State Sales Taxes for Startups 101

What is State Tax Nexus:

• Tax Nexus describes the relationship between a taxing authority and a business.
• Tax Nexus must exist before a state’s taxing authority can levy a tax on a business.
• A business must have a substantial presence in a State before it creates nexus.
• To determine your business has Tax Nexus in a state:
  • Registering to do business in the state
  • Physical Presence in the form of Employees, Property, or Assets in a state
  • The Supreme Court’s decision in South Dakota vs Wayfair many states enacted economic nexus laws for businesses that generate a material amount of revenue in states even if there is no physical presence in the state!

Tax nexus is the relationship between a taxing authority and a business. The way it goes is a business has to have one before it can be taxed.

So there are a couple of different types of thresholds to establishing a state tax nexus.

The basic idea is you must have a prominent presence in a state. There are a couple of ways for you to check and see if your company has this. The simplest way is just to see if you have a state registration to do business in that particular jurisdiction. The reason for that is when you start conducting business in a state, typically you have to register. The state knows you registered with them; so they are more likely to check on you and make sure you’re filing the right sales tax and tax returns. So that’s the first shortcut.

The more established way is to evaluate whether you have employees, assets, or property in a state. Anyone who’s working in a state will start triggering a state tax nexus.

So for example, if you’re a startup, and you have a W2 employee working in North Carolina, and that W2 employee is renting office space, you are going to start triggering a nexus in North Carolina. That is, that’s a pretty clear cut. It’s a little tougher to determine sometimes if there’s a computer or some very small amount of assets in North Carolina. But, you can pretty much bet that if you have employees in NC, then you are going to have a nexus.

It’s really important to distinguish between employees versus contractors. If they are contractors, and they have their equipment, such as their own laptop, you are not establishing nexus in that state.

Now, in the modern-day, there’s a lot of business conducted over the internet in the form of eCommerce sales, software or SAAS sales, or service sales.

A few years ago, the states realized this and felt like they were missing out. They brought it to the Supreme Court. The case was called Wayfair versus South Dakota, and the Supreme Court ruled in favor of South Dakota. This ruling gave states the ability to tax businesses, even if they didn’t have a physical presence in the state. You can read more on the Supreme Court’s sales tax ruling here.

So all of a sudden, online sales, online software sales, online diagnostic, or some forms of biotech stuff, all of a sudden become taxable if they pass a certain threshold of around $100,000. Of course, this has to be made even more confusing by some states having their sales taxes be based on a different revenue number in that state, or them having a particular number of “transactions” in that state, or a combination of things.

AND, not all states are collecting this type of sales tax. So the sales taxes you owe are really going to be dependent on the specific number of sales, specific states, and the dollar amount of your sales in those locations. It gets confusing fast.

However, if you’re doing business across the United States, and you have some states where you’re getting close to that $100,000 threshold, it’s getting very likely that you have created a tax nexus, and you’ll have to file sales tax returns. You’ll probably also have to file a state tax return.

In closing, the big picture on the tax nexus is that if you’re doing business in a state physically with employees, property, assets, etc. you have most likely triggered the tax nexus. If you’re doing business in the sense that you’re selling a lot of goods or services over $100,000, you have also probably triggered tax nexus.

Kruze has one of the largest tax teams serving VC-backed startups. Our Sales Tax team works with companies generating anywhere from a few hundred thousand dollars a month in revenue to tens of millions a month in revenue. Our process will help you stay tax compliant. We’ll work with you to assess your tax exposure and develop a plan to protect your startup. Our process includes:

• Mapping your sales tax nexus. We create a comprehensive nexus analysis of your business, sales, and revenue to determine where you’re subject to sales taxes on a state-by-state basis.
• Create a sales tax compliance plan. Based on your sales tax map, we’ll outline the states in which you need to register, register your startup with the appropriate states, and set up a schedule to file sales tax returns and make payments.
• Resolve any issues with unpaid sales tax. If your startup has any existing sales tax issues, we will work with you to address them. Many states have voluntary disclosure programs that offer full or partial amnesty to startups that are filing for the first time.
• Set up revenue and invoicing systems. We’ll recommend tools and resources that you can use to stay compliant.
• Monitoring for new jurisdictions. Our team (and software) will actively monitor your revenue to understand if new filings and tax collections are needed.
• File returns and remit payments. We’ll file your sales tax returns for the states where you have nexus, and may sure your payments are accurate and on time.
• Track your tax obligations and adjust as needed. Sales tax laws change and evolve, and your startup will grow. We will adjust your plan for any changes in existing tax obligations, and work with you to add states as your sales increase.

If your startup is ready to start making sales or already selling products, it’s important that you prepare to deal with sales taxes.

Surprising to some, but the number of transactions your startup does can also trigger state sales tax.

Typically, when a state is looking at transactions, they’re setting the threshold at 200 transactions, which doesn’t seem like a lot. 

Your startup accountant will know which states consider revenue and transactions and which states consider revenue or transactions. 

For some startups that are selling something at a low price point, they may not realize they’ve triggered the state sales tax requirement because they haven’t reached the revenue threshold, but they’ve certainly exceeded that 200 transactions threshold and should be filing.

Believe it or not, many states do have a SaaS sales tax.

This is a fairly new thing. A few years ago, there were roughly 13 states that taxed SaaS, and now it’s in the 20s. 

More states are looking at different and new types of transactions to tax in order to fill their revenue gaps. SaaS is quickly becoming one of those transactions, especially in bigger states.  Both New York and Texas have implemented a SaaS sales tax. California and Florida have not, yet.

Given the different rules and laws that govern each state, it’s critical to work with your startup accountant and conduct a sales tax nexus study.

The rules are different from state to state, so be sure you understand your tax obligations and what triggers them. It is much, much better to do a study before you get a sales tax notice! 

If you have any questions about startup taxes or want more information on startup accounting, please contact us.

Income Tax

You only pay income taxes when your company has a positive net income. Most startups are actually losing money. This means the majority don’t really have to worry about paying income taxes. They do still have to file income taxes but they don’t have to pay them until the business is profitable.

Out of all of our clients at Kruze Consulting, only about 5% are profitable. Those clients do need to make estimated income tax payments throughout the year and pay their income tax, depending on what their projections are and what their actual revenue is at year-end.

Sales Tax

Sales tax is what you pay when you generate sales and you charge your customers an added tax. The amount you charge and the sales tax you collect and remit depends on: 

• Where your customers are
• What kind of business you are
• What you are selling
• If you have state tax nexus in the states you are selling in

Sales Tax Nexus

There are four key criteria for tax nexus but the thing that trips people up the most is whether or not they are operating in a state where there are revenue, sales, or transaction thresholds that can actually trigger sales tax. If you are passing those state sales tax thresholds because you have tax nexus, you do need to collect and remit those sales taxes.

You will definitely want to talk to your startup CPA firm, like Kruze, about this as we can determine if you should be collecting sales tax from your customers. You are responsible for doing the calculations and determining what you should be adding to the invoices. You will collect that money from your customers and then you will remit it to the states where you owe taxes.

Always Remit Sales Tax

It is very important that you always remit your sales tax once you collect it. If you don’t you risk serious repercussions, and it could even get you thrown in jail. If you are ever unsure of how much tax you are supposed to send to the government having collected sales tax, remit it to the state governments. On the other hand, if you don’t think you actually need to remit the tax collected, then you can give it back to your customers. Either way, do not hold onto that money. The IRS will not look on you kindly.

Again, don’t try to do this without help. Consult your startup accountant.

Some biotech and manufacturing startups can save almost four percent on sales and use tax for qualified purchases in California.

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