For years it used to be that if you didn’t have an office or hire employees in the US, then you didn’t have to do much in the way of US tax filings.
The Wayfair decision changed all that.
Why is the Wayfair decision important?
Nexus refers to whether or not you have a presence in a particular tax jurisdiction. The Wayfair decision (2018) effectively introduced a new concept of nexus called ‘economic’ nexus. With economic nexus, you could be deemed to have a presence in a state if you sell goods or services there - even without an office, warehouse or employees.
So how do you know if you have nexus?
In the US, each state has their own set of rules as it pertains to sales tax and economic nexus. To know whether you have economic nexus in a particular state, you would effectively need to study the sales tax act of that state and determine if your business activity triggers nexus.
If you don’t consider yourself an expert in the various state sales tax acts, you would then need to get a nexus study.
What’s a nexus study?
A nexus study is a formal review to determine if your business has nexus in a particular jurisdiction. While you may be focused on sales tax, you’ll be pleased to know that there is also nexus for income tax purposes, which is separate from sales tax nexus.
Large accounting firms and specialized cross border tax firms will typically offer nexus study services. The advantage of doing a nexus study through these channels is that generally speaking, you can do an income tax nexus study in conjunction with a sales tax nexus study. The downside, however, is the cost. At prices of $1,500 per state, you may be looking at 75K if you plan on doing the study in 50 states.
If you’re not keen on spending that kind of money for a nexus study, you can use one of the software companies that handle US sales tax. Avalara and TaxJar both offer cost-effective nexus studies, starting from $4,500 USD across all states. That’s a nicer price tag although keep in mind you’re getting a US sales tax nexus study only, not an income tax nexus study.
There may also be additional studies you’ll want to complete including a ‘tax exposure analysis’ which quantifies the estimated tax due by jurisdiction or a study to determine whether or not your product is actually taxable in a particular state (ie. Saas products are taxable in some states but not others).
How often do I need to do a nexus study?
Well – if your revenues and locations of your customers stay exactly the same year over year, then just one time will suffice…unless the rules change, which, well, seems to be often. Of course, it’s unlikely that you’ll have the exact same customer mix year over year so how often you decide to do the nexus study is up to you. Presumably, if your customer base is constantly changing and growing, you may want to do a nexus study each year or every few years.
What do I do once I have sales tax nexus in a state?
If you’ve determined you have economic nexus in a state for sales tax purposes, you’ll need to charge your customers US sales tax. Keep in mind that there can be hundreds of sales tax rates within a particular state, so you’ll probably want to use software to calculate the appropriate rates. Avalara, TaxJar and The Tax Valet are probably your best bet for calculating and filing your sales tax returns.
What about income tax nexus?
Unfortunately, TaxJar and Avalara conduct sales tax nexus only. If you want to determine your income tax requirements, you may need to engage a larger accounting firm or cross border tax firm for a formal income tax nexus study.
Wait – so if I want to be compliant in the US, how much is this going to cost me?
Let’s say you really want to know if you should file sales tax and income tax returns in every state. You first do an income tax and sales tax nexus study with a cross border tax firm for 75K. You then learn that you have to file an income tax return in each state. At a price of $500 per return, that’s 25K for your annual state returns. You’ll also need to pay Avalara or TaxJar their fee for calculating sales tax in each jurisdiction. So in your first year of business, you’ve just spent over 100K of accounting fees.
That’s ridiculous! People don’t actually spend that kind of money on US compliance, do they?
If you’re a larger company, say with 10M+ of sales in the US, you may decide that it’s worth the money to be completely compliant. You may even decide to spend that kind of money each year and do an annual nexus study to ensure you’re still on side. But if you’re a smaller company, those kinds of fees could put you out of business.
I’m a smaller business - what should I do?
If you sell any kind of products into the US, you could have US sales tax exposure – meaning that you’d be required to register for US sales tax at least in one state. Given the price point for Avalara and TaxJar, a nexus study with them is probably a good place to start. Once you complete the study, you can use that company to manage the filings of your state sales tax returns. Assuming your business continues to grow, you may want to do a nexus study on an annual basis and eventually conduct an income tax nexus study as well.
What If I decide not to do anything?
It’s hard to say how the tax authorities plan to police the US sales tax system – particularly as it’s up to each state to enforce their own rules. With the millions of businesses selling to the US, there’s no doubt that a large portion of them will choose not to be compliant and will wait to see what happens. You can think of compliance as a spectrum – you can do annual income tax and sales tax nexus studies, you can do just a sales tax nexus study, you can register in a few states, or you can do nothing. Where you choose to be on the spectrum is up to you (including your wallet and moral compass) - but an understanding of the costs of compliance vs. your exposure, if you choose to do less, should help you arrive at a decision.