29 Sep 2008
2 min read

Sales Tax Nexus and 3rd Party Contractors

Discover new methods states employ to identify companies with sales tax obligations, and learn how you can avoid them.
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In the intricate landscape of business operations, the utilization of 3rd party contractors is a common strategy to streamline tasks, especially when operating across state borders. However, what many businesses fail to recognize is the potential sales tax nexus that comes with this practice. In this blog, we delve into the nuanced world of sales tax implications, the associated risks, and practical considerations for businesses relying on 3rd party contractors.

Understanding Sales Tax Nexus: A Crucial Connection

So, you engage 3rd party contractors to execute tasks on your behalf in a state where you have no physical presence. Does this establish sales tax nexus in that state? The answer, in most cases, is a resounding "yes, probably."

For numerous clients in a similar predicament, the dilemma revolves around whether to register in these states and the subsequent need for a comprehensive benefits vs. cost analysis. Often, businesses seek to gauge the risk of being identified by taxing authorities when their sole connection with a state is through unrelated 3rd parties.

Navigating the Risk Terrain

Assessing the risk percentage in such scenarios is a challenge, but drawing insights from the experiences of others in analogous situations can provide valuable perspective.

Common Methods States Employ to Identify Businesses:

Audits of Other Companies: States frequently uncover non-registered businesses through audits of companies with which they have a direct connection. For instance, if you use a 3rd party contractor for services in a state where you lack physical presence, an audit of your customer could inadvertently lead authorities to scrutinize your tax status.

Payroll and Sales Tax Return Comparisons: Companies with employees in a state often register promptly for payroll tax but may overlook sales tax registration. States exploit this by comparing payroll tax returns with sales tax returns, effectively pinpointing businesses with nexus due to their workforce presence.

Photo by Wesley Tingey on Unsplash

1099 Data Sharing: States have collaborative agreements with the IRS, allowing them access to 1099 data for businesses in their jurisdiction. By cross-referencing payors making payments to contractors in the state with a list of registered companies, states compile a comprehensive list of businesses utilizing 3rd party contractors.

Mitigating Your Exposure: The Voluntary Disclosure Process

Given the multitude of methods states employ to uncover businesses within their borders, a proactive approach is crucial. If your exposure is substantial, considering the voluntary disclosure process becomes paramount. This strategic move allows businesses to limit their exposure and rectify compliance issues before facing potential penalties.

In conclusion, the use of 3rd party contractors introduces a layer of complexity to sales tax obligations. By understanding the methods states employ and evaluating your exposure, you can make informed decisions to navigate the intricate landscape of sales tax nexus and ensure compliance in an ever-evolving business environment. If a state has Identified you as having nexus in their state it may be time to reach out to us for a quick conversation about what to do next.

Conclusion

In conclusion, businesses using third-party contractors across state lines should be aware of the potential sales tax nexus implications. From audits to cross-referencing payroll tax and sales tax returns, states are eager to find out-of-state companies with potential nexus obligations. Additionally, we discussed how states use IRS 1099 data to identify companies utilizing third-party contractors in their jurisdiction. To manage this risk effectively, businesses should consider voluntary disclosure processes and proactive compliance measures.
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