By Michael J. Fleming
In our many webinars, individual conversations and review of community forums, the question of nexus is perhaps one the most misunderstood and hotly debated topics. There are usually a series of question that range from what is nexus to how can states have the right to force me to collect their taxes. We touched on some of these topics in our white paper entitled, Where Should FBA Sellers Register to Collect Sales Tax. Today we will address the following questions:
- What is nexus?
- What creates nexus for FBA sellers.
What is Nexus?
States do not have the power to tax just anyone they want. In order for a state to tax you, you must have some sort of connection, tie or link with that state. This connection link or tie is referred to as “nexus.” Once a sufficient connection with the state exists, then you fall under the state’s power to tax you or force you to collect taxes on its behalf.
When it comes to sales tax nexus the connection or link must have some physical component. However what you and I consider to be “physical” and what the states or US supreme Court consider to be physical are often two different things. The US Supreme Court in two different decisions, (SCRIPTO v. CARSON, 362 U.S. 207 (1960), TYLER PIPE INDUSTRIES v. DEPT. OF REVENUE, 483 U.S. 232 (1987)), has said that even the activities of unrelated third-parties acting on your behalf could be enough to create nexus if they are helping you to “establish or maintain” a market.
There is no national law that tells us what does or does not constitute nexus. Instead, we have a patchwork of state laws that are influenced by the US Constitution and US Supreme Court decisions. There are some activities that all states agree on and some activities that vary widely amongst the states as whether they create nexus or not. In this article we will discuss the two most common nexus creating activities for FBA sellers.
What creates nexus for FBA sellers?
While are there are many activities that can create nexus, we are going to concentrate on the two areas that should be of most concern to FBA sellers.
First, let’s consider your own activities. Wherever you have your base of operations would be a link or connection with that state. Whether you are conducting business from your home or from an office, storefront or other location, you are creating a physical link with that state. This link allows the state to force you to pay its taxes and collect taxes on its behalf.
The second activity to think about is where you own property. One of the most overlooked issues when it comes to property is owning inventory in a state. Inventory is your property. You own it and having it in another state is a nexus creating activity, one way or another, in every state. This comes as a shock to many FBA sellers. You may be shipping your inventory to one or two locations, but then Amazon is moving it around the country to their other locations. Everywhere they move your inventory you have nexus.
It does not matter if Amazon moves your inventory around or you move it around. Nor does it matter if they move it without your knowledge. It is still your property and it creates a physical presence for you wherever it is. I often hear that, well I only have a little inventory there. While it is true, that you have to have “more than the slightest physical presence” in a state according to Quill (Quill Corp. v. North Dakota, 504 U.S. 298 (1992)), the Court did not define what more than the slightest physical presence meant.
Quill, for you old timers who remember what a diskette is, had a total of 3 diskettes in the state of North Dakota. So we know that you must have more than 3 diskettes, but is the magic number 4, 5, 100, or 1000. We just don’t know, so we are at the states’ mercy and therefore suggest being conservative.
Having said that you should be conservative when approaching nexus, we need to mention that you should also take materiality into consideration. We discuss materiality in greater depth in “Let’s Not Panic and Go Overboard – A Case Study in Materiality” . However we would like to add that just because you have nexus in a state does not necessarily mean that you need to take action. There are costs involved in becoming compliant and you need to weigh these costs against the taxes, fines and penalties if a state does find you. If the cost of compliance is greater than the cost of non-compliance then we suggest waiting until your business grows before taking action. However, don’t wait too long as the costs of non-compliance grow with each year.