Nexus Confusion: Sales and Use Tax

Businesses without a physical presence in a state may be challenged to know if they should collect sales and use tax. Reasons for uncertainty and tips on improvements revealed.

September 27, 2007
by Annette Nellen, CPA/Esq

The best way for a business to simplify its nexus determination for sales tax purposes is to set up a sales office in the state in question (see Business Across State Lines in today’s issue). Then, it clearly has nexus and must collect sales tax there. But, this approach isn’t the business reality or plan for Internet-era businesses. Businesses without an obvious physical presence in a state, but with customers there, may be challenged to know if they should collect sales and use tax. This article looks at the reasons for uncertainty and what improvements might be made.

Sales and Use Tax Nexus

For a state to subject a vendor to sales and use tax (SUT) collection obligations, the vendor must have nexus with that state. Nexus is a connection between the vendor and state such that subjecting the vendor to the state's laws is neither unfair to the vendor nor likely to harm interstate commerce — requirements stemming from the due process and commerce clauses of the U.S. Constitution.

In the 1992 Quill Corp. v. North Dakota decision (504 U.S. 298), the Court ruled that due process and commerce clause nexus requirements were not the same because they were “animated by different constitutional concerns and policies.” Due process nexus requires “minimum contacts” with the jurisdiction. The Court found no due process concern where a vendor not physically present in a state purposefully availed itself of the benefits of an economic market in the state, such as Quill did, by sending catalogs into the state.

The Court held that the commerce clause required “substantial nexus” as indicated by physical presence. The Court noted the existence of over 6,000 state and local jurisdictions in the U.S. that imposed SUT without consistent rules. Requiring non-present vendors to collect SUT could harm interstate commerce.

Physical Presence Confusion

Since Quill, the challenge has been to determine how much and which type of physical presence is needed to have substantial nexus. The Court noted that the few floppy diskettes Quill sent to North Dakota customers did not satisfy substantial nexus.

The defining line between slightest and substantial presence varies from state to state. It is not unusual to see dissenting opinions and higher courts disagree with lower courts. A business with similar operations in two states might find that it is required to collect SUT in one but not the other.

An example of differing nexus interpretations involved online operations of booksellers that operated physical stores and expanded to online sales. Separate legal entities were formed for the online operations to reduce the number of physical locations of the entities, thereby reducing SUT obligations. The online entities (online) shared a name with the physical entities (physical) which also handled some returns for online customers.

Despite similar fact patterns, a 2007 Louisiana ruling (St. Tammany Parish Tax Collector v. BarnesandNoble.com (05-5695 ED La) concluded that online did not have nexus, while a 2005 California decision reached the opposite conclusion in Borders online, LLC v. BOE, 29 Cal Rptr 3d 176.

The Louisiana tax agency raised the nexus issue because online and physical had common membership and gift card programs, cross-promotional advertising and physical gave preferential product return treatment to online’s customers. The court found that activities physical performed for online did not rise to a level to indicate that physical marketed online’s products on behalf of online. Physical did not take orders for online and did not provide facilities for customers to place orders with online. The membership and gift card programs did not generate revenues for online. The court also found that the benefits online derived from physical’s advertising and returns did not impute physical’s presence to online. The court also noted prior cases holding that the physical presence of one corporate entity cannot be imputed to a related corporate entity (SFA Folio, (1991)).

In contrast, the California court found that physical’s activities for online made it a representative and promotional and return activities constituted “selling” thus creating SUT obligations for online (per California Revenue & Taxation §6203(c)).

Why Confusion Is a Problem

If a company believes it does not have nexus in a state and the state later finds that it does, the company will owe tax, interest and penalties. If a company errs on the side of caution and collects SUT, it may be incurring unnecessary compliance costs. Customers unaware they owe a use tax if they are not charged sales tax will find the company has higher prices than its competitors who are not collecting SUT.

Companies must spend significant time reviewing their operations and relationships and the law of every state in which they have customers to determine if they have SUT nexus, yet not achieve certainty. Confusion also results due to special state rules where some physical presence is ignored, such as certain trade show activity. But again, rules differ from state to state, are not always clear and interpretations continue to evolve.

Possible Solutions

States should take steps to make SUT nexus requirements as clear as possible. They could provide a checklist for businesses to allow them to determine if they have SUT nexus under state law and the Quill standards. If the checklist indicates a physical presence, the tax agency should help the vendor with its collection responsibilities. Simplified compliance approaches should be provided. For example, if the vendor only sells items online, the state should allow the vendor to have a link on its site such that when the customer’s credit card is charged for the goods purchased, it is also charged to the state tax collector for the SUT. This eliminates filing for vendors and reduces their compliance costs and credit card fees.
If the checklist indicates the vendor has no physical presence, the state should provide a safety mechanism to help ensure customers pay use tax. The state could ask non-present vendors to note on their Web site or catalog that they have no SUT collection obligation in State X, so State X customers must self-report use tax on the purchase. If vendors comply with this request, they could be relieved of liability should a later audit indicate that a non-fraudulent mistake was made on the checklist.

Several states have adopted the uniform SUT law created by the Streamlined Sales Tax Project. The hope is that Congress will reverse Quill for these states to allow them to collect SUT from non-present vendors. However, not all states have adopted this law and some may not. Alternatively, Congress could exercise its authority under the commerce clause to provide uniform SUT nexus guidance.


The SUT nexus issue will not go away anytime soon and will continue to pose complexities and costs, particularly for e-commerce companies. States need to do more to reduce the uncertainty which should also improve their SUT collections.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.