If you’re a business owner who sells goods or services in multiple states, you're probably already well acquainted with the concept of sales tax nexus. Having nexus in a state means that you’ve established enough of a presence there, either physical or economic, to become obligated to register to collect sales tax from buyers in the state, file tax forms with the state, and remit payment.
But what happens when your connection to a state ends? While you might assume that your sales tax obligations end, too, that's not necessarily the case, thanks to something called trailing nexus.
Trailing nexus can extend your sales tax obligations for a long time after your connection to a state ends. This guide will explain the rules for trailing nexus so you can better understand how it affects your sales tax obligations.
What is trailing nexus?
Trailing nexus, or residual nexus, is when a state requires you to continue to comply with sales tax regulations after you no longer meet nexus thresholds in the state.
For example, say you have two physical stores, one in California and one in Oregon, but you decide to close your California location.
If you no longer have employees, inventory, or real estate in California, and if you no longer sell to California-based customers, your no longer have nexus in the state. But your sales tax obligations there continue.
California’s Regulation 1827 says that a retailer with a physical presence during any portion of a calendar year has nexus not only for that calendar year, but also for the following calendar year as well. This rule applies to physical nexus and economic nexus. So you'd have to close your location and have less than $500,000 in annual sales for more than a year before your sales tax collection obligations ended in California.
If you’re no longer selling anything in California, you simply need to file some required forms. However, if you’re doing some business but not enough to hit California’s nexus threshold, you're still required to collect and remit sales tax for the duration of the period that trailing nexus lasts.
How long does trailing nexus last?
Each state sets its own sales tax rules. So rules regarding how long trailing nexus lasts also vary from state to state.
As mentioned above, in California, trailing nexus lasts for the calendar year when you establish nexus, as well as for the following calendar year. Colorado and Washington have similar rules.
In Michigan, however, a seller who has physical nexus is considered to have nexus for the remainder of that month and for the following 11 months, whether or not physical nexus ends. However, if an out-of-state seller establishes economic nexus but then that nexus ends, the seller must still comply with Michigan’s sales tax rules until a full calendar year passes in which the seller doesn't meet the threshold for economic nexus.
Minnesota also has different rules for physical nexus and economic nexus while Missouri's confusing rules say that "once nexus has been established, it will continue to exist for a reasonable period of time after the vendor no longer has a physical presence in the state." But the rules go on to say that the department presumes that the vendor has nexus for at least one reporting period after they no longer have a physical presence.
Texas and Washington also have trailing nexus. While Texas eliminated its 12-month trailing nexus policy in 2015, this rule change happened before the South Dakota v. Wayfair case that established the concept of economic nexus in 2018.
With economic nexus rules in place, Texas now requires an out-of-state company's revenue to drop below the threshold for economic nexus for 12 consecutive months before the company is no longer required to collect sales tax.
Business implications of trailing nexus
Trailing nexus has significant implications for your business, since you retain obligations in a state even when you no longer have a physical presence or a high volume of sales there. Specifically, you are still obligated to:
- File sales tax returns. They still have to be filed on time at the frequency required by the state.
- Collect and remit sales tax on residual sales. If you're still doing some business in a state but have dropped below the economic nexus thresholds, you'll need to collect sales tax on whatever items you are selling and remit those amounts.
- Respond to audits or notices. If you receive an email from the state, you must respond. If the Department of Revenue audits you, you’ll need to be prepared to produce the appropriate documents. In fact, your risk of an audit will not disappear when you no longer have nexus in a state, so you should always be audit-ready.
- Carefully track when nexus starts and ends. If you expect that you will no longer have to collect sales tax in a given state at some point, careful tracking of the date when you last met the threshold will be important.
You'll also have to think carefully about whether you want to cancel your sales tax registration when nexus ends. If you expect your sales volume to pick up again shortly or if you plan to move into another physical location in the state soon, then canceling your registration and then re-registering may not be worth the hassle.
How to handle trailing nexus
With trailing nexus rules in place in a number of states, it's important that your business do everything possible to remain in compliance with sales tax rules anywhere that you had obligations to collect tax.
Keeping detailed records of your exit date from a state is crucial in case you are audited — which is a very significant risk, as states don't like to lose revenue sources and may have questions if you used to pay tax there and decide that you no longer need to.
You should also consider confirming with the state's Department of Revenue whether nexus has actually ended and when it ended. If your dates don't match up with the state’s, it's best to find out why before you stop remitting tax and find yourself facing penalties and fees.
Unfortunately, managing all of these trailing nexus issues can take time, put your business at risk of losing money, and lead to a lot of headaches. The good news is, you can just opt out of doing this yourself. Numeral can handle all of these issues for you.
Numeral will track nexus, will track when nexus ends, will help you understand the rules for trailing nexus, and will take care of registration and deregistration issues for you. Numeral also collects and remits taxes on your company's behalf while you have nexus and have to bear the burden of this obligation.
It can be difficult enough to understand all of the sales tax rules in a state where you're actively doing business — so if news of trailing nexus has you even more frustrated with these complicated sales tax rules, contact Numeral today to hand off this task, so you can focus on the parts of your business that help you drive success.
