Understanding State Tax Nexus: When Your Business Must Pay State Taxes

State tax obligations can be a complex maze for businesses operating across multiple states. The key concept that determines whether your state has tax obligations in a particular state is “nexus” – a sufficient connection that gives the state legal authority to tax your business.

What is State Tax Nexus?

Nexus represents the level of connection between a business and a state that allows the state to legally impose tax obligations on that business. This connection can be established in various ways, and the thresholds vary significantly from state to state.

Historically, nexus required physical presence in a state – such as having an office, employees, or inventory within state borders. However, modern nexus standards have expanded dramatically, particularly after the landmark 2018 Supreme Court decision in South Dakota v. Wayfair. This ruling upheld that states could impose tax collection obligations on businesses without a physical presence in the state, based solely on their economic activities.

Today, businesses can create nexus through physical presence, economic activity (such as exceeding sales thresholds), or specific business activities like using in-state sales representatives or attending trade shows. Understanding these various types of nexus is essential for maintaining tax compliance and avoiding unexpected tax liabilities.

Types of State Tax Nexus

Physical Presence Nexus

Physical presence remains the most straightforward way to establish nexus. When your business maintains a tangible connection to a state, you almost certainly have tax obligations there. Physical presence can include:

Property or facilities – Owning or leasing offices, warehouses, retail stores, or manufacturing facilities in a state establishes clear physical presence. Even temporary or shared workspaces can create nexus in many states.

Employees or representatives – Having employees or sales representatives working in a state, even temporarily, typically creates nexus. This includes remote workers who perform their duties from their homes in other states.

Inventory storage – Storing inventory in a state, whether in your own warehouse or through a third-party fulfillment center (like Amazon FBA), generally creates physical presence nexus. This is particularly relevant for e-commerce businesses using distributed fulfillment networks.

Equipment or property – Owning or leasing equipment, machinery, or other tangible property in a state can establish nexus, even if you don’t maintain a formal business location there.

Economic Nexus

Economic nexus is based on the volume or value of business conducted in a state, regardless of physical presence. Following the Wayfair decision, nearly all states with sales tax have implemented economic nexus thresholds. These thresholds typically include:

Sales thresholds – Dollar amount of sales into the state (typically ranging from $100,000 to $500,000 annually, depending on the state)

Transaction thresholds – Number of separate transactions into the state (commonly 200 transactions, though some states have eliminated this criterion)

Once a business exceeds either the sales threshold or the transaction threshold (or both, depending on state requirements), it creates economic nexus and must comply with that state’s tax laws.

Click-Through Nexus

Click-through nexus laws target businesses that generate sales through in-state referrals. These laws typically apply when:

• You have an agreement with an in-state resident who refers customers to your business via links on their website
• These referrals generate a certain level of sales (often $10,000 or more annually)
• The in-state resident receives compensation for these referrals

Many states implemented click-through nexus provisions before the Wayfair decision as a way to capture tax revenue from online sales. While economic nexus has somewhat superseded these provisions, click-through nexus remains relevant in certain states.

Affiliate Nexus

Affiliate nexus occurs when a business has an affiliated entity operating in a state. This commonly applies when:

• Your business has a related entity (subsidiary, parent company, or company under common ownership) with physical presence in the state
• The in-state entity performs services that help establish or maintain your market in the state
• The relationship between the entities goes beyond mere ownership

The affiliate relationship can create nexus even if your specific business entity has no direct physical presence in the state.

Marketplace Nexus

With the growth of online marketplaces like Amazon, eBay, and Etsy, many states have enacted marketplace facilitator laws. These laws typically:

• Require the marketplace facilitator (e.g., Amazon), rather than individual sellers, to collect and remit sales tax
• Relieve marketplace sellers from the obligation to collect tax on sales made through the marketplace
• May still require sellers to register and file returns for direct sales not made through the marketplace

Even with marketplace facilitator laws, sellers may still have nexus and other tax obligations in states where they exceed economic nexus thresholds.

How Nexus Impacts Different State Taxes

Nexus doesn’t just affect sales tax – it can trigger obligations across multiple tax types.

Sales and Use Tax

The most common tax impacted by nexus determinations is sales and use tax. When a business has nexus in a state, it must:

1. Register for a sales tax permit
2. Collect the appropriate sales tax from customers at the combined state, county, city, and special district rates
3. File sales tax returns on the required schedule (monthly, quarterly, or annually)
4. Remit the collected taxes to the state tax authority

The complexity increases because sales tax rates, filing frequencies, and taxability rules vary widely across states, counties, and cities.

Income Tax and Franchise Tax

Many states impose corporate income tax, franchise tax, or both on businesses with nexus in their state. Unlike sales tax, which is collected from customers, these taxes are paid directly by the business. Income tax is typically based on the portion of business income apportioned to the state, while franchise taxes may be imposed on the privilege of doing business in the state, often with minimum tax amounts regardless of profitability.

Some states have adopted “factor presence” nexus standards for income tax that mirror economic nexus thresholds for sales tax, while others maintain different standards for income tax nexus.

Gross Receipts Tax

Several states impose gross receipts taxes as an alternative to traditional corporate income taxes. These taxes are imposed on a company’s gross sales or receipts without deductions for costs or expenses. States with significant gross receipts taxes include Washington (Business & Occupation Tax), Texas (Franchise Tax, which is actually a gross receipts tax), Nevada (Commerce Tax), and Ohio (Commercial Activity Tax).

The nexus thresholds for these taxes often differ from sales tax thresholds, requiring separate analysis.

State-by-State Nexus Considerations

While it’s impractical to cover every state’s specific nexus rules in detail, understanding some key variations can help illustrate the complexity businesses face.

California

California has one of the highest economic nexus thresholds at $500,000 in annual sales. The state does not have a transaction threshold. However, California is also known for its aggressive enforcement of nexus provisions, particularly for income tax. The state applies a “doing business” standard that includes factor presence tests: $662,851 in California sales (for 2023, adjusted annually), $66,285 in California property, or $66,285 in California payroll.

New York

New York also maintains a $500,000 sales threshold, but adds a transaction threshold of 100 transactions. The state imposes complex sales tax rules with numerous local jurisdictions. For income tax purposes, New York has historically taken an expansive view of economic nexus, even before the Wayfair decision.

Texas

Texas has a $500,000 economic nexus threshold for both sales tax and franchise tax (its primary business tax). The state does not use a transaction count threshold. Texas is notable for having a different tax year for franchise tax (based on the federal income tax year) versus sales tax (calendar year), creating compliance challenges.

Florida

Florida was one of the last states to adopt economic nexus, implementing a $100,000 sales threshold with no transaction count requirement. Florida has no state income tax for individuals but does impose a corporate income tax on businesses with nexus in the state.

States without Sales Tax

Five states do not impose a general sales tax: Alaska (though local sales taxes exist), Delaware, Montana, New Hampshire, and Oregon. However, these states may still impose other taxes on businesses with nexus, such as income tax or gross receipts tax. For example, Oregon imposes a Corporate Activity Tax on businesses with Oregon sales exceeding $1 million.

Managing Nexus Compliance

Navigating the complex world of state tax nexus requires a strategic approach. Here are essential steps for managing your business’s nexus compliance:

Regular Nexus Assessment

Businesses should conduct regular nexus assessments to identify where they may have created taxable connections. This assessment should include:

Review of physical presence – Document all states where you maintain offices, employees, inventory, or property.

Analysis of sales by state – Track sales volumes in each state to monitor when you approach or exceed economic nexus thresholds.

Evaluation of business activities – Identify activities like trade show attendance, affiliate relationships, or remote workers that might create nexus.

Technology solutions can help automate this tracking, particularly for businesses with complex operations or rapidly growing sales in multiple states.

Voluntary Disclosure Agreements

If you discover that you have established nexus in states where you’re not registered, voluntary disclosure agreements (VDAs) can provide a path to compliance while potentially limiting exposure. VDAs typically offer:

Limited lookback periods – States may agree to limit tax assessment to a specific period (often 3-4 years) rather than all open tax years.

Penalty abatement – Most VDA programs waive or reduce penalties, though interest on back taxes is usually still required.

Anonymity during negotiation – Many states allow businesses to negotiate VDAs anonymously through a representative before revealing their identity.

VDAs provide a structured approach to addressing past non-compliance while establishing proper registration going forward.

Streamlined Tax Registration

For sales tax compliance across multiple states, the Streamlined Sales Tax Registration System allows businesses to register for sales tax in multiple member states (currently 24 participating states) through a single registration process. While this doesn’t eliminate the need to file separate returns, it simplifies the initial registration process.

Nexus-Limiting Strategies

Businesses can sometimes implement strategies to limit nexus creation or manage tax impacts:

Entity structuring – Using separate legal entities for different functions can sometimes limit nexus spread, though states increasingly look through such structures.

Drop shipping arrangements – Carefully structured drop shipping can sometimes avoid inventory nexus, though this area is increasingly regulated.

Fulfillment center selection – Strategic location of inventory can manage where physical presence nexus is created.

These strategies should always be evaluated with qualified tax professionals, as aggressive tax planning can lead to greater scrutiny from tax authorities.

The Future of State Tax Nexus

State tax nexus continues to evolve as business models change and states seek to capture tax revenue from an increasingly digital economy. Several trends are shaping the future of nexus determination:

Digital Products and Services

States are expanding their tax bases to include digital products and services. This includes:

SaaS (Software as a Service) taxation – More states are explicitly including SaaS in their tax base, though treatment varies significantly.

Digital goods – States increasingly tax digital goods like downloaded software, music, e-books, and streaming services.

Digital advertising – Some states have begun imposing taxes on digital advertising services, though these face ongoing legal challenges.

As business models continue to evolve, expect states to adapt their nexus and taxability rules to capture revenue from these sources.

Remote Work Impacts

The dramatic increase in remote work following the COVID-19 pandemic has created new nexus challenges:

Employee location nexus – Employees working remotely from states where a business had no previous presence may create nexus in those states.

Temporary nexus waivers – While many states provided temporary nexus relief during the height of the pandemic, most of these provisions have expired.

Businesses with distributed workforces need to carefully track employee locations and understand the potential nexus implications.

Federal Legislation Possibilities

Congress has periodically considered legislation that would create nationwide standards for state tax nexus. Proposals have included:

Federal nexus thresholds – Establishing uniform economic nexus thresholds across all states.

Nexus safe harbors – Creating protected activities that would not establish nexus.

Simplification requirements – Requiring states to simplify their tax systems before imposing collection obligations on remote sellers.

While no significant federal legislation has passed to date, the possibility remains that Congress could act to create more uniformity in this area.

FAQ: State Tax Nexus Questions

How do I know which states’ tax thresholds I’ve crossed?

Determining which states’ tax thresholds you’ve crossed requires systematic tracking of your business activities across all states. For economic nexus, you’ll need to monitor both your sales revenue and transaction counts by state. Many e-commerce platforms and accounting systems can generate reports showing sales by ship-to address, which serves as a starting point. For physical presence, maintain a database of all locations where you have employees, inventory, equipment, or property. Tax compliance software like Avalara, TaxJar, or Sovos can also provide automated nexus monitoring, alerting you when you approach or exceed various state thresholds. I recommend reviewing this data quarterly to catch any new nexus triggers before they create significant compliance issues.

If I use Amazon FBA, do I have nexus in every state with an Amazon fulfillment center?

When you use Amazon’s Fulfillment by Amazon (FBA) service, your inventory can be distributed across Amazon’s nationwide network of fulfillment centers, potentially creating inventory nexus in multiple states. Historically, most states considered inventory in fulfillment centers sufficient to create physical presence nexus. However, the landscape has evolved with marketplace facilitator laws. While Amazon now collects and remits sales tax on your behalf for sales through their platform in states with marketplace facilitator laws, this doesn’t necessarily eliminate your nexus. You may still have income tax, franchise tax, or gross receipts tax obligations in those states. Additionally, you remain responsible for sales tax on any direct sales not made through Amazon. I recommend maintaining visibility into where Amazon stores your inventory and consulting with a tax professional about potential obligations beyond marketplace-collected sales tax.

Can I just register in high-revenue states and ignore states where I do minimal business?

Selectively registering only in high-revenue states while ignoring states with minimal sales is technically non-compliant if you’ve established nexus in those lower-volume states. Each state’s nexus thresholds apply independently, and exceeding them creates legal tax obligations regardless of whether it seems economically sensible to comply. That said, businesses must make practical risk-assessment decisions. States typically focus enforcement efforts on larger taxpayers, so the audit risk for minimal activity may be lower. If you choose this approach, understand that it carries risk: states generally have the ability to look back several years (often 3-7 years depending on the state) for unpaid taxes, plus penalties and interest. A better approach might be using streamlined registration systems where available and implementing simplified compliance processes for low-volume states to manage the administrative burden while maintaining technical compliance.

Does having a remote employee working from another state automatically create nexus?

Having a remote employee working from another state typically does create nexus in that state, though there are nuances to consider. Most states consider the physical presence of an employee sufficient to establish nexus, even if the employee works from home and doesn’t meet with customers. However, during the COVID-19 pandemic, many states provided temporary nexus relief for pandemic-related remote work arrangements. Most of these provisions have now expired. A few states have adopted more permanent provisions regarding remote workers, such as establishing de minimis thresholds before nexus is created. The nature of the employee’s work can also matter – some states distinguish between employees performing purely administrative functions versus those directly generating revenue. If you have remote employees, I recommend documenting exactly what functions they perform, how their presence benefits your business in that state, and consulting state-specific guidance, as this area continues to evolve in the post-pandemic landscape.

If I exceed nexus thresholds in a state, how quickly must I register?

When you exceed nexus thresholds in a state, the timing requirements for registration vary by state and tax type. For sales tax, most economic nexus provisions require registration within 30-90 days after crossing the threshold. Some states specify the exact timeline (e.g., “by the first day of the second calendar month after exceeding the threshold”), while others are less precise. For income taxes, registration is typically tied to when returns are due, which is generally after the close of your tax year. The practical challenge is often not the registration deadline itself, but the obligation to collect tax, which typically begins immediately upon establishing nexus. If you’re approaching thresholds in key states, I recommend preparing registration documentation in advance so you can quickly register when needed. If you’ve already exceeded thresholds and haven’t registered, consider whether a voluntary disclosure agreement might be appropriate to address past exposure while coming into compliance.

How does nexus differ for online courses or digital services compared to physical products?

Nexus determination itself follows the same principles for digital services as physical products, but the application can differ significantly. For physical products, inventory location creates clear physical nexus, while digital businesses rely primarily on economic nexus. The greater distinction comes in taxability and sourcing rules. Digital services and online courses face inconsistent treatment across states – some explicitly include these in their tax base, while others exempt them as services or educational products. Sourcing rules (determining which jurisdiction’s tax applies) also vary: some states use the customer’s location, others use billing address, and some have specific rules for digital products. These inconsistencies create compliance challenges unique to digital businesses. Additionally, digital businesses often need to collect and maintain different documentation to support tax decisions than physical product sellers. If you sell digital products or services, I recommend focusing first on high-population states with clear digital product taxation (like Washington, Texas, and New York) to address the bulk of your potential liability efficiently.

What penalties might I face for non-compliance with state tax obligations?

Penalties for non-compliance with state tax obligations can be substantial and typically fall into several categories. For failure to collect and remit sales tax, states commonly impose penalties of 5-25% of the tax due, with some states imposing additional penalties for negligence or fraud that can reach 50% or more. Interest accrues on both the unpaid tax and penalties, often at rates several percentage points above the federal rate. Many states also impose personal liability on responsible persons (such as owners, officers, or managers) through “trust fund recovery” provisions, particularly for sales tax that should have been collected from customers. Beyond monetary penalties, non-compliance can result in liens against business assets, revocation of business licenses, and in extreme cases, criminal prosecution. The statute of limitations for assessment typically ranges from 3-7 years, but in cases of non-filing, many states have an unlimited lookback period. The most effective way to mitigate these penalties is through voluntary disclosure programs before an audit occurs, as these programs typically offer substantial penalty reductions.