What is nexus and why is it important for sales tax in California?

TL;DR

• Sales tax nexus is the commercial link that a seller has with a state. It is the presence of your business (physical and otherwise) in a state.
• Once you know you have nexus, you should register with the state, and start collecting sales taxes.
• Nexus in California can be of different types: Physical nexus, Economic nexus, Trailing nexus, Marketplace nexus.
• You will have physical nexus here if you have a physical presence, such as through a store or through employees.
• You will have economic nexus here if your sales to California exceed $500,000.
• You will have trailing nexus here if your business's 'trailing' presence (after moving from one place to another) still generates sales for you.
• In the case of marketplace nexus, a marketplace facilitator has to collect sales tax on behalf of the sellers making sales (exceeding $500,000) through the marketplace.
• If you are an out-of-state seller with nexus in CA, you'll have to collect taxes for using a local dropshipper's services to deliver the product to your customer. If you don't have nexus, but the dropshipper does, then the latter has to collect sales tax from you.

As a seller, knowing when you are liable to collect and pay sales tax is important, so you can duly complete your responsibilities and avoid any penalties. Sometimes, you may be unaware of having a sales tax liability, only to find out later that you owe a large amount of taxes to the state. In order to avoid this, you should first identify your link with a state, which is known as nexus. This is the first step in recognizing whether you are liable for sales tax collection and payment. This guide will offer a simple definition of the term and the different kinds of nexus, in order to help you understand how you can be liable for sales tax in California.

What is nexus and why is it important for sales tax?

Nexus is defined as the connection that a seller has with a state. If you have a defined presence in the state—through a store, employees, agents, contractors, or even online sales above a certain threshold—you have nexus there. The different ways in which you can have nexus are discussed in detail later on in the guide, but first let's look at why it's important.

Nexus is the first step in recognizing whether you have tax liabilities to a state. You should be able to identify the commercial link you have with a state in order to know whether you will need to register for a seller's permit there, and collect and pay sales taxes. This means knowing how exactly you conduct business in a state (even if you are actually located outside the state). 

This guide will help online sellers, out-of-state sellers, sellers who hire contractors, and sellers of all kinds, understand under what conditions they have nexus with the state of California so that they can move ahead with their sales tax compliance.

What leads to nexus?

Each state has different rules for how exactly nexus can be determined, and there are many ways in which you can have nexus in California. 

Nexus through physical presence

When is it applicable?

While considering sales tax nexus in California, a direct physical presence can be established through stores, offices, warehouses, inventory, employees, temporary agents, and even traveling salespeople and business representatives. Moreover, if you make use of warehouses in a state (even if you don't own the warehouses), you will have nexus there. If your primary location is in one state, but you have branches or offices in other states, you will have nexus in all those states.

When is it not applicable?
If your presence in California is solely restricted to exhibitions, conventions, and trade shows, you will not have sales tax nexus there. However, if these events continue for more than 15 days or if you have gained a revenue of more than $100,000 from such exhibitions here in the preceding calendar year, you will have a sales tax liability and have to get a permit.

Economic nexus

A business has economic nexus when a certain volume of transactions takes place between the business and the consumers in a state. As of April 1, 2019, sellers are considered to have economic nexus in California if they exceed $500,000 in taxable sales to California consumers. This applies to businesses that are located in California as well as remote sellers and marketplace facilitators.

So, sales tax nexus can exist through both direct and indirect means. The easiest ways to determine nexus are through direct means involving physical presence and transaction volume, but there are other ways that you can be engaged in business in a state and be liable for sales tax. With the advent of online sales, online and remote sellers can also have nexus in California.

What does nexus mean for online and remote sellers?

Online sellers are required to charge and collect sales tax from their online buyers. Moreover, if you are situated outside the state but have stored items in a warehouse or even a fulfillment center in California, you will have sales tax nexus in the state. Here are the types of nexus that apply to online and remote sellers:

Trailing nexus:

In California, a trailing nexus exists when the lingering or "trailing" effect of the business's presence still generates sales for it. This means that even if your business doesn't have employees or physical presence in the state anymore, you must still collect and pay sales tax for the remaining part of the calendar year. For instance, after a salesperson has advertised a certain product, sales can be generated for the business even after the salesperson has left.

Trailing nexus is applicable for any business that has moved its presence from one state to another, and is therefore especially relevant for remote sellers. In California, a business in this situation has nexus for the fiscal quarter in which it stopped its business presence in the state, as well as the quarter that follows. Businesses with trailing nexus have to be registered with the California State Board of Equalization (BOE).

Marketplace nexus:

For marketplace nexus, it is important to distinguish between the business that acts as a seller, and the one that acts as a facilitator.

A marketplace facilitator allows business to happen by providing a marketplace (which can either be a physical space or a website). It is a business entity that lists and fulfills orders, and facilitates delivery services for third-party sellers and businesses. For example, Amazon is a marketplace facilitator.

A marketplace seller is a business that has an agreement with a marketplace facilitator to sell products through its marketplace. For example, if seller A decides to sell their products on Amazon, seller A becomes a marketplace seller. 

In California, a marketplace facilitator has to collect sales tax on transactions made through the marketplace by any seller who exceeds $500,000 in sales in the state. If the seller also makes direct sales in the state, without using the marketplace, those sales are also counted toward the $500,000 threshold. However, the seller is only responsible for collecting sales tax on the direct sales (and the marketplace facilitator is only responsible for collecting sales tax on the marketplace sales).

What else should be considered by out-of-state sellers?

Apart from the kinds of nexus mentioned above, out-of-state sellers may also have to consider tax liabilities when they deal with dropshipping.

Dropshipping refers to when a product is shipped directly to a customer by the wholesaler, on behalf of an out-of-state retailer. A California sales tax liability for a dropshipment transaction exists when an out-of-state seller (without nexus in California) sells a product to a customer in California. Such transactions essentially involve two sales and one consumer—the dropshipper (manufacturer or wholesaler) sells the product to the out-of-state seller, and the seller sells the product to the customer. The dropshipper bills the seller for the wholesale price, and as the product is meant for resale, it is exempt from sales tax. The seller bills the customer for the retail price, which is subject to sales tax. Finally, the dropshipper ships the product to the in-state customer.

If the out-of-state seller/retailer has nexus in California, then they will be liable to collect sales tax on the transaction, even though the product is actually being handled by the dropshipper. In this case, the retailer provides a resale certificate to the dropshipper as the product is meant for resale, and the retailer collects sales tax from the end buyer and pays it to the tax authority.

If the out-of-state seller does not have nexus in California, but the dropshipper does, then the dropshipper has to charge sales tax from the retailer, unless the retailer provides a resale certificate.

Note: The out-of-state seller has to ensure that their resale certificate is valid in California. If not, they may have to register with the CDTFA for a resale certificate.

What is the next step?

As a seller, once you identify that you have nexus in California, you will have to register for a sales tax permit in the state. When you make sales in California, you will have to determine how much sales tax should be collected based on the local and state sales tax rates, and file your sales tax returns by the due date.

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