Nexus is a foundational concept in U.S. taxation that determines when and where a business must comply with state or local tax laws. Simply put, nexus means a business has a tax presence in a state sufficient enough to require it to collect, report, and remit taxes such as sales tax, income tax, or payroll taxes.
The Importance of Nexus for Businesses
Understanding nexus is critical for any business operating across state lines or selling to customers in different states. Without nexus, a business generally has no obligation to collect or pay taxes in that state. However, once nexus is established, the business becomes responsible for registering with the state’s tax authorities, collecting applicable taxes, filing returns, and paying any taxes due.
Physical Nexus vs. Economic Nexus
Traditionally, nexus was based on a physical presence, such as owning or leasing property, having employees, or storing inventory in a state. This standard was established by the 1992 Supreme Court decision in Quill Corp. v. North Dakota, which limited states’ ability to impose sales tax collection requirements to businesses with a physical presence.
However, the rise of e-commerce challenged this approach. The Supreme Court’s landmark 2018 ruling in South Dakota v. Wayfair, Inc. overturned Quill and introduced the concept of economic nexus, allowing states to require out-of-state sellers to collect sales tax if their sales or transaction volume exceeds certain state-defined thresholds. For example, a common threshold is $100,000 in sales or 200 separate transactions annually, but these vary by state.
Types of Nexus and Their Impact
While sales tax nexus is the most widely recognized, nexus can apply to multiple tax types:
- Sales Tax Nexus: Obliges businesses to collect sales tax from customers when nexus thresholds are met. For details, learn more in our article on Sales Tax.
- Income Tax Nexus: Requires businesses with sufficient connection (e.g., employees, property, or business activities) in a state to pay corporate income taxes there.
- Payroll Tax Nexus: Triggered by having employees working in a state, requiring withholding and remittance of state income and unemployment taxes.
- Inventory Nexus: Storing inventory in third-party warehouses, such as Amazon fulfillment centers, may establish nexus, even without other physical presence.
- Affiliate and Click-Through Nexus: Generated when businesses use in-state affiliates or pay commissions to residents for referrals, leading to sales tax obligations.
Each of these nexus types comes with specific rules that vary by state, making compliance complex for businesses operating nationally.
Real-World Example
Consider “Cool Widgets Inc.,” an online seller headquartered in Oregon (which has no statewide sales tax). Before Wayfair (pre-2018), if Cool Widgets sold to customers in states like California or Texas without a physical presence there, it generally didn’t have to collect sales tax.
After Wayfair, if Cool Widgets sells over $100,000 or exceeds 200 transactions in California, it must register with the California Department of Tax and Fee Administration, collect sales tax from customers, and remit it timely. Additionally, storing inventory in Texas fulfillment centers may establish inventory nexus in Texas, irrespective of sales volume.
Nexus Triggers
Common factors that establish nexus include:
- Owning or leasing physical property (offices, stores, warehouses)
- Having employees or representatives in the state
- Storing inventory, even in third-party warehouses
- Exceeding economic nexus thresholds for sales or transaction volume
- Engaging affiliates or referral agents within the state
Challenges and Compliance Strategies
Navigating nexus obligations can be complicated because each state sets different criteria and thresholds. Businesses should:
- Monitor sales volumes and transaction counts by state to identify economic nexus triggers
- Keep detailed records of physical presence and inventory locations
- Use sales tax automation software to manage multi-state compliance
- Consult tax professionals specializing in state taxation to avoid costly penalties
Common Misconceptions
- Nexus only applies to sales tax — in fact, it can trigger income, payroll, and other taxes
- Physical presence is required — after Wayfair, economic presence can suffice
- Small remote employees won’t affect nexus — even a single remote employee can create nexus for payroll and income taxes
Frequently Asked Questions
- Does using Amazon FBA create nexus? Yes, storing inventory in Amazon fulfillment centers in certain states usually creates inventory nexus.
- What if I ignore nexus obligations? States may impose back taxes, penalties, and interest which can be costly.
- Do nexus rules change often? Yes, states frequently update laws as tax policies evolve.
For authoritative information, see the IRS’s general tax topics at IRS.gov.
Understanding nexus helps businesses comply with their tax responsibilities effectively, avoid penalties, and plan for multi-state operations with confidence.