If You Do Business in Multiple States, You Might Owe More Taxes Than You Think
As your small business expands its sales efforts and reaches more customers across the country, you will encounter a complex series of nexus regulations. These sales tax and use laws vary from state to state. Here's what you need to know to comply.
Growing their business is a critical goal for many business owners. But the process can be complex and confusing — especially if it involves nexus. The Sales Tax Institute defines sales tax nexus as "the level of connection between a taxing jurisdiction such as a state and an entity such as your business. Until this connection is established, the taxing jurisdiction cannot impose its sales taxes on you."
Before 2018, a company needed a physical presence in a state for nexus to exist. So, for example, if your business was in California but you had a warehouse in Indiana, you were required to collect sales tax from customers in both states.
But the Supreme Court ruling in the South Dakota v. Wayfair case in 2018 changed how out-of-state businesses collect and remit sales taxes. The ruling leaves it up to each state to determine nexus, and a physical presence is no longer required. Most states now mandate that remote retailers with more than 200 transactions or $100,000 in in-state sales collect and remit sales taxes to the state where the goods are purchased and delivered.
Nearly every state has enacted nexus laws affecting remote sellers. The sales tax percentage varies by state and often by municipality, and each state has its own rules, registration processes and tax collection agencies. When a remote seller or marketplace facilitator (see the common terms below) crosses the nexus threshold, the business must obtain a seller's permit and register to remit the state's sales tax on each taxable purchase.
Common nexus terms
Although the terminology varies from state to state, it's important to know the following terms:
- Remote seller: A person or business that does not have a physical presence in a state, selling and shipping products to consumers in that state.
- Marketplace facilitator: A business, such as Amazon, eBay, and Etsy, that sells goods and services on behalf of third-party sellers. The facilitator contracts with marketplace sellers to help sell their products through a physical or electronic marketplace.
- Marketplace seller: A person or business selling through physical or electronic marketplaces operated by a marketplace facilitator. Marketplace sellers don't need to collect tax on transactions when a marketplace facilitator collects and remits the sales tax for them.
- Voluntary disclosure: Each state also has its own process for unregistered remote retailers to self-disclose and pay previously unpaid or underpaid tax liabilities (without penalties in most cases). The self-disclosure period is typically three to four years, and the penalties are high for failing to pay the sales tax owed.
- Streamlined sales tax system: This allows remote sellers in 24 Streamlined member states to submit one application to collect and remit sales and use taxes. Remote sellers can register in each individual state or for all 24 member states. Check Marketplace Sellers and Marketplace Facilitators for more information on registration.
- Sales and use tax. Although many states use the words "sales and use tax" as one term, the taxes are actually different.
- Sales tax is a state-set percentage of sales on taxable goods passed through to the customer at the time of sale. Customers pay the sales tax on applicable purchases, but the business owner must collect and remit the sales tax to the appropriate agency.
- Use tax is a percentage of taxable goods not collected from the customer at the time of purchase. Instead, it is the customer's responsibility to remit the tax to the appropriate state agency. When use tax is due, businesses must inform their customers of their obligation to pay the tax.
- Local or municipality taxes. Most states have additional local (city or county) sales tax regulations. The state determines what the highest add-on tax can be, and the city or county decides what to charge.
How to register for sales tax
Most states collect sales tax through their state departments of revenue. Remote sellers obtain a seller's permit and then set up a business account on the state's tax remittance portal. Remote sellers and marketplace facilitators can set these up directly or through a third party.
Also, in most cases, sales taxes are remitted monthly and paid directly through the online portal.
Nexus for payroll
Employing workers in another state establishes a different type of nexus: income or payroll nexus. If a business has an employee working in another state, it must register to pay payroll taxes in that state.
It can get complex. For example, if you have employees (even part-timers) in Connecticut, your business is required to register with the Connecticut Department of Revenue Services, Connecticut Department of Labor (Tax Division) and the Connecticut Paid Leave agency. Employers are required to withhold federal taxes even in states without an income tax.
Some states have reciprocal agreements where taxpayers who live in one state and work in another can be exempted from paying taxes in both states. Because paying multi-state payroll taxes can be overwhelming, many small business owners use a third party to help with registration and a payroll service to handle the payments.
Since the Supreme Court decision in 2018, most states have enacted new nexus laws. In many states, failure to comply is considered a felony. In others, it's a misdemeanor. And since the regulations vary from state to state, it's imperative you learn what the laws are in every state.
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