by Derek Rowley © 2009 All Rights Reserved

Nexus is a Latin work for a common tie or connection, and it is a key term in business today in determining the tax jurisdiction that applies to state business taxes. Because of the interconnected nature of our economy today, the discussion of tax nexus has clear implications for many small businesses. They often find themselves operating in multi-state environments, but typically lack the expertise and means to limit their tax liability and audit risk.

In 2006, for example, an independent survey of over 500 small and mid-sized companies found that companies average more than $325,000 per year in annual costs to manage just sales tax compliance alone. Even so, those companies still paid an average of $32,000 each year in penalties and interest due to errors and omissions.

This illustrates that nexus is a very complicated and fluid issue these days, as the various states are aggressively pushing the boundaries of the legal limits on their power to impose tax on businesses operating across state lines. What’s worse, the penalties for underreporting, underpaying, and under-collecting can be devastating - especially given the fact that there is no statute of limitations on state tax issues. That means that if your business is snared in a tax nexus dispute, states can go back years to collect additional revenue.

There are generally two separate tax issues that involve nexus:

• Sales & Use Tax
• Corporate Tax.

If an auditor determines that you failed to collect sales tax from your customer, the result is that you just decreased your profit margin by the percentage of the sales tax. (What is your profit margin - 7%?, 9%?) Imagine what would happen if a state tax auditor determined that you failed to collect state sales tax - and that sales tax rate is 9% - there goes your entire profit margin! And that is before penalties and interest. Then, you repeat the process using the state corporate income tax calculations.

Today, states are desperately revenue hungry. So, they respond by aggressively closing tax loopholes, and assertively chasing perceived transgressors to increase revenue collections. Many state and local governments have outsourced this tax collection process to private companies that collect a bounty on any tax revenues they identify. These revenue department commando units roam trade shows, business centers, telephone directories and websites looking for evidence of non-compliance.

States also send out mass mailings of nexus questionnaires to companies suspected of underreporting or underpaying taxes. While some companies choose to ignore these questionnaires, doing so can be dangerous because failing to respond usually eliminates any option for settlement. These questionnaires are designed to catch you - so use extreme care and professional tax help when filling them out. Some tax experts recommend responding with a letter rather than with a survey when your answers are complex or not clear-cut. These nexus questionnaires can catch you even if the questionnaire wasn’t sent to your company. An answer to a survey question by one of your vendors (or a state tax audit of one your vendors) could target your company for an audit appointment.

Your best protection against exposure to unforeseen tax nexus is to be aware of of the basic activities that create nexus. This requires that you conduct a thorough evaluation of how you conduct business in every jurisdiction you do business. Ask yourself questions such as:

Where do you maintain a permanent place of business? Include all your locations, warehouses, and properties, including leased property at customer locations.

• Have you operated a temporary place of business? If so, where - and for how long? This includes trade show booths, sales meetings, off-site training, and movable equipment at job sites.

• Where you do have individuals operating permanently? This includes administrative personnel, sales representatives, customer service personnel, and agent.

• Where do you have individuals operating temporarily? And how long are/have they working there?

• Did you sign a contract in another state? That could significantly alter your nexus status for any transactions or revenue generated under that contract.

• Did you send anyone out to perform installation or training? That almost always creates nexus.

• How do you ship products into another state? If it is a company owned or leased truck, you’ve got nexus problems.

If, after assessing your operations, you find that you have established tax nexus, the law requires you to register in those jurisdictions and begin paying taxes. If there are back taxes, talk to a tax professional about your options. There may be voluntary disclosure, amnesty or exemption programs that you can utilize to resolve your tax requirements.

However, if you are starting a business, make sure you register in any jurisdiction where you will be collecting taxes BEFORE you start collecting. Otherwise, you may find yourself in violation of fraud statutes, which can get ugly quickly.

What should you do now?

• Be proactive. Don’t wait until you get a nexus survey in the mail. Contact a tax professional, such as one of our tax team at NCH Tax Solutions, to discuss your nexus activities and help manage your nexus exposure.
• Be smart. Many nexus-creating activities can be managed by changing your processes to accommodate nexus laws. Our Office Package service is one solution that works for many business models. Call our office and talk to one of our consultants for more information.

by Derek G. Rowley (c) 2009. All Rights Reserved

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