State tax nexus has become more challenging for businesses to manage and stay ahead of when conducting business activities. Nexus refers to the connection that a business has in a particular state. The connection can be either a physical one or economic one. Once nexus is established for state tax purposes, businesses that have inadvertently triggered nexus are then potentially subject to state income and non-income taxation.
Once your business understands what creates nexus, it can develop strategies to minimize or mitigate potential tax liabilities.
Understanding the Triggers of State Nexus
State nexus is typically triggered by various factors. Once you understand what these factors are, you can develop strategies to proactively manage your exposure. The primary factors that can potentially create state tax nexus include:
- Physical Presence: The traditional notion of physical presence is a significant trigger for state nexus. This includes having a physical office, warehouse, or employees in a particular state. However, in today's digital age, physical presence has expanded to include temporary offices, trade show participation, or even having an affiliate in a state.
- Economic Presence: Also known as factor presence, economic presence has gained prominence with the rise of internet-based businesses as well as the expansion of historical physical business activities to include the internet. When a business generates a certain level of revenue within a state – even without a physical presence – it can trigger nexus with a state.
- Remote Employees: The increase in remote work arrangements can also contribute to your nexus with a state. If employees are working remotely from a state different from your business's primary location, it may trigger nexus with that state. The remote worker creates a physical presence in a state, and that physical presence is the easiest way for your business to trigger nexus.
Strategies to Limit State Nexus
To not fall victim to state tax nexus, your business must adopt methodologies that will allow you to either minimize or mitigate the associated exposures.
Here are several strategies to minimize the state tax exposures that result when nexus is triggered:
- Evaluate Physical Presence: Regularly assess your physical presence in various states. Consider the impact of temporary offices, trade show participation, or any other physical connections. If possible, minimize these connections to reduce the risk of triggering state nexus.
- Understand Economic Nexus Thresholds: Stay informed about economic nexus thresholds in the states where you operate. Monitor your sales, transactions, and revenue in each state to ensure compliance. If your business is close to surpassing a threshold, evaluate the feasibility of restructuring to limit economic nexus.
- Implement Technology Solutions Carefully: Technology is both friend and foe when it comes to state nexus. It is becoming the new battleground for states seeking a way to tax remote businesses. Assess your technology needs and internet capabilities carefully. Platforms that are creating a more connected client service experience are being scrutinized by states to find a connection that can be used to assert nexus over out-of-state businesses.
- Review Remote Work Policies: Given the prevalence of remote work, clear policies for employees working from different states must be established. Consider the impact of remote work on state nexus and determine how these employees’ presence in the state affects your business.
- Seek Professional Advice: Engage with tax professionals who specialize in state tax laws. They can provide valuable insights into the specific regulations of each state and help you navigate the complexities of state nexus. Regular consultations with tax experts can ensure that your business remains compliant and minimizes its tax exposure.
Businesses must be proactive in understanding what creates state nexus to determine if nexus has been created. You can no longer take comfort in the fact that you do not have a physical presence in a state to be protected from that state’s income and non-income taxes. While businesses selling tangible goods have some limited protections, those protections are also under attack daily.
Carefully evaluate your business activities beyond the borders of your home state to manage state tax nexus. These activities can be of a physical or economic nature. By staying informed and seeking professional advice, your business can navigate the new rules related to activities that can trigger nexus. Only by understanding what types of activities can trigger nexus can your business defend itself from potential state tax liabilities.