Anchin’s U.S. Expansion Playbook: State Tax Nexus – Sales and Income Tax Obligations for Foreign Businesses in the U.S.

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Under state tax laws, “nexus” refers to the sufficient connection or presence a business has with a state that causes a business to be subject to a state’s income tax, sales tax, or both.  When a business has nexus in a state, it is obligated to meet that state’s tax compliance requirements and may incur related tax liabilities.

Sales Tax Nexus

The U.S. does not have a Value Added Tax (VAT) or a Goods and Services Tax (GST); instead, most states have a sales tax regime. When a foreign business conducts business in a U.S. state, it may be obligated to charge a sales tax to be remitted to the state, which the consumer ultimately pays. How each state’s government applies sales tax varies, but a critical factor foreign businesses must be aware of is nexus. Nexus dictates a business’s (either foreign or domestic) exposure to state taxation. Nexus can be created in multiple ways, including:

1. Physical presence: Having employees, leasing, or owning property or assets (including inventory/stock) usually increases the risk of establishing physical presence nexus.
2. Economic nexus: This is dependent on the volume of revenue generated in a state, or in some states, the number of transactions in the state. If the state’s economic sales tax nexus threshold is exceeded, tax filing and potential sales tax exposure exists.

Understanding nexus rules for state sales tax purposes is crucial, as foreign businesses may unknowingly have reporting requirements in multiple states. This is especially important for sales tax because several states impose personal responsibility for the remittance of the sales tax on responsible persons, such as owners, officers, directors, employees, managers, partners or members of the business). Since sales tax is determined independently in each state, a foreign business will need to keep track of all its sales on a state-by-state basis. Not meeting the economic nexus threshold in one state does not mean a business will not meet it in another state. Several states have set their economic nexus as either $100,000 in sales or 200 separate transactions during the tax year. This could lead to cases where a foreign business with one sale worth $50,000 would not have economic nexus but another foreign business with 200 transactions, each worth $1 would have economic nexus.

If business activities in a particular state create nexus, that business may be required to complete a sales tax return and remit sales tax to the state. The deadline for sales tax returns will vary from state to state. States also may have specific e-commerce rules if a business’s sales do not involve a physical transaction. Several states have websites available where a business can calculate its owed sales tax based on the address of its customers.

Foreign businesses with physical stores in the U.S. must consider state compliance requirements, although nexus would likely be limited to the state(s) where their stores are located. However, foreign businesses that sell, or plan to sell, to U.S. customers through e-commerce channels should anticipate significant state tax compliance requirements. However, a business’s use of a marketplace facilitator would shift the primary responsibility for collecting and remitting sales tax from the individual seller to the marketplace facilitator.

Further analysis and commentary on sales tax and its impact on a foreign business’s operations in the U.S. will be provided in the next article of the series.

Income Tax Nexus

Historically, a business’s obligation to pay state income tax was tied to its physical presence within a state. This standard, based on traditional commerce, considered a storefront, office, warehouse, or employees within the state as creating a clear enough connection to justify taxation. Even temporary activities, such as attending trade shows or storing inventory, could trigger income tax nexus. Recently, states have begun adopting economic nexus standards (similar to sales tax) for income tax purposes, allowing them to tax businesses based solely on substantial economic activity. Many states now have economic income tax nexus thresholds, such as $500,000 in sales or 25% of total business activity within the state.

For sellers of tangible personal property, Public Law 86-272 provides immunity from state income taxes for businesses with in-state activities that are limited to soliciting orders, provided that the orders are approved and fulfilled from outside the state. However, its relevance has been challenged in the digital age as some states consider certain internet-based activities, such as providing post-sale support via chat or using cookies for purposes beyond solicitation, as sufficient to void this immunity. Additionally, some states have implemented gross receipts or excise taxes to circumvent the protection of P.L. 86-272.

Understanding income tax nexus is critical for foreign businesses entering the U.S. market, as it determines whether a company is subject to state income tax obligations. Some may incorrectly assume that unless they open a U.S. office or hire local employees, they won’t owe state income taxes. However, minimal physical activities can trigger nexus in certain states even for businesses without a formal U.S. establishment. Foreign businesses must also closely monitor economic activity and in-state solicitation for state tax purposes, as well as the avoidance of potential exposure.

For more information on how U.S. state tax nexus, both sales and income tax, may affect your foreign business, please reach out to Kevin Brown or Gwayne Lai of Anchin’s International Tax Group, Alan Goldenberg of Anchin’s State & Local Tax Group, or your Anchin Relationship Partner.

Stay tuned for the next installment of our U.S. Expansion Playbook series, which will dive deeper into sales tax and potential exposure for foreign businesses.