Economic Nexus and Sales Tax Exposure for Online Sellers | HL Hunt
Economic Nexus and Sales Tax Exposure for Online Sellers
Since South Dakota v. Wayfair in 2018, a business can owe sales tax in a state it has never set foot in, from the moment its sales there cross a threshold. A seller with $340,000 a year of uncollected sales into a 7% state for three years owes $93,177 with interest and penalties, which is 76% of the profit it made on those sales. The tax was never its money. Because it was not collected, it now comes from margin.
What you'll learn
What changed in 2018
For decades a state could require a seller to collect its sales tax only if the seller had a physical presence there. The rule came from National Bellas Hess in 1967 and was reaffirmed in Quill Corp. v. North Dakota in 1992. A business shipping from one state to customers in forty others collected tax at home and nowhere else.
In South Dakota v. Wayfair, Inc. (2018), the Supreme Court overruled the physical presence rule. South Dakota's statute required out-of-state sellers to collect if they had more than $100,000 of sales into the state or 200 separate transactions in a year, and the Court upheld it. Every state with a sales tax now has an economic nexus rule of its own. Many use the $100,000 threshold; several have since dropped the transaction count; a few set higher thresholds.
The consequence is that a small business selling online can owe sales tax in a state it has never visited, and the obligation begins when it crosses the threshold, not when it notices. Per our small business tax analysis, collected sales tax is held money, not revenue. Uncollected sales tax is worse: it is the seller's own money, owed out of margin.
How the exposure accumulates
A business sells $340,000 a year into a state with a combined rate of 7%, well above that state's threshold. It has not registered, so it has collected nothing from customers for three years.
| Item | Amount |
|---|---|
| Tax that should have been collected, three years | $71,400 |
| Interest, roughly | $7,497 |
| Penalty, at an assumed 20% | $14,280 |
| Total | $93,177 |
| Profit on those sales over three years, at a 12% margin | $122,400 |
The arithmetic is unforgiving for a structural reason. Sales tax is a share of revenue, often 6% to 10%, and small business margins are often a similar size. An uncollected tax obligation is therefore roughly the same order as the profit on the same sales, and adding interest and penalties pushes it past. Per our pricing analysis, a margin that looks healthy can be entirely consumed by a cost nobody priced.
Exposure also does not stop at a few years, and per our growth analysis, it grows fastest in exactly the years a business is expanding into new states. Where a business never registered, there is generally no return on file to start a limitation period, so a state can in principle look back further. At five years the same business owes about $163,625.
Voluntary disclosure
Most states offer a voluntary disclosure agreement: a business that comes forward before the state contacts it registers, pays the back tax and interest for a limited lookback period, and in return the state typically waives penalties and limits the lookback, commonly to three or four years. The Multistate Tax Commission runs a program that lets a business approach several states at once, anonymously at first.
- With a three-year lookback and no penalty, the same business owes about $78,897, against $163,625 for a five-year exposure with penalties.
- The protection is lost once the state makes contact. A nexus questionnaire or audit letter usually ends eligibility, and per our business tax debt analysis, a liability assessed after contact is negotiated from a weaker position.
- Some of the tax may be recoverable from customers for business-to-business sales, where customers can sometimes be asked to self-assess use tax or provide exemption certificates.
Timing is the whole value of a VDA. A business that discovers its exposure and waits loses the penalty waiver the day a letter arrives, and per our ambiguity analysis, uncertainty about whether a threshold was crossed is a reason to measure, not a reason to wait.
Marketplace sales are usually someone else's problem
Every state with a sales tax has adopted a marketplace facilitator rule, requiring large marketplaces to collect on sales they facilitate. If 60% of this business's sales into the state were through a marketplace, its own direct exposure falls to about $37,271. But states differ on whether marketplace sales count toward the seller's own threshold, so a business can owe tax on its direct sales even when its direct sales alone would not have crossed the line. Per our marketplace payments analysis, the platform's role is defined by contract and by state law, and both need reading.
Measuring where you have nexus
- Report sales by destination state, monthly, separated into direct and marketplace channels.
- Track each state's threshold and measurement period, which may be the current or prior calendar year, or a rolling twelve months.
- Note which states count marketplace sales toward your threshold and which exclude them.
- Register before the threshold is crossed when you can see it coming, since collection must start promptly once you cross.
- Check product taxability. Many states exempt some goods, such as groceries or clothing, or tax digital products differently.
- Remember physical nexus still exists. Inventory in a third-party warehouse, employees or contractors working in a state can create nexus regardless of sales volume.
Item six is the one that surprises businesses using fulfilment networks. Inventory stored in another state's warehouse is physical presence, and per our cross-border analysis, the same logic of presence-by-asset applies across borders to value added taxes.
A back-tax bill is a cash event, and it lands on the business
Uncollected sales tax is paid out of margin, often on a voluntary disclosure timetable. HL Hunt Business Credit Builder establishes tradelines in your business's own name, so a facility to spread an unexpected tax liability is available on the business's record rather than the owner's.
The cost of complying
The reason small sellers resist registering is that compliance is genuinely costly. Each registration brings a filing calendar, rate tables that change by city and county, product taxability rules, and returns, sometimes monthly. A business with nexus in a dozen states can face over a hundred filings a year, and per our reconciliation analysis, the tax collected has to reconcile to the deposits it arrived in.
- Automated rate and filing services reduce the work to a subscription, priced per transaction or per return.
- States in the Streamlined Sales and Use Tax Agreement offer certified service providers, in some cases at no cost to qualifying sellers, and simplify registration across member states.
- Collecting at checkout costs nothing in margin, because the customer pays the tax. The compliance cost is real; the tax itself is not the seller's if collected.
That last point is the whole argument for registering on time. A business that collects pays only the administrative cost. A business that does not pays the tax itself, plus interest and penalties, out of profit. Per our year-end analysis, the annual review is the natural point to check every state against its threshold, and per our cash flow forecasting analysis, a discovered liability belongs in the forecast the week it is found.
The argument against economic nexus
The dissent in Wayfair, and many small-seller advocates since, argued that the decision imposes compliance costs on small remote sellers that large retailers absorb easily, and that thresholds of $100,000 capture businesses too small to bear the burden of filing in many jurisdictions. That argument is about policy, and it has force: the fixed cost of multi-state compliance falls hardest on the smallest sellers that cross thresholds. It does not change the obligation of a seller that has crossed one. The practical response is to use the simplification tools that exist, and to treat each state threshold as a line to be planned for rather than discovered afterwards.
Frequently asked questions
A state's right to require remote sellers to collect sales tax based on sales into the state, allowed since South Dakota v. Wayfair in 2018.
Here $93,177 after three years on $340,000 a year at 7%, which is 76% of the profit on those sales.
A deal to pay limited back tax and interest, usually with penalties waived, available only before the state contacts you.
The marketplace generally collects on its sales, but some states count those sales toward your threshold, creating obligations on your direct sales.
Key takeaways
- South Dakota v. Wayfair (2018) let states require remote sellers to collect sales tax based on sales volume.
- Every state with a sales tax now has an economic nexus rule; many use a $100,000 threshold.
- Three years of uncollected tax on $340,000 a year at 7% becomes $93,177 with interest and penalties.
- That is 76% of the profit on those sales, because sales tax rates are a similar size to small business margins.
- Without a return on file, exposure can extend further back: about $163,625 at five years here.
- A voluntary disclosure agreement, available only before state contact, cut this to about $78,897.
- Marketplace facilitators collect on their own sales, but some states count those sales toward your threshold.
- Collecting at checkout costs only administration; failing to collect costs the tax itself.
References
- National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967).
- Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
- South Dakota v. Wayfair, Inc., 585 U.S. 162 (2018).
- Streamlined Sales and Use Tax Agreement, Streamlined Sales Tax Governing Board.
- Multistate Tax Commission, National Nexus Program and Multistate Voluntary Disclosure Program.
This guide is educational and does not constitute tax or legal advice. All figures are stylized illustrations using assumed sales volumes, tax rates, interest, penalty rates, margins, marketplace shares, and lookback periods, and do not describe any particular business or state. Economic nexus thresholds, measurement periods, marketplace facilitator rules, product taxability, voluntary disclosure terms, interest and penalty rates differ by state and change over time. Consult a qualified tax adviser about your own obligations.