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How trailing nexus impacts your SaaS business

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How trailing nexus impacts your SaaS business

Anrok | Streamlined sales tax for SaaS

Nexus rules are some of the trickiest elements of sales tax in the U.S. Each state has its own rules for what gives a company nexus there—physical presence, volume of sales, or volume of revenue from those sales. But another lesser-discussed tricky element of nexus is how hard it is to lose it once you’ve established it.

Once you’ve registered to collect sales tax and filed returns with a state, it can be difficult to close that sales tax registration so you can stop filing returns. This is the case even if your company no longer has an office or employee in the state. This lingering responsibility to a state regarding sales tax is called trailing nexus.

The ins and outs of nexus

There are two ways of triggering nexus in a state—physical presence and economic presence. Each state has its own rules for both of these types of business presence.

Physical presence involves having a material, physical connection to the state, such as maintaining an office or warehouse there, having an employee there, or working in the state for a certain amount of time each year. Economic presence is judged by how much business you do with customers in the state; states measure this via number of sales, volume of revenue from those sales, or a combination of both.

Trailing nexus occurs regardless of which type of business presence triggered your nexus. As far as states are concerned, it doesn’t matter how you got your status as an established entity responsible for filing tax returns. What matters is that you keep on doing it.

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What a trailing nexus policy looks like

Washington’s policy is representative of states that maintain trailing nexus rules. (Some states, such as Florida, Connecticut, and New York, do not have trailing nexus.) Washington’s policy holds that a company that has established nexus in Washington, either due to physical or economic presence, continues to have nexus for the remainder of the year in which it met the threshold and the entire following year.

This means that even if a company meets the nexus threshold but immediately makes a change through which it no longer meets that threshold, the company still has nexus for a good long while. For example, say Wisconsin AirCloud Company hired an employee in Washington on January 1st of 2022, thereby establishing nexus in Washington. Even if the company were to fire that same employee a week later, Wisconsin AirCloud would still be responsible for collecting sales tax from Washington-based customers and submitting sales tax returns to Washington until the end of 2023.

This is a good example to look at because some other large states that tax SaaS have similar statutes on the books, including Texas, Massachusetts, and Arizona.

Should you seek to end your nexus?

Rules on how nexus can end vary by state, so it’s important to look up the specific rules for the states in which you have nexus before contemplating a course of action. Often, a state likes to see a history of at least a year with no sales and zero-dollar returns before they are confident that they are not going to miss out on revenue if they allow a taxpayer to close an account.

The process of de-registering can be time-consuming and aggravating, and it can cause complications for you in the event that you ever trigger nexus in that same state again in future years. That’s why withdrawing your sales tax registration may not be worth the audit risk for fast growing SaaS companies unless your business is significantly downsizing and is unlikely to ever trigger nexus in the state again.

If you do decide to de-register, make sure you go through the proper channels with the state. You should ensure that the account is actually closed and the reason is documented to help mitigate audit risk if the state sends a notice or if you ever need to re-register. In states with no written policy on the matter of trailing nexus, things can get confusing. The administrative burden may be on the taxpayer to prove their withdrawal from the state and argue for cessation of nexus.

How to manage your nexus obligations

Tracking where you have nexus and thus where you need to collect and pay sales tax is a difficult job, especially when you take into account policies like trailing nexus, which might require you to collect sales tax even when you no longer have employees in a state.

For fast-growing SaaS companies, it might be result in higher ROI to take the long-term view than to spend time cleaning-up what is often an ambiguous and temporary loss of nexus. If you do decide to de-register in a state, it is best to talk to a tax advisor and ensure your reasons are documented and the company is covered.

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