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Nexus And Your Software Business

Written by Ian Landsman, published on 01.06.2016

There’s a number of important articles I want to write about running a small software company in the coming months, but several of them will end up touching on the concept of nexus. Rather than explain it in each one, I thought I’d put together this one goto page on the matter.

Fair warning, this is not going to be interesting. That said, much of what you do running a small software company is not interesting! Unlike other tedious tasks, doing this one right will keep you out of jail so that’s a plus.

What is Nexus?

Unfortunately no one can be told what nexus is. Well, that’s not true though it does vary a lot from state to state. Still, the general concept is pretty well defined by this Sales Tax Institute post:

Nexus, also known as sufficient physical presence, is the determining factor of whether an out-of-state business selling products into a state is liable for collecting sales or use tax on sales into the state. Nexus is required before a taxing jurisdiction can impose its taxes on an entity.

How is Nexus Determined

Every state has it’s own determination of nexus. Yes, every state. So, if your business is like mine and operates in a few states (5 for us) you’ll have to figure this out for each and every state.

Yes. That’s right, that will be a huge pain.


Before you go further, I’ll note that having a great accountant is key. A great one. Not the one your brother uses for his taxes, not the one around the corner from your house. An accountant who is familiar with working across multiple states and complex tax issues.

Welcome to 2016 where your small couple of person software company is involved in a regularly changing highly complex interstate tax issue!

So, now how do you actually determine nexus? Well, basically states are really cracking down on this because they’re all desperate for more tax dollars. As such, they are expanding the definition all the time.

Here’s a few points to give you an idea of the complexity and scope from Accounting Today:

Thirteen states would apply sales and use tax to fees paid by in-state customers to remotely access canned or prewritten software that is hosted on a web server.
Ian’s Note: aka SaaS! More on this in a future post.

All but six jurisdictions tax an out-of-state employer that permits an employee to telecommute from a home within their borders.

Twenty-three states said nexus would arise for reimbursing sales staff for the costs of maintaining an in-home office.

Job fairs or other recruitment activities would trigger income tax nexus in 21 states.
Ian’s Note: You setup a booth at a job fair in Duluth? Hello nexus!

Thirty-six states said nexus would arise from having employees hire, supervise, or train other employees within their borders.

Right, so in all likelihood you will be doing some activity in the states your remote employees live in which will require you to register in those states, collect sales tax, and file other taxes in those states.

Impacts of Having Nexus

So you caught a case of nexus, what does that mean?

I’m not going to go into a ton of details here, you really need to talk to your accountant but here’s a basic list.

  • You’ll have to collect sales tax on transactions in the state.
  • You’ll need to file income taxes with the state.
  • You’ll need to pay certain payroll taxes.

FYI, you can have nexus of one type, but not another. For example, a certain type of transaction may cause you to collect sales tax on that transaction, but not file it with your income taxes!


Things you think might get you around this but won’t.

  • You don’t hire employees, your staff is made up of contractors/freelancers. Probably doesn’t matter!
  • You have staff that travel to a state, but don’t live in it. Still nexus!
  • You use affiliates and other loosely coupled arrangements to sell in states. Nexus-R-You!

Now, some of these above examples may not apply in certain states. Others may end up with extremely small tax liabilities that probably you won’t get busted on and there are also often minimum transaction sizes that come into play. Never-the-less all of these types of business operations can generate nexus.

More Loopholes

I heard that using a company like JustWorks will prevent me from having to deal with any of this. No no no!

PEO organizations like JustWorks may help with some of the payroll related items, but it has nothing at all to do with collecting sales tax and income taxes. If you have an employee working for you in Nebraska, paying them and managing their benefits with JustWorks will not remove your companies nexus in Nebraska.

I’m Not Deterred!

Good! So, you have an employee you want to hire in another state. What do you do?

Hire a payroll provider

Once you operate in multiple states you need a payroll provider such as ADP, Just Works, whatever. You don’t want to be the one figuring out every little nuance of payroll for every jurisdiction and let me tell you, there are a lot of them! We’ve made a few mistakes in this area over the years before we got fully organized with HelpSpot and our fingers are still sore from opening hundreds of physical letters from the city of Louisville’s Metro Commission.

Hire a registered agent

Oh boy, where to begin on explaining this. Well, in every state you operate in you’ll need a physical address. The state will only want to send you correspondence to an in state address.

Now you could use your employee’s address but that has some downsides. Primarily that A) if they leave all your mail for that state will be going to their address still B) they don’t want to deal with all your crappy state mail and yes there is lots of it.

A registered agent is a genius money making operation that gives you a physical address to use in a state. That’s it. You pay them a few hundred dollars a year and they give you an address and forward your mail to another address.

Note that this isn’t an address you can just use. They’ll throw out anything they get that isn’t from the state so you can only use it for this one purpose, to receive mail from the state and have it forwarded to you.

These are the domain name companies of the physical world, aka highly shady. So you’ll want to get one recommended if you can. Most good accountants (see above!) will have one they can recommend to you.

Register with the Secretary of State

Hiring an employee in a new state is very much like starting another business in that state. You need to register your business name, your address (registered agent!), your federal tax ID, and company officer info.

What the Secretary of State gives you is a business ID at the state level which you’ll need for the rest of this process.

Register with the Department of Labor

The Department of Labor is in charge of giving you an unemployment withholding ID. This ID you’ll need to send to your payroll provider so that they can file unemployment returns on your behalf.

This is usually an optional service that payroll providers provide, but it’s not really optional. Just pony up the money and let them do this. Every jurisdiction and sub-jurisdiction has their own rates and places to mail this stuff. Nothing you want to deal with.

Register for Sales and Use Tax

Every state is pretty different on how you do this. Usually they’ll have a website that gives you the basic info, but honestly, you’re going to end up spending a lot of time on the phone in this process. Don’t try to avoid it as that will only delay you further, the government isn’t internet enabled in most of these states yet.

You’ll go through a series of questions to determine if you need to collect tax or not. Usually, they’ll have no idea about your software business and no understanding of the distinction between SaaS, download, etc. So, you’ll want to have spoken with your accountant ahead of time so you already know the right answer. If for some reason, you think they’re not giving you the right answer by saying you don’t have to collect you should make sure to get that in writing in case they change their mind later.

Other Tricky Jurisdictions

The above is usually all you need to do, however, there are special cases. We hit one that I mentioned above with the city of Louisville. It turned out that they have a special withholding tax that we weren’t aware of and that ended up being years of headache to get figured out. So at the very least check into your employee’s city to make sure there’s nothing special on the payroll front that might need to be done.

Final Thoughts

Don’t do any of this on your own. Don’t do any of this based solely off this article! You absolutely must have an great accountant. If you are making enough revenue to start hiring employees, you should have enough to pay a few thousand dollars for the advice you need to do it right.

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