Nexus Is Crucial, Complex Connection for State Tax Professionals
After financial crisis, states enacted broader laws to increase revenues

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Nexus is a wondrous word, replete with meanings. A quick search turns up all kinds of interesting uses. Nexus is a cell phone, it is a type of android from the movie Blade Runner, and it appears in the names of songs, bands, and albums. It is a superhero, the center of the DC Comics universe, and a plot device in a Star Trek movie. The list goes on.

But for tax professionals, particularly state and local tax professionals, a discussion of nexus is really the discussion of one basic question: can a person (or transaction) be subject to tax?

For academics, a discussion of nexus can cover significant and complex theoretical questions about the Due Process Clause, the dormant Commerce Clause, and a state’s sovereign authority to impose tax. However, for tax professionals, a discussion of nexus is a practical question: is my client or company exposed to tax in a particular jurisdiction?

It is no secret that states lost significant revenue during and after the 2008 financial crisis.1 That loss resulted in states enacting broader and broader nexus laws in an effort to increase revenues, particularly with respect to sales and use taxes. Sales and use tax nexus has always been an important issue, but a number of recent developments could represent significant changes in the nexus landscape.2

In this article, I will try to answer three simple, practical questions:

  1. What is the current state of the law?
  2. What should you be worried about?
  3. What should you do now?

We will focus primarily on sales and use tax,3 although there will be some important discussions about the state of income and gross receipts taxes toward the end.

What Is the Current State of the Law?

The dormant Commerce Clause requires a person (or transaction) to have “substantial” nexus with a state before the state may impose a tax on the person or transaction.4 Despite many states’ efforts to impose a different standard, for sales and use tax nexus, substantial nexus requires physical presence.

A retailer has physical presence either directly, by having property or employees5 in a state, or indirectly, through a third party that has a physical presence in the state and engages in activities that establish and maintain a market for the retailer.6 This has been the rule since 1992, when a case commonly referred to as Quill was decided. Since Quill, there have been various attempts to expand the definition of nexus and what constitutes physical presence. Currently, several efforts are underway to address the physical presence rule. Although many other issues exist, we will focus on four primary ones:

  • economic nexus provisions;
  • reporting and notification requirements;
  • marketplace nexus bills; and
  • federal legislation.
Economic Nexus Provisions

States have long wanted to use an economic nexus standard, rather than a physical presence standard, to establish substantial nexus for sales and use tax. However, until recently few states had such statutes on the books,7 and the precedential power of Quill was likely considered so strong that few states would try.

Within the last year, however, states have started to explicitly push back on Quill. States are passing economic nexus statutes or adopting administrative positions under which an out-of-state retailer is required to collect sales and use tax if the retailer’s sales into the state exceed a threshold amount. As of this writing, at least five states (South Dakota, Wyoming, Alabama, Tennessee, and Massachusetts) have passed or adopted economic nexus statutes or administrative actions,8 and many more are considering similar legislation.9 All of these approaches are being challenged by trade groups or taxpayers as being unconstitutional under Quill. Of the five states, South Dakota’s challenge is the furthest along, so I will focus on that.

The bill enacted by South Dakota was designed to move a challenge to Quill in front of the U.S. Supreme Court as quickly as possible. The South Dakota statute provides that an out-of-state retailer that makes more than $100,000 of sales into South Dakota has substantial nexus and is required to collect and remit sales and use tax. The statute has an anti-retroactivity feature that prohibits the state from enforcing a collection requirement while the statute is being challenged, as well as a provision allowing a challenge to be filed directly in court without having to go through the standard audit and assessment process. Pursuant to these provisions, the state filed suit against four out-of-state retailers (one of which settled) in a South Dakota district court. The retailers attempted to remove the case to federal district court, but the federal district court remanded the case back to state court. On March 6, the state district court granted the retailers’ motion for summary judgment.10 The case now moves forward to the South Dakota Supreme Court as South Dakota v. Wayfair, Inc. et al.

This case will move quickly and should be tracked closely. Assuming the South Dakota Supreme Court affirms the lower court and the U.S. Supreme Court then grants certiorari, if South Dakota’s approach is approved by the U.S. Supreme Court, then it is expected that virtually every state with a sales and use tax will pass some version of the South Dakota statute relatively quickly. In response, there may be a renewed effort by online retailers to get legislation passed at the federal level (discussed further below) to provide some protections for businesses.

If the approach is not approved by the U.S. Supreme Court (or if the South Dakota Supreme Court rules against the state and the U.S. Supreme Court does not grant certiorari), then there will also likely be renewed calls for federal legislation, but this time likely from the states and probably from retailers with large physical presence footprints.

It is very difficult to predict what Congress would do if that happens, particularly in this political climate. However, whichever way the U.S. Supreme Court decides, we will likely see a significant push for federal legislation soon after such a decision.

Reporting and Notification Requirements

Of more immediate concern are the reporting and notification requirements enacted by Colorado, which are finally coming close to being enforceable. A short history of this effort is helpful. In 2010, Colorado passed a statute that required out-of-state retailers (without a physical presence) to provide three types of information reports: 1) notification to purchasers upon purchase that the transaction may be subject to sales and use tax; 2) an annual report to the purchaser of the purchases; and 3) an annual report to the state about the purchases, including the identity of the taxpayers.11 The intent of the statute was to make the reporting compliance so burdensome that retailers would instead collect sales and use tax.12

The constitutionality of the statute was soon challenged by the Direct Marketing Association (DMA), a trade association, which filed a suit in federal district court and obtained an injunction preventing the statute from going into effect.13 During the subsequent litigation, suit was also filed in state court and an injunction obtained there as well.14 After a lengthy run in the federal courts,15 it appears that the statute is finally set to go into effect. Although the federal injunction was lifted as part of the federal litigation, the state injunction has remained in effect, preventing any enforcement.

That is about to change. Recently, the DMA and the state settled the state case and in doing so the state agreed that it would not enforce the statute until July 1, 2017.16 Thus retailers will have to decide whether to comply with the reporting requirements or to comply voluntarily with the Colorado sales and use tax law. However, there is an effort to repeal some of these requirements.17

Retailers also may have to make this decision in other states. Several states are currently considering similar provisions.18

Marketplace Nexus Bills

Unlike the economic nexus and reporting requirements, no state has enacted any marketplace nexus provisions, at least as of this writing. However, six states have proposed some version of these bills in the current legislative cycle.19

These bills, the earliest of which were proposed (but not passed) in Washington and New York states in 2015,20 typically require marketplace providers (or facilitators) with physical presence in those states to collect sales and use tax on sales made “through” the marketplace. Most (but not all) of these bills would require marketplace providers to collect and remit sales and use tax, even if the sellers are already collecting or the seller would rather collect and remit the tax on its own returns. The bill introduced in the Washington legislature this year would also impose Colorado-style reporting requirements on marketplace providers (and sellers) that do not have nexus with Washington.21

As stated above, no state has passed any of these bills. However, more and more of these bills are being proposed.

Federal Nexus Legislation

All of these nexus developments have been, in some way, a reaction to the lack of federal legislation. As anyone who has been following these issues knows, aside from 2013, when legislation passed the Senate,22 there has been little movement on legislation at the federal level.

Three different bills are currently being discussed: the Marketplace Fairness Act (MFA),23 the Remote Transactions Parity Act (RTPA),24 and the Online Sales Simplification Act (OSSA).25 MFA and RTPA are revisions of bills that have previously been proposed. They would authorize states to impose sales and use tax collection requirements on remote sellers for sales made into the state so long as the states either were members of the Streamlined Sales and Use Tax Agreement (SSUTA) or had enacted certain simplification requirements. Both bills would require states to provide software to assist businesses with complying with the collection requirements. RTPA has some additional protections for businesses, including a safe harbor from audits for small sellers.

OSSA presents a significantly different approach. OSSA would establish a federal definition of physical presence more limited than the current definition. Sellers with physical presence would comply with existing laws, but sellers without it would be subject to an origin sourcing regime, allowing the state of origin of the sale to collect tax from the sellers. The bill would also establish a clearinghouse for the origin states to send the money collected to the destination state. As is readily apparent, the OSSA approach would differ significantly from the current approach to sales and use tax laws. In essence, it would make the state of origin the collecting and remitting agent for the state of destination of the sale.

It is unclear what if anything will happen in this Congress with these bills, none of which have been introduced in the current session of Congress. As discussed above, if the U.S. Supreme Court rules on South Dakota’s case, there will likely be a significant push for federal legislation this year. However, it remains to be seen who will lead the effort to pass the legislation and what effect such an effort will have. Despite decades of little progress at the federal level, taxpayers need to be aware of discussions at the federal level in light of the possibly enormous impact such legislation could have.

[I]f the U.S. Supreme Court rules on South Dakota’s case, there will likely be a significant push for federal legislation this year.

Other Nexus Developments

Although these are the four primary issues, other developments have emerged. More and more states have enacted or are proposing “affiliate nexus” and “click-through nexus” provisions.26 These are widespread enough that most companies should have already developed strategies to address them.

What Should You Worry About?

Obviously, this answer differs among industries and companies. Retailers and service providers will be most affected, but buyers of property and taxable services may be, too.

Retailers of tangible personal property should be concerned about each of the four primary issues discussed above. With respect to the economic nexus provisions, retailers should consider a number of things. If the South Dakota provision is upheld by the U.S. Supreme Court, then retailers will have to collect sales and use tax if they have sufficient sales to cross a certain threshold27 and will be required to do so without any of the protections historically discussed at the federal level. Determining the moment when the threshold is crossed presents additional difficulties that are beyond the scope of this article.

Sellers should consider whether to review taxability of their products or services in various states to prepare for compliance with notification and reporting requirements. We are likely to see more states enact these provisions after Colorado’s provisions become effective.

However, even if the U.S. Supreme Court upholds South Dakota’s approach, that does not necessarily mean that all other state regimes will be approved. First, South Dakota is a member of SSUTA. If South Dakota’s statutory regime is determined not to violate the dormant Commerce Clause, does that also mean that the statutory regimes of states that are not members of SSUTA are also approved? In addition, will Alabama’s and Tennessee’s approaches, enacted administratively, be approved?

Although the South Dakota litigation is moving quickly, a more immediate issue is the Colorado reporting requirement and similar legislation that could take effect over the next year. Retailers of tangible personal property will need to determine whether to comply with the reporting regime or to collect and remit sales and use tax. Retailers will have to determine the costs and risks associated with both paths. As the reporting requirements are unlike existing tax notification and reporting requirements, retailers will need to determine the cost of creating a system to comply and what ongoing costs are. And if a retailer decides to collect and remit, then the costs of commencing collection (including taxability review, rate determination, ongoing return filing costs, and costs associated with audits) must be determined as well. Retailers should also be concerned that, if Colorado sees a favorable result from the approach, it will spread to other states very quickly.

With respect to the “marketplace” legislation, retailers that sell through marketplaces will need to be concerned about reviewing the contracts associated with marketplace providers. The primary issue will be whether the law allows a retailer to collect on its own (if it has nexus with the state) or whether the marketplace provider must collect. This is a concern, because retailers may want to keep collecting if they have the systems already set up and if they think they can perform those activities in more cost-efficiently than the marketplace provider can. Either way, a retailer’s agreement with the marketplace provider will need to be updated and reviewed. Retailers will also need to ensure that they have retained all required documentation from the marketplace provider to ensure that the retailer is not liable if the marketplace provider does not comply.

Retailers or sellers of services should also have concerns about these various approaches. With respect to economic nexus, service providers may believe that their service is not taxable in many states. However, if economic nexus becomes the law of the land, then states may seek to expand the tax base to include more and more services, as has been the trend even without nexus. The pace of this expansion may increase if economic nexus is adopted. Service providers should monitor taxability changes vigilantly.

With respect to Colorado’s reporting requirements, service providers should also be concerned about taxability determinations. Colorado’s requirements have various carve-outs for exempt and other nontaxable sales of services. Thus service providers, even those without nexus with Colorado, should still review whether their services are subject to tax in Colorado. If they are, then the service provider would be required to comply with reporting requirements.

Even if a company is not a retailer or a service provider, but rather a buyer of services and tangible personal property, there are still several issues to be concerned about. First, if economic nexus is adopted, buyers will need to ensure that they maintain any applicable resale, component part, or other exemption documentation. Many more retailers and service providers will be asking for exemption documentation if they are required to collect tax. Second, buyers should review their use tax remittance procedures to make sure that buyers will not be subject to both sales and use tax on the same transaction. This will be particularly important for companies that remit use tax on services and software purchases that are billed to one address for a company but used in multiple locations. Furthermore, buyers will need to review their use tax compliance for states that enact reporting requirements to make sure that they remit use taxes on reported transactions within those states.

What Should I Do Now?

Primarily, companies should track and monitor the South Dakota litigation. This case will move forward quickly and could have a significant impact, particularly if the state wins. If it does, there will likely be significant effort at the federal level to move federal legislation to establish some protections for online retailers. But if the state loses, we should expect the states and retailers to push for federal legislation to address the physical presence issue.

Second, companies should monitor the state economic nexus, reporting requirements, and marketplace bills discussed above and any new bills that might come along. Companies should, if they are not already doing so, leverage their government affairs or similar departments that can leverage contacts within state government and legislatures to ensure that relevant bills are brought to the company’s attention. At the same time, it is important to also monitor regulatory developments and any rulings or guidance issued by state revenue authorities. Given the difficulty of getting tax legislation passed in certain states, some state revenue authorities are taking matters into their own hands and pushing for nexus expansion through non-statutory methods. This was the route taken in Alabama, Tennessee, and Massachusetts. Being informed of these developments is critical. For example, Alabama is already aggressively enforcing its regulation despite constitutional challenges.

Finally, sellers should consider whether to review taxability of their products or services in various states to prepare for compliance with notification and reporting requirements. We are likely to see more states enact these provisions after Colorado’s provisions become effective. Companies may want to be proactive in determining taxability.

A Note on Gross Receipts Taxes

Although we have focused on sales and use taxes, it is important to note a related case that may be heard by the U.S. Supreme Court. This is the case challenging the economic nexus of the Ohio Commercial Activity Tax (CAT). Ohio imposes the Ohio CAT instead of a corporate income tax. An out-of-state corporation is required to pay the CAT if it meets certain thresholds, including making more than $500,000 of sales into the state.28 In November 2016, the Ohio Supreme Court upheld that provision as constitutional in the Crutchfield and companion cases.29 The taxpayer could have appealed to the U.S. Supreme Court by April 16, but the parties settled the case on April 14, 2017.30
This leaves open the possibility that another taxpayer could challenge the threshold, perhaps in another state with a gross receipts tax such as Washington.

A Final Word

Nexus developments will be moving quickly this year. It will be more important than ever for companies to monitor legislative and litigation developments on nexus to prepare for what is coming. Furthermore, although the South Dakota statute was designed to prohibit its being applied retroactively, other states will not necessarily follow suit. Companies should be wary of any state that attempts to use nexus expansion to go after past tax liability, rather than collecting and remitting on a prospective basis.


  1. “Fiscal 50: State Trends and Analysis,” The Pew Charitable Trusts, February 2, 2017,
  2. Please note that this article was completed in mid-April. It may not include all updates at publication time.
  3. For our purposes, “nexus” will mean “sales and use tax nexus” unless otherwise specified.
  4. Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
  5. Quill v. North Dakota, 504 U.S. 298 (1992).
  6. Scripto, Inc. v. Carson¸ 362 U.S. 207 (1960); Tyler Pipe Indus. v. Washington, 483 U.S. 232 (1987).
  7. Some exceptions are Minnesota (Minn. Stat. § 297A.66) and Vermont (Vt. Stat. Ann. Tit. 32 § 9701). These states had historical provisions before Quill that were on the books but not enforced. Oklahoma passed a statute declaring “Quill is dead” a few years ago (68 O.S. § 1407.5(B)), but to this date has not appeared to enforce it.
  8. Two states, South Dakota and Wyoming, have passed such statutes. South Dakota SB 106 (2016), Wyoming HB 19 (2017). Under both bills, the threshold amount is $100,000. Alabama has attempted to implement a $250,000 threshold through regulation. Ala. Reg. 810-6-2-.90.03. Tennessee’s ruling, which the department claims is the implementation of a broad statute passed in 2015, established a $500,000 threshold. Tenn. Rev. Rule 1320-05-01-.129. The Massachusetts directive also establishes a $500,000 threshold. Mass. DD 17-1: Out-of-State Internet Vendor Sales Tax (April 3, 2017). Returning to the discussion of decreasing state revenues, it is worth noting that South Dakota, Wyoming, and Tennessee do not have individual income taxes.
  9. See, e.g., New Mexico SB 123 and HB 202, North Carolina SB 81, North Dakota SB 2298, Rhode Island HB 5175, Utah SB 110, and Washington SB 5585.
  10. South Dakota v. Wayfair, Inc. et al, 32CIV16-000092, South Dakota Sixth Circuit Court, County of Hughes (March 6, 2017).
  11. Colo. Rev. Stat. §39-21-112.3.5.
  12. Phil Horwitz, the Colorado Department of Revenue’s tax policy director, said he “thinks most retailers would simply choose to collect the tax to avoid the more unpleasant option of having to send tax notices to their customers.” Colleen Slevin, “Colorado Considers New Tactic to Tax Online Sales,” The Denver Post, February 8, 2010,
  13. Direct Marketing Assoc. v. Huber, 2012 WL 1079175 (U.S. Dist.Ct. Colo. March 30, 2012) (reversed).
  14. Direct Marketing Assoc’n v. Colo. Dept. of Rev., Col. Dist. Ct.-Denver, Dkt. 13CV34855 (February 18, 2014).
  15. The statute was first struck down by the federal district court. Then the Tenth Circuit of Appeals held that it did not have jurisdiction to hear the appeal due to the Tax Injunction Act. The U.S. Supreme Court reversed the Tenth Circuit, holding that federal courts did have jurisdiction, and remanded the case back to the Tenth Circuit. The Tenth Circuit then ruled that the statute was constitutional, and the U.S. Supreme Court declined to hear the case. (See Brohl v. Direct Marketing Association, 137 S.Ct. 593 (2016).)
  16. Eric Yauch, “Colorado Agrees to Temporarily Waive Penalties for Use Tax Law Under DMA Settlement,” State Tax Notes 36-2 (February 24, 2017).
  17. Colorado SB 238 is making its way through the legislature and, at the time of this writing, would repeal the annual notice requirement the retailer is required to file with the Department of Revenue.
  18. See, e.g., Arkansas SB 140, Georgia HB 61, Hawaii SB 161, Kansas SB 111, Nebraska LB 44, Rhode Island HB 5175, Utah SB 83, and Washington SB 5855. It should also be noted that several other states, including Kentucky, had enacted notification requirements for the time of purchase but those states did not pass penalty provisions, nor were there annual requirements.
  19. See Minnesota SF 1164, New Mexico HB 202, Georgia HB 225, Rhode Island HB 5175, Washington HB 5585. (Additional states proposed some version in the last legislative cycle as well.) Ultimately, New York’s marketplace provision was not included in the enacted budget. A few states have attempted to leverage existing consignment and co-vendor provisions to tax marketplace sales. See TPR 16-3, Arizona Transaction Privilege Tax Ruling, Arizona Department of Revenue, September 20, 2016; and California Board of Equalization Publication 109, October 2016.
  20. Washington HB 2224 (2015-2016). Governor Cuomo also proposed it as part of his 2015-2016 budget for New York. fy1516littlebook/BriefingBook.pdf.
  21. Washington HB 5585.
  22. S.743, 113th Congress (2013-2014).
  23. S.698, 114th Congress (2015-2016).
  24. H.R. 2775, 114th Congress (2015-2016).
  25. OSSA has not been formally introduced as a bill.
  26. See, e.g., Arkansas SB 140, Utah SB 101, Idaho HB 155.
  27. Thresholds are likely to differ in different states.
  28. Ohio Rev. Code § 5751.01(H)-(I).
  29. See Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760 (November 17, 2016).
  30. Brian Bardwell, “Parties Settle Constitutional Challenge in Ohio Economic Nexus Case,” State Tax Notes, April 17, 2017.

Mark Yopp is a partner at McDermott, Will & Emery in New York City.

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