April 24, 2018
by Kevin Harris
As states look for ways to increase their sales tax revenue, they are increasingly seeking income from manufacturers and distributors who may not be located in their own state, but distribute their products there. At the same time, distributors – especially those planning to expand their operations across state borders – must have a firm understanding of how state and local taxes (SALT) factor into their overall growth objectives. ABC Distributing Co. may have its best year ever, but if its owners have not considered cross-border SALT obligations, they could be in for a big surprise.
Background: Understanding Economic Nexus
It may not be a word that comes up in everyday conversation, but “nexus” is an important concept for Texas distributors with a multistate presence to understand. As you know, Texas does not impose an income-based tax, though the state has a margin tax based on gross receipts. However, when it comes to selling goods and services across state lines, it’s a different story because nexus includes sales tax.
For the purposes of manufacturing and distribution, nexus is best defined as “sufficient physical presence.” It’s the factor which determines whether or not an out-of-state business selling products into another state is liable for collecting sales or use tax on sales into that state. In other words, nexus is simply the cost of doing business in another state. For example, if you sell goods and services in Beverly Hills, California, you must file a 9.5% sales tax.
Forty-five states and the District of Columbia have a sales tax, and each state has its own rules for determining nexus. Some states look at annual in-state sales exceeding a certain threshold, and others the amount of separate in-state transactions.
What Establishes Nexus?
Nexus can seem fairly straightforward, but what creates nexus varies from state to state. For example, Texas nexus rules consider a seller to have sales tax nexus if a business has any of the following in the state:
- An office or place of business
- Resident employees present in the state
- A warehouse or storage space
- A place of distribution
- A sales or sample room
- Another place where business is conducted
Rules in other states include:
- Your employees regularly solicit business there
- Your business has property, including intangible property in that state
- You are drop shipping from a third-party provider
Nearly 20 states pursued economic nexus models in 2017 to capture lost revenue from untaxed remote sales. By doing so, they effectively nullified a 1992 Supreme Court decision that prohibited states from imposing sales and use tax collection obligations on vendors without a physical in-state presence.
Internet Sales Tax
While not directly related to nexus rules for manufacturers, you may be hearing a lot of buzz about how internet sales factor into the nexus discussion. Over the past decade or so, there has been a mounting concern by states about online businesses and nonpayment of sales tax. After all, if they can add to their coffers the significant amount of revenue potentially due to them, it would add a nice revenue stream.
In 1967, the Supreme Court ruled that states could not require mail-order catalog companies to collect sales taxes unless the purchaser lived in a state where the company had a physical presence, such as a warehouse or distribution center (e.g., Amazon in Texas). That’s very likely about to change—the Supreme Court is expected to decide on internet sales tax in the coming weeks. See our related blog: Supreme Court to Rule on Internet Sales Tax.
Requirements of Distributors
Does your distribution business meet the requirements for having a tax nexus in specific states? If it does, you’ll need to collect sales tax on applicable products and services in each state and may be required to pay state income tax on any income generated within that state. Some businesses that have nexus in several states choose to set up separate profit centers within each of the states.
Increasingly, it will be essential for manufacturers and distributors with a multistate presence to gain a firm grasp on how to effectively manage nexus. When these taxes are not part of a business’ overall tax planning strategy, it becomes challenging to support growth and reduce costs and risks. To best navigate through widely varying provisions, you should discuss your business’ tax obligations and strategies with a tax professional who can best review the statutes in each of the states you might be considering as a place in which business could be conducted.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.