, tax collected, exemption certificates received, and returns filed. Good recordkeeping is your best defense in the event of a state audit.

How CLS Can Help

While CLS does not provide tax preparation or filing services, our compliance management platform helps businesses track where they are registered and monitor their ongoing obligations across all 50 states. Our registered agent services, foreign qualification filings, and annual report monitoring ensure your entity-level compliance is handled, so you can focus on your tax obligations. Contact us for a free consultation about your multi-state compliance needs, or explore our state guides to understand specific requirements in each state.