This guide will briefly define and summarize the concept of nexus for state and local sales taxes.
What is Nexus?
Nexus means the minimum level or amount of connections with the state that will permit the state's taxing authority to require a seller of goods subject to a sales/use tax to register and withhold sales/use taxes on the state's behalf. Nexus over the seller must be present for a state to levy a sales/use tax against the seller.
State and Federal Constitutional Requirements for Nexus
The United States Constitution and the federal courts place the most significant restraints on the states with respect to creating nexus with sellers. The Commerce Clause of the United States Constitution limits the state's ability to regulate interstate commerce, or in this context, assert a sales/use tax on interstate sales. The federal courts have created a multi-prong test to determine when a state taxing authority's nexus rules are in violation of the Commerce Clause. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). If the court holds that the state's nexus rule is in violation of the Commerce Clause, then that nexus rule is unconstitutional and therefore unenforceable. Under the Supremacy Clause of the United States Constitution, a state cannot enforce a law if that law violates the United States Constitution. State laws and regulations also determine the presence of nexus. All state nexus laws must be constitutional under the state's constitution. However, most state constitutions lack clauses like the Commerce Clause and those constitutions are usually not focused on interstate commerce. Thus, few state nexus rules will ever be unconstitutional under the state's constitution. Further, states have a monetary incentive to tax out-of-state sellers whenever possible; state legislators may amend the state constitution to permit their newest tax. In summary, all nexus rules must be constitutional under the federal and state constitutions, but more likely only the United States Constitution will place significant restrictions on the state's nexus rules.
Quill Corp. v. North Dakota
Quill Corp. v. North Dakota, 504 U.S. 298 (1992) is a United States Supreme Court case that lays out the physical presence standard for nexus regarding sale and use taxes. Quill was a mail order office supply company with no employees or stores located in the State of North Dakota. Quill solicited customers in North Dakota via mail order catalogs the company shipped in from out-of-state. Customers would fill out the order form located in the catalog and mail it to Quill's fulfillment center in the other state. Quill would then mail the goods to the buyer from an out-of-state warehouse. Sales to buyers in North Dakota represented 5% of Quill's total gross sales and made Quill North Dakota's sixth largest office supply vendor in the state. North Dakota had a law requiring out-of-state companies who regularly and systematically solicited customers within the state to collect sales/use tax from its customers (the nexus law). Under this law, North Dakota has nexus with Quill. When North Dakota assessed Quill with a tax deficiency, the taxpayer challenged the constitutionality of the nexus law. The Supreme Court upheld prior case law and stated that the solicitation of customers is not enough to create nexus; instead Quill had to have some physical presence in the state to be obliged to collect a sales/use tax on the state's behalf. The important rule to remember from Quill is that, according to the U.S. Supreme Court, a state cannot require a seller to withhold sales/use taxes if the seller has no physical presence in the state.
Scripto v. Carson
Scripto v. Carson, 362 US 207 (1960) is another United States Supreme Court case that is important for determining if nexus exists in present cases. Notice that the U.S. Supreme Court decided Scripto before Quill; however, both cases are still good law and their rulings should hold true today. Scripto was a Georgia-based company that manufactured pencils, pens, and other writing utensils. The company had no physical presence in Florida. Scripto contracted with 10 brokers to solicit sales from retailers within Florida. The brokers did not work for Scripto but instead were independent contractors who were paid a commission on their sales. Florida assessed Scripto with an unpaid sales/use tax obligation based on the sales made by the Florida brokers. Scripto fought the case and argued that because it had no offices, stores, factories or employees within Florida, it could not have nexus within the state. The U.S. Supreme Court held that even though the brokers were not considered employees, they served a role for Scripto that was similar enough to an employee's role that there was a physical presence for the company in Florida. Thus, Florida had nexus over the taxpayer and Scripto was forced to pay the assessment. The important rule to remember from Scripto is that a company cannot hire an agent or independent contractor to do something that its employee couldn't do without possibly creating nexus in the process.
Obligation to Withhold if Nexus Exists
Once nexus exists, the firm must withhold the requisite sales/use tax on behalf of the taxing authority. This means that a business has to collect taxes for the state, county, and city governments with nexus and taxing authority over the taxed transaction. Nearly every state has laws that will hold the business liable for any tax deficiency, meaning that if the customer did not pay the sales/use tax, the business will have to pay instead. Given that sales/use taxes are generally assessed as a percentage of gross sales, the owed sales taxes when the business failed to collect can be devastating to a company. Further, many states will hold the owners personally liable for any sales/use tax deficiency not paid by the company. This means that the state can sue the owners and, in some cases managers, personally for unpaid sales/use taxes. Thus, it is of utmost importance that if a business has nexus with a foreign state, then the company must withhold the requisite sales/use taxes from the transaction.
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