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Tax Nexus, TPP, Exemptions & Other Sales Tax Terms

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Written by Monika Miles, Miles Consulting Group, Inc. (formerly Labhart Miles)

Tax Nexus

Nexus is the necessary sufficient connection that an entity must have in order for a state to impose a tax. Generally, some physical contact between a taxpayer and the state must occur. The concept is based upon U.S. Constitutional principles for interstate commerce.

Some examples of physical presence that might trigger nexus for a company:

  • An employee living or working in a state
  • An independent contractor working on behalf of the company in a state, engaging in activities such as sales, repairs, maintenance, training, etc.
  • Soliciting sales in a state (i.e.; regular travel to visit prospective customers in a state)
  • Ownership of property in a state (i.e.; inventory; property, plant & equipment)
  • Rental of property (including leased office or warehouse space)
  • Participating in trade shows in a state

Example 1: Acme Company is headquartered in California, has an office and employees in California. Acme has nexus in California.

Example 2: Roadrunner Corp sends Charlie, a salesperson from California, into Nevada to call on the company's largest customer twice per month. Charlie has created nexus for Roadrunner in Nevada.

Unfortunately, the determination of what constitutes nexus in a given state is not always clear. In the example above, if Charlie only entered Nevada once per year, would that be enough to constitute creation of nexus? What if that one visit generated sales of $1 Million? Very few states have specific rules as to how many days a company may enter in order to create nexus. In many cases, a thorough analysis of the company's activities in a given state is recommended before making a judgment of whether nexus is created or not.

Why It's Important: In today's economy, company representatives often travel to call on customers and are "full service" with respect to a transaction and the customer relationship. A company representative is likely to sell product, engage in training, repairs and maintenance, trouble-shooting, etc. as part of customer service. These activities performed in a state are likely to cause nexus and require sales tax collection on sales into the state. As mentioned above, the activities do not have to be performed by a company employee to create nexus. A third party contractor may give a company nexus as well.

Tangible Personal Property and the Definition of a Sale:

The term "tangible personal property" or TPP refers to property which can be seen, weighed, measured, felt or touched, or perceived by the senses. It does not include electrical transmissions, stocks, bonds, or other intangibles. Most sales tax statutes refer to the taxability of a product by whether or not it is TPP. In general, unless otherwise exempt, sales of TPP are subject to sales tax.

A sale is a transfer of title or possession, exchange or barter, in any manner or by any means whatsoever, of tangible personal property, for a consideration.

The sales tax applies to transfers of TPP and the performance of certain services:

  • For a consideration valued in money
  • By a person (or company)
  • In a state
  • Unless otherwise exempt.

The measure of the tax is essentially the sales price of the item (not the cost).

Sales Tax on Services (and Bundled Transactions):

In many states, certain services are also taxable. The types of services that might be taxable include certain types of labor and fabrication. For example, in California, jewelry repair services are not taxable, but fabrication of a piece of jewelry is taxable.

Taxpayers need to be aware of bundling transactions where a sale of TPP might be accompanied by services such as installation or training. Installation and training are generally not subject to sales tax if separately stated on an invoice. However, if bundled together as "one price" with the TPP, the entire sale could be deemed taxable. Other items, such as delivery services, may also be subject to tax.

Why It's Important: Companies often like to sell a "full service" item, complete with the widget, warranty, service contract, training, and installation all bundled into one price. Unless the seller charges sales tax on the individually taxable items, an auditor may lump the entire transaction together, thereby taxing items which would otherwise not be taxable. Rules differ among the states, so taxpayers should use caution with bundling a transaction. Where possible, if an invoice includes both product and services, it's best to document specific line items for each identifiable cost - if economically feasible. We've seen clients continue to bundle a transaction for valid business reasons. We just recommend that companies review their policy and understand why they are billing the way they do.

Sales Tax Exemptions:

However, it is important to understand that some transactions are exempt from sales tax. Exemptions fall into one of the following categories:

  • Due to the nature of the seller (Es. A Reseller of products)
  • Due to the nature of the buyer (Ex. U.S. Government)
  • The nature of the property/service transferred or performed (Ex. some medical devices, food products, drugs, etc. may be statutorily exempt in certain states)
  • The intended use by the purchaser (Ex. - sales for resale, or used in manufacturing, in certain states)
  • Nature of the transaction (Ex.- transmission of software over the internet)

Why It's Important: If a sale is exempt, and proper documentation exists, the seller may not be required to collect sales/use tax. However it is important for the seller to maintain the documentation in the company files as the burden of proof is on the seller to provide evidence of exemption.

Don't forget to check the following Sales Tax 101 sections to learn more about sales tax:

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