State Sales & Income Tax Nexus: What Small Business Owners Need to Know

As a small business owner, expanding beyond your home state or even incorporating in the US from another country is exciting! But it also introduces new tax considerations – specifically something called "state income tax nexus" as well as "state sales tax nexus."

Don't let the fancy term intimidate you. In this article, we'll break down what nexus means, how it affects your business, and what you need to do about it.

What is a Tax Nexus?

Simply put, state tax nexus means your business has a significant connection to a state that gives the state the right to tax you. Think of nexus as a state's way of saying, "Your business is active enough here that you owe us taxes on some of your income."

When your business has nexus in a state, you generally need to register with that state's tax authority and file income tax returns there. If you only do business in your home state, you have nexus only there. But if you do business in multiple states, you could have nexus in each of those states, creating tax responsibilities in each one.

Let’s break it down further.

Sales Tax Nexus vs. Income Tax Nexus

It's important to distinguish income tax nexus from sales tax nexus, as they're related but not the same:

Sales Tax Nexus

• Requires you to collect and remit sales tax on sales to customers in that state
• Often triggered by economic thresholds (like $100,000 in sales or 200 transactions)
• Means you collect tax from your customers and pass it to the state

Income Tax Nexus

• Requires your business to pay income tax on profits earned in that state
• Typically triggered by physical presence or employees
• Some states also claim income tax nexus based on revenue thresholds
• The tax comes from your business earnings, not your customers

You might have one type of nexus but not the other, or you might have both, depending on your business activities.

What Triggers Income Tax Nexus?

Whether your business needs to file income tax in a particular state depends on if you have "nexus" there. Here are the common factors that determine if you’ve reached nexus:

1. Physical Presence

If your business has a physical presence in a state, you almost certainly have nexus there. This includes:

• Having an office, store, or warehouse
• Storing inventory (even in a third-party warehouse)
• Owning or leasing property in the state including using shared workspaces
• Setting up a booth at a trade show
• Visiting clients or customers. Brief visits usually won't create nexus, but extended or repeated visits might.

Essentially, if you plant your flag in a state in any tangible way, that state views your business as "present" for tax purposes.

2. Employees or Representatives

Hiring employees who live or work in another state will create nexus in that state. It doesn't matter if the employee is:

• Full-time
• Part-time
• Remote
• Independent contractors

If they're working from that state, your business now has a taxable presence there. Even independent contractors, sales agents, or other representatives working on your behalf in a state can establish nexus.

What Triggers Sales Tax Nexus?

Significant Sales or Economic Activity

You can establish nexus even without physical presence if your sales or revenue in a state are high enough. Many states have adopted "economic nexus" rules, meaning if you exceed a certain sales dollar amount or number of transactions in the state, you have nexus and must file taxes there.

For example, a state might say you have nexus if you had over $100,000 in sales or 200 transactions with customers in that state in a year. These thresholds vary by state, but the idea is that earning significant income from a state can trigger tax obligations, even if you never set foot there.

Hiline can help you determine if you’ve qualified in any state but this chart breaking down state-by-state thresholds is a great place to start.

Who Does Nexus Apply To?

State income or sales tax nexus can apply to businesses of all types and sizes:

• Any business operating in multiple states (online businesses, consultants, contractors)
• Retailers and e-commerce sellers (even small online shops)
• Service businesses and consultants
• All business entities (sole proprietors, partnerships, LLCs, corporations)

There generally isn't a blanket "small business exemption" for nexus. A business with $50,000 in sales could have the same nexus obligations as one with $5,000,000 in sales if the smaller business has an office or employee in the state.

In essence, any business owner whose operations aren't 100% confined to one state should evaluate nexus.

Why State Tax Compliance is Important?

Ignoring state tax deadlines and obligations can be risky and costly. Complying with state tax laws is important for several reasons:

1. Avoiding Penalties and Interest

States can impose hefty penalties and interest if you fail to file required tax returns or pay taxes due. If your business establishes nexus in a state and you don't file a return, the state can later bill you for all unpaid taxes plus interest on those overdue amounts.

2. No Time Limit on Back Taxes

If you never file in a state when you should have, there's often no statute of limitations for the state to come after you. This means if you triggered nexus five years ago and the state discovers it now, they can potentially assess five years (or more) of back taxes owed, plus penalties and interest.

3. Maintaining Good Standing

If you operate as an LLC or corporation, states often require you to register for sales tax when you do business in a state outside your formation state. However, there is not an automatic need to register for income tax. Keep in mind, failure to comply could result in fines or an inability to enforce contracts in that state.

4. Peace of Mind

Knowing that you're on top of your state tax obligations lets you focus on running and growing your business without constantly looking over your shoulder.

How to Determine if Your Business Has a State Tax Nexus

Here are the steps to figure out if your business has nexus in a state:

1. List Your Business Activities by State
   
   • States where you have a physical location
   • States where any employees or contractors work
   • States where you make sales or deliver products/services
   • States where you store inventory or equipment
2. Check State Thresholds and Rules
   
   • Visit state tax agency websites for nexus information
   • Look for economic nexus thresholds (minimum sales amounts)
   • Check how they treat remote employees or contractors
   • See if they follow federal Public Law 86-272 (which may protect some businesses that only sell tangible goods)
3. Use Professional Guidance if Needed
   
   • Consider getting help from a tax professional who specializes in multistate tax
   • They can conduct a formal "nexus study" for you
4. Document Your Findings
   
   • Keep a record of your nexus determinations
   • Document why you do or don't have nexus in each state

Being Proactive: Nexus Evaluation

A proactive approach to nexus can save your business money and headaches. Here’s what we recommend:

• Conduct Regular Nexus Evaluations – Review annually or upon major business changes.
• Catch Nexus Early – Starting to file from the beginning means you avoid accumulating back taxes and penalties.
• Financial Planning – Knowing where you have to pay helps with budgeting.
• Voluntary Disclosure Opportunities – If you discover past nexus you didn't address, many states offer programs to come clean with reduced penalties.

For International Business Owners Expanding to the US

If you're a business owner outside the United States planning to expand into the American market, you face unique tax considerations. Many international entrepreneurs mistakenly focus only on federal taxes, overlooking the crucial state-level requirements. Here's what you need to know about state income tax nexus as a foreign business:

1. The US Tax System is Two-Tiered

Unlike many countries with centralized tax authorities, the US has both federal (national) taxes and separate state taxes. Each of the 50 states sets its own tax rules independently of the federal government.

2. International Tax Treaties Don't Apply at State Level

This is critically important to understand: While your country may have a tax treaty with the US federal government that limits your tax exposure, these treaties typically do not protect you from state taxes. Even if you're exempt from US federal income tax, you could still have state tax obligations.

3. Nexus Rules Apply Equally to Foreign Businesses

The same triggers we discussed earlier apply to your business:

• If you open a physical office, store, or warehouse in a state, you'll have nexus there
• If you hire US-based employees or contractors working in specific states, you create nexus in those states
• If your sales to customers in a state exceed that state's economic thresholds, you might have nexus there

Planning Your US Expansion Strategically

Given these complexities, consider the following when planning your US entry:

• Research state tax rates and requirements before choosing where to establish operations
• Budget for state tax compliance costs (registration fees, ongoing filing requirements)
• Consider working with US tax professionals who understand multi-state taxation
• Evaluate whether establishing a US subsidiary makes sense for your business structure

The Bottom Line for International Businesses

Don't make the common mistake of thinking US federal tax rules are all you need to consider. State tax compliance is equally important and potentially more complex. Taking the time to understand state nexus rules before you expand can save you significant headaches and unexpected tax bills down the road.

Taking Control of Your Multi-State Tax Obligations

Understanding and managing state income tax nexus and sales tax nexus is a crucial part of growing your business beyond state lines. When your business establishes a significant connection to a state – whether through physical presence, employees, or sales volume – you're required to file and pay taxes there. 

Proactive compliance around your taxes saves you from painful penalties, interest, and unexpected tax bills that could derail your growth plans. Plus, as your business expands, your tax situation becomes more complex!

That's where Hiline comes in. Our team specializes in helping small businesses navigate multi-state taxation and US business expansion with confidence. We offer nexus studies to determine where you have obligations, handle multi-state registrations, manage ongoing filings, and provide strategic tax planning to minimize your burden.

Don't let state tax compliance slow your growth. With Hiline by your side, you can expand your business across state lines knowing your tax obligations are handled properly. Contact us today to take the guesswork out of state income and sales tax nexus.

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