In the current economic landscape, more and more states are feeling the budget crunch. To raise revenues, states are sending nexus questionnaires to out-of-state businesses. Be careful in how you respond to these or else your company may be subject to additional tax liabilities.
What is a nexus questionnaire?
Nexus questionnaires are forms produced by states that are sent to businesses not currently filing income tax, sales tax or use tax returns to obtain information concerning the out-of-state company’s business activities and to determine whether those activities subject the company to nexus. After your response, the state may follow-up with further examination or simply conclude that your out-of-state company has nexus and should file returns.
What is nexus?
Before responding to the questionnaire, the concept of “nexus” needs to be understood. Nexus describes the amount and degree of business activity that must be present before a taxpayer becomes subject to a state’s taxing jurisdiction. In general, nexus is created for income tax purposes if an entity does business in the state and/or derives income from sources within the state. All states have their own meaning of nexus, but in general, most states will consider nexus to occur if you have “physical presence” or “economic presence” in the state.
“Physical presence” in a state is created when your business has the following:
- Maintains an office
- Employs personnel
- Maintains a warehouse
- Owns or leases property
- Maintains capital
- Maintains store inventory
- Has an affiliate within the state
Nexus can also be established for your company if it is temporarily doing physical business in a state for a trade show or craft fair.
“Economic presence” in a state is defined differently by each state. The U.S. Supreme Court’s 2018 ruling in the South Dakota v. Wayfair case has helped pave the way for establishing economic presence nexus. The Wayfair case overturned the precedent set by Quill v. North Dakota requiring physical presence before nexus is achieved. The Wayfair case now allows nexus to occur on an economic presence versus a physical presence. This means that many more states can assess tax on your business, which may not have a physical presence in their state. In general, each state sets an economic threshold that, if passed, puts your business in an economic nexus within that state. These thresholds may be a certain amount of sales within the state either by meeting a certain dollar amount in sales or a certain number of transactions. Many online retailers achieve nexus due to the “economic presence” test.
One thing to be wary of if you are an online retailer . . . if you sell your product through Amazon or a similar type of company, you may have nexus in states that you are unaware of. For logistical purposes, Amazon may store your inventory in a state that you’re unaware of, which puts your company in a physical presence nexus relationship with that state.
What if I have nexus?
Once you determine if your company has nexus within a state, then you are required to file income tax returns and pay tax on income earned in the state. Similarly, if your company has sales and use tax nexus, you will be required to collect and remit sales and use taxes on sales made to purchasers in the state.
In general, the questions that are asked on a nexus questionnaire can be quite broad. The question may be stated in such a way that may make you think the response should be a simple “yes.” However, a more accurate answer may be “yes, but . . .” In other words, if you answer “yes” to a question without providing further explanation, it is easier for the state to conclude that your company has nexus. Further explanation may provide a solid basis for concluding that you do not have nexus.
Great care should be taken when responding to a nexus questionnaire. Review the answers with your tax professional before returning the questionnaire to the requesting state.
Kelly Lynch, CPA