Economic Nexus Isn’t Just for Retailers

August 3, 2020

Distributors, manufacturers, and wholesalers may not have to collect and remit sales tax, but that doesn’t necessarily mean they’re free from sales tax obligations. They likely need to register with the tax department, file returns, and validate exempt transactions if they have a physical presence in a state or make significant sales into a state where they have no physical presence.

What triggers a sales tax obligation

Physical presence

Having a physical presence in a state creates sales tax nexus — the connection that triggers an obligation to comply with the state’s sales tax law.

It seems straightforward, but not every state defines “physical presence” the same way. It’s not always limited to a brick-and-mortar store or distribution center. For example, physical nexus can be established when an out-of-state business:

  • Arranges for a third-party to make a delivery in Washington
  • Attends one trade show in Texas for one day
  • Has an employee present in Arizona for just two days per year

For more details, see this state-by-state guide to physical presence nexus.

Economic activity

Since the Supreme Court of the United States overruled the physical presence rule in South Dakota v. Wayfair, Inc. (June 21, 2018), a sales tax obligation can also be established solely through sales activity in a state (e.g., sales volume or number of transactions). This is economic nexus.

All but two of the 45 states that have a sales tax now enforce economic nexus, as does Washington, D.C., and some parts of Alaska, which has local sales tax but no state sales tax. Florida and Missouri are the only two states that have a sales tax but haven’t adopted economic nexus, and they likely will eventually.

Most state economic nexus laws provide an exception for small sellers, those selling under a certain threshold. This economic nexus threshold varies from state to state. Examples of thresholds include:

  • California: $500,000 in sales (including exempt sales and sales for resale) in the preceding or current calendar year
  • Illinois: $100,000 in sales or 200 transactions (including exempt sales but not sales for resale) in the preceding 12 months
  • New York: $500,000 in sales and 100 transactions (including exempt sales) in the previous four sales tax quarters
  • Texas: $500,000 in sales (including exempt sales and exempt services) in the previous 12 months

For a complete list of economic nexus thresholds, see this state-by-state guide to economic nexus laws.

Distributors can have economic nexus

Many distributors don’t engage in retail sales and therefore don’t need to collect or remit sales tax. Yet if their sales exceed the economic nexus threshold in a state where exempt sales are included, they may be required to register, file returns, and track exempt sales with a valid exemption or resale certificate. Businesses that fail to do so risk being out-of-compliance.

To learn more about sales tax risks for distributors, check out managing exempt sales during the rise of economic nexus.