Following the 2018 Supreme Court decision for South Dakota v. Wayfair, the precedent of sellers needing to have a physical presence in a state for sales tax to be collected was officially overturned. States had been seeking ways to capture ecommerce revenue for years, with economic nexus legislation already spreading across the country. However, the 2018 decision made these new rules lawful, and this type of legislation continues to impact United States startups in increasing and evolving ways. As of 2023, all states have enacted economic nexus legislation of some kind. So, every business of every size must understand the state requirements and evaluate the tax implications.
In general terms, economic nexus means sellers must collect and remit sales tax once a threshold of sales transactions or gross receipts activity is met within the state.
In general terms, economic nexus means sellers must collect and remit sales tax once a threshold of sales transactions or gross receipts activity is met within the state. The possibility exists that sales tax regulations will be adopted at the federal level, which could simplify things in the future. However, currently, economic nexus laws vary greatly by state. For example, if qualified by sales transaction totals, thresholds range from $100,000 to $500,000. For some, attention is instead paid to gross receipts, which can directly affect startup income if they do not register to collect/remit sales and use tax. Just last year, the U.S. Government Accountability Office reported, “a third of state tax collections come from sales taxes.” This means we can expect states to keep strengthening economic nexus legislation and become more aggressive in enforcing collection attempts.
Consequences for failing to properly understand tax liabilities are serious. It could of course lead to an audit and penalties. But for startups, a more pressing and often overlooked concern is how fundraising and due diligence might be affected. If engaged in talks for a merger or acquisition, a potential partner or buyer will look for tax liabilities, and if uncovering these, the business opportunity may be negatively impacted or missed entirely.
Again, while states have long worked to collect sales tax, meaning no business could ever entirely avoid being affected, the 2023 reality is it’s critical to fully review your startup’s situation. And with differences in how each state is determining economic nexus, you must periodically double check assumptions in every state to understand tax liability. Read on to learn more.
Economic nexus taxability
While physical presence is still a factor in determining taxability, economic presence laws now mean that if you sell remotely to anywhere in the United States, your business likely will have additional state tax liability and registration requirements.
Economic nexus is established for sellers “not having physical presence in the state.” Again, thresholds vary regarding a set level of sales or number of transactions within a state, so the situation is fundamentally complex in trying to understand which state may be owed what.
Factors that determine liability include but are not limited to:
- The type of transaction considered taxable
- The applicable range of sale dates
- The number of transactions vs. total sales dollars
If your startup has economic nexus within any state and fails to register, collect, and remit the required sales tax to that state, you’re out of compliance. You’re on the hook to pay the outstanding balance out of pocket, and when you go state by state, this burden can become exponentially high quickly.
More on sales tax variances by state
So, we know tax definitions and requirements vary. Regarding the type of transaction, this is sometimes defined as “gross,” meaning all sales, such as resale, taxable, and exempt sales. Other states only focus on “retail” sales, which would exclude resale.
Considering date ranges, the time period covered could be a calendar year, a fiscal year, or still some other measure of defined time. Startups should definitely evaluate liability if exceeding the threshold in the current or prior year. But note that some states perform a quarterly evaluation with a rolling 12-month lookback. If you have liability, this aspect alone makes it challenging to determine when your tax requirements go into effect.
And finally, in every state except Connecticut and New York, economic thresholds are based on transaction count OR sales dollar totals—only in Connecticut and New York are both transaction count AND sales dollars required to meet the threshold. And there’s a trend of states changing or dropping the transaction count entirely, with Colorado, Iowa, Washington, and Wisconsin among these. South Dakota made this change in July, and Louisiana followed suit in August.
What happens next?
The first piece of advice—engage an expert. Even if you’re confident in determining your state- by-state thresholds, each state then has different requirements regarding collection and remittance. For some, it’s on the transaction following having reached the threshold, while others allow for a transitional period before you must begin to collect.
A tax professional will help you determine the following:
- Applicable sales tax in each state for a given tax year
- Whether your startup is compliant by state
- Any outstanding liability by state
Don’t assume you’ve identified everywhere you have liability either before or after the fact. And know there are options if it’s determined your startup is behind.
Many states offer something called Voluntary Disclosure Agreements (VDAs) to help you get caught up. By volunteering any unpaid state taxes, VDAs often offer benefits such as reduced or eliminated penalties, as well as friendlier lookback terms. And if you do owe, and a VDA is to be of use, bear in mind that VDAs are usually not an option once an audit has been triggered.
Failure to comply with state sales tax laws is already a serious violation and fast becoming more so. Tax liabilities owed as a result of economic nexus not only can result in stiff penalties, but it can lead to significant missed business opportunities for your growing startup. Whether you’re planning now for growth or ensuring your ongoing compliance as laws keep changing, having a tax expert is a critical component in your startup’s tax strategy.