Many small business owners assume they only need to worry about taxes in the state where their business is located. In reality, that’s often not the case.
As businesses become more mobile and technology makes it easier to serve customers across state lines, tax obligations have become increasingly complicated. One of the most misunderstood concepts in state taxation is nexus. Unfortunately, nexus is also one of the most common reasons business owners receive unexpected notices, penalties, and assessments from state tax agencies. Understanding how nexus works—and recognizing when it applies to your business—can help you avoid costly compliance issues and make smarter growth decisions.
Another common misconception is that filing in multiple states means more tax. This is usually a minimal difference as only the income allocated to those states is taxed at their rate, and your home state will give you a credit for the tax paid to other states (subject to a few calculations).
What Is Tax Nexus?
Nexus is simply a legal connection between your business and a state that gives that state the authority to impose tax obligations on your company. Once nexus exists, a state may require your business to:
• File income tax returns
• Collect and remit sales tax
• Register as a foreign entity
• Pay payroll taxes
• Submit informational filings
The important thing to understand is that nexus can be created in many ways. You do not need a physical office, warehouse, or storefront in a state to trigger tax obligations. In today’s business environment, many companies create nexus without even realizing it.
How Nexus Has Changed
Historically, businesses generally needed a physical presence before a state could require tax filings. That changed significantly after the U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair. The ruling allowed states to impose sales tax collection requirements based on economic activity rather than physical presence alone. As a result, nearly every state now has some form of economic nexus standard. This means a business can create tax obligations simply by generating enough sales within a state, even if the company never sets foot there. For many small businesses, this was a major shift that dramatically increased compliance responsibilities.
The Two Most Common Types of Nexus
Physical Nexus
Physical nexus occurs when your business has a tangible presence within a state. Examples include:
• An office or storefront
• Employees working in the state
• Inventory stored in a warehouse
• Equipment located in the state
• Job sites or construction projects
• Regular travel by employees
Many business owners recognize these situations as creating tax obligations. What often gets overlooked is how little activity may be required to establish physical nexus in some states. A single employee working remotely from another state may be enough.
Economic Nexus
Economic nexus is based on the amount of business conducted within a state. Most states establish thresholds based on:
• Revenue generated
• Number of transactions
• A combination of both
Once a business exceeds those thresholds, filing requirements may be triggered even without any physical presence. For example, an Indiana-based company selling products or services nationwide may unknowingly cross economic nexus thresholds in multiple states. Without monitoring sales activity, those obligations can remain hidden until a state identifies the issue.
What Small Businesses Commonly Overlook
Remote Employees
Remote work has become one of the biggest nexus traps for small businesses. A business owner may hire a remote employee who lives in another state without realizing that employee’s presence can create income tax, payroll tax, and registration obligations. Many companies expanded remote work during recent years and never evaluated the resulting tax consequences.
Independent Contractors
While contractors generally create less nexus exposure than employees, they can still create tax obligations depending on the state and the activities being performed. Businesses frequently assume contractor relationships eliminate state tax concerns, which is not always true.
Business Travel
Attending trade shows, visiting clients, managing projects, or performing services in another state can create nexus. Owners often focus on major expansions while overlooking routine travel activity that may establish filing requirements.
Inventory Stored Outside Your Home State
Businesses using third-party fulfillment providers frequently encounter unexpected nexus issues. Inventory stored in warehouses located across the country may create tax obligations even when the business owner has never visited those locations. This is especially common among e-commerce businesses using fulfillment services.
Sales Tax Exposure
Many business owners focus exclusively on income taxes and fail to evaluate sales tax requirements. Sales tax nexus often develops before income tax nexus becomes a concern. States have become increasingly sophisticated in identifying businesses that should be collecting sales tax but are not. The result can be years of uncollected tax liability, penalties, and interest.
The Risks of Ignoring Nexus
The challenge with nexus is that states generally do not notify businesses immediately when obligations begin. Years may pass before a state discovers the issue. When that happens, businesses often face:
• Multiple years of back tax filings
• Penalties and interest
• Audit costs
• Administrative burdens
• Potential tax assessments based on estimates
Because many states share information with one another, a problem discovered in one jurisdiction can quickly expand into a broader compliance review.
Why Proactive Planning Matters
Nexus is no longer just a concern for large corporations. Small businesses now operate in an environment where remote work, online sales, cloud technology, and interstate commerce can create tax obligations almost anywhere. The good news is that most nexus issues can be managed effectively when identified early. Regular reviews of employee locations, sales activity, inventory storage, contractor relationships, and business operations can help identify exposure before it becomes a problem.
It is also important to note that your CPA probably is not actively reviewing this for you unless you ask. The reason is most CPAs are built around offering compliance for specific services as requested, and have engagement letters that very narrowly define what they are responsible for and when. Unless you specifically ask them to monitor this, it is your job and your job alone to know the rules and when they apply. There will not be an get out of jail free cards if you are contacted by another state and you expect to rely on third-parties to have advised you ahead of time. The businesses that avoid costly surprises are typically the ones that view tax compliance as part of their growth strategy rather than a year-end filing exercise.
What to Ignore as a Business Owner
Unlicensed individuals and promoters.
If you are hiring a CPA or EA for tax services, you should trust them more than Tik Tok and Twitter. While there can be great ideas on social media, they are often related to a specific set of facts that may not always apply to you. Another area to be wary of are others in your industry. We had a conversation with a transportation company owner who did a fabulous job with trips, but the extent of their tax knowledge was that they were pretty sure they paid taxes. When confronted with a situation where a tour operator was physically going on trips and acting as a tour guide, on top of booking lodgings and events, they were adamant that our knowledge and advice had to be wrong because they had not heard of multi-state taxation. When we presented IRS code sections specifically applied to their situation we were again met with insistence that we were wrong because the tour company owner said so.
The Bottom Line
Nexus is one of the most important—and most misunderstood—concepts in state taxation. A business does not need an office, storefront, or major presence in a state to create filing obligations. In many cases, a remote employee, growing sales volume, inventory storage, or occasional business activity can be enough. As states continue increasing enforcement efforts, business owners who understand nexus and monitor their exposure will be in a much stronger position to avoid unexpected tax bills and compliance headaches.
Modern tax planning isn’t just about preparing returns. It’s about identifying risks before they become liabilities and ensuring your business can grow confidently across state lines. If your business serves customers outside your home state, now is a good time to evaluate whether nexus rules may already be affecting your filing obligations.
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