What is Economic Nexus?

Economic Nexus

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Economic Nexus

“Economic nexus” is a legal term used in the context of U.S. state sales tax laws. It refers to the criterion that determines whether an out-of-state business selling products or services is obligated to collect and remit sales tax to a particular state.

Historically, states could only enforce sales tax collection from businesses that had a physical presence in the state, such as a store, warehouse, or office. However, the rise of e-commerce challenged this traditional physical presence standard.

In 2018, the U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc. changed this precedent. The court ruled that states could require out-of-state sellers to collect and remit sales tax based on an economic nexus, even if the sellers didn’t have a physical presence in the state.

Under the economic nexus laws, which vary by state, a business establishes an economic nexus in a state by exceeding a certain threshold of sales or transactions in that state. This threshold is typically measured by gross revenue from sales or the number of individual transactions.

For instance, South Dakota’s law, which was at issue in the Wayfair case, established an economic nexus if a business had more than $100,000 in sales or 200 individual transactions in the state within one year. Other states have adopted similar standards, though the specific thresholds can vary.

Example of Economic Nexus

Let’s say you own a successful online furniture business based in Texas, USA, called “Lone Star Furnishings”. You don’t have any physical stores, warehouses, or offices outside of Texas, but you sell and ship your products to customers all over the United States through your e-commerce website.

One of your top markets is California, where you have a large number of customers. In the past year, you made over $200,000 in sales from customers in California.

Even though Lone Star Furnishings does not have a physical presence in California, under California’s economic nexus laws, your business has established an economic nexus in the state because it has exceeded the state’s sales threshold (which, as of my knowledge cutoff in September 2021, was $500,000). This means that Lone Star Furnishings is required to collect and remit sales tax on its sales to customers in California, even though it is not physically located in the state.

This is just one example, and the specific rules and thresholds can vary by state. It’s also worth noting that this area of tax law can be quite complex, so businesses that engage in interstate sales should seek professional tax advice to ensure compliance with all applicable laws and regulations.

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