Handling sales tax nexus audits

Be wary when a state sends a nexus questionnaire.
By David J. Brennan Jr., Esq., LL.M.


It has been more than four years since the Supreme Court held in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), that a state can require businesses to collect sales tax under an economic nexus standard if they have a sufficient level of sales into the state, even if they have no physical presence there — and the practical results of the Court's holding are becoming clear.

Many businesses have begun and continue the process of determining where they may have sales tax exposure under an economic nexus standard in states where they do business and of registering with states where they believe they have nexus. State taxing authorities are beginning to audit entities that registered due to having economic nexus in a state. This article discusses the issues faced by some businesses that registered due to the economic nexus standard, as well as businesses that have not registered, how to challenge an assessment, and what to do to mitigate a company's exposure.


A state usually will have information about a company's activities in the state and an idea of what it is looking for when it makes contact with the business regarding tax nexus — a term that refers to the degree of contact a person or entity must have with a jurisdiction before being subject to taxes there.

A standard first document for a state taxing authority to send a business that it thinks may have nexus with a state is a nexus inquiry letter. This letter may or may not be paired with an audit notice. The nexus letter is typically a questionnaire for the business to fill out. The questionnaire's purpose is to determine whether the business has nexus and thus a tax registration requirement with the state. Even if a business has already registered for sales tax in a state, the state's taxing authority may send an inquiry letter if it believes the business should have registered sooner than it did.

The letter may focus broadly on a "tax" registration requirement as opposed to a specific tax type, as the questionnaires usually attempt to elicit information for the purpose of determining the areas the state can "help" the business become compliant. The questionnaires typically consist of "yes/no" questions, sometimes with small areas to provide fuller responses. Businesses must be aware that the answers they give on nexus questionnaires could lead not only to additional exposure for sales and use tax but also provide the state evidence that the taxpayer may be liable for numerous other tax types.

In responding to the nexus inquiry letter, some states require the company to use the questionnaire form the state sends. This is problematic because a one-size-fits-all form can produce inaccurate responses. Each business has unique circumstances that must be taken into account in determining whether it has nexus with a state. A question with a "yes/no" answer may not tell a business's whole story and can provide a false indication of tax liability. Once a state believes there is a liability, it can be challenging to overcome that perception and convince the state otherwise. Submitting a letter alongside the yes/no form in these circumstances to explain the answers is often the best way to provide the nexus information in the format required by a state while still providing clarifying details to help mitigate exposure.

Some states will accept a letter describing the business's activity in lieu of the nexus questionnaire form sent by the state; however, some states require that the form be filled out and returned even if a separate letter describing its activities is also sent. If a state requires the nexus questionnaire form be filled out and returned and the business does not return the form, the state may automatically take the position the business has nexus with the state. If a business that is already registered fails to submit the nexus form, the state may take the position the company had nexus before its registration date. Not all states inform the business of the consequences of not completing the form.

If a questionnaire is not returned and the state taxing authority determines a business has nexus, it could make an estimated assessment based on the information it has at that time and ignore information the business later provides to show its actual sales are below the state's threshold for economic nexus. The state can also impose a higher interest rate (usually called a penalty interest rate) plus penalties on the assessment. Some states take the position the penalty interest rate and penalties cannot be waived. Although this may seem extreme, a case of this type is being litigated in one state.


Keep in mind the state likely initiated contact with the business based on information the state already possessed. Some states are refusing to turn over this information to the business under audit, forcing a company to challenge an assessment with no knowledge of what the state is basing the assessment on. This arguably violates the company's right to due process.

Businesses that believe they have been wrongly charged an assessment have several options available to dispute it, depending on where they are in the audit process. One option may be to have a conference with the auditor and the auditor's supervisor. These conferences rarely produce meaningful results; however, they are worthwhile because it is beneficial for a business to resolve as many issues in an audit as possible at the lowest level.

The next step would be to file an appeal or protest of the assessment. The business usually has a limited time after receiving an assessment to file some sort of written notice with the state that the business is appealing or protesting the assessment. The written notice might be a required form or a free-form letter disagreeing with the assessment. In any event, it is critical to file this appeal or protest before the deadline. Missing the deadline can have a number of ramifications for a business — including losing its ability to challenge an assessment altogether.

If the result of the appeal or protest is unfavorable, the last option is usually litigation. Litigation can start with a hearing before some sort of informal or formal appeals tribunal or with a formal case in a court. Usually, if certain requirements are met, rulings by an appeals tribunal can be further appealed to a court, and rulings by a court can be further appealed to a higher court.

For many businesses, the biggest nexus issue recently has been whether using a fulfillment service, such as Amazon's Fulfillment by Amazon (FBA), creates tax nexus in states where inventory is present because the fulfillment service has moved it there. For more on this topic, see the sidebar, "Selling Goods Through Fulfillment Services: Possible Nexus Effects."


There are ways to mitigate a business's risk of potential tax liability, one of which is to file a voluntary disclosure with the state. A voluntary disclosure allows the business to come clean in the state and get any past liabilities cleared up. Moreover, assuming there are no issues of tax collected but not remitted, the company can "cut off" prior liabilities so that the business only needs to worry about the voluntary disclosure period. The lookback period for the exposure is usually limited to three or four years, depending upon the state involved.

Perhaps the biggest advantage of a voluntary disclosure is that it starts the statute of limitation running. For tax returns that are unfiled, a state can usually go after a business indefinitely. In other words, theoretically, 20 years from now, a state could tell a business it is responsible for 20 years of taxes if no returns were filed. By performing a voluntary disclosure and filing future returns, the company can start the running of the statute of limitation and prevent such a situation.

Filing a voluntary disclosure can clean up not just a sales and use tax issue but other types of tax matters as well. Even if the business does not have nexus for sales and use tax purposes, the business might be liable for other types of taxes, such as a limited liability entity tax, a stock tax, or a franchise tax, to name a few. The type of tax depends upon the state involved. In making a voluntary disclosure, determining the tax types for which the business is liable is key.

A business may also reap other benefits from clearing its tax liabilities and reporting properly in a state. One huge benefit can be getting the tax issues resolved before selling the business. Buyers of a business will perform their state tax due diligence review to determine what type of risk is inherent in the purchase. If a seller has unresolved tax issues, a buyer will likely want to mitigate its risk by forcing the business to pay the liabilities or put a large sum of money in escrow, or it will pass on the acquisition altogether. Thus, the consequences to a company of sticking its head in the sand and not resolving its liabilities could be greater than just the tax amounts owed to the state(s).


A business should be wary when a state sends an audit notice or nexus questionnaire, even if it is already registered with the state taxing authority. The inquiry should be taken very seriously and an appropriate response provided to the state.

Many states are aggressively enforcing new sales tax nexus rules, so businesses should be prepared for a fight. Currently, the biggest area of concern for many businesses will be states where inventory is present due to a fulfillment service provider, such as Amazon's FBA service. A company can mitigate its overall exposure to an assessment of sales and use tax by a state by being proactive and performing a voluntary disclosure with the state.

Selling goods through fulfillment services: Possible nexus effects

The biggest area of concern for many businesses receiving nexus inquiry letters involves the state tax nexus consequences of using a fulfillment service, such as Amazon's Fulfillment by Amazon, or FBA. These services operate by having businesses send inventory to fulfillment centers, and when customers order the business's products, the fulfillment service handles packing, shipping, customer service, and other aspects of filling the orders. In these instances, the fulfillment service can (and does) move the inventory of the business across the country — and does so without the business's knowledge. In response to taxing authorities' requests, fulfillment service providers apparently have been providing information to the states on whether a business has inventory in the state. Once the state receives this information from the fulfillment service provider, it may decide to investigate whether the company has nexus.

The state will send out an audit notice or nexus inquiry letter to the business, whose owner may or may not know of the inventory's presence in the state. The state will take the position that because the inventory was moved into the state by the fulfillment service provider, nexus existed from the moment the inventory was first present. This could lead to an assessment going back almost a decade, depending on when the inventory was first present.

From a legal standpoint, having inventory in the state via a fulfillment service provider probably should not create nexus, just as it should not create personal jurisdiction or venue (see Sportpet Designs, Inc. v. Cat1st Corp., No. 17-CV-0554 (E.D. Wisc. 3/2/18); Wireless Environment, LLC v. HooToo.com, Inc., No. 15CV1215 (N.D. Ohio 8/30/16)). Since this issue is just working its way through the courts in various states, however, it may not be known for several years how the issue will be resolved in different states. As of this writing, there do not appear to be any state court decisions directly on this issue. Because of this uncertainty, businesses are regularly forced to litigate this matter.

Since most states now have statutes in place that require "marketplace facilitators" such as Amazon to collect sales tax on behalf of sellers on the platform, the issue of sales tax nexus from inventory in fulfillment centers could diminish over time. Time will tell how aggressively states will pursue this unsettled area of tax nexus now that their loss of sales tax revenue from online marketplaces has mostly been corrected going forward.

About the author

David J. Brennan Jr., Esq., LL.M. (Tax), is a senior attorney at Moffa, Sutton, and Donnini PA, a Fort Lauderdale, Fla.-based firm, which has a primary focus on state and local taxes. He was a senior attorney at the Florida Department of Revenue from 2014 to 2016. He would like to thank Joseph Moffa for his contributions to the article. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld at David.Strausfeld@aicpa-cima.com.


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"The State of Economic Nexus," The Tax Adviser, Oct. 2021

"Three Years After Wayfair: Future Impact and Lingering Issues," The Tax Adviser, Sept. 2021

"A Practical Guide to Economic Nexus," JofA, June 2021

Podcast episode

"Sales Tax: Nearly 4 Years After Wayfair, What's on the Horizon," JofA, Jan. 27, 2022

Online resources

AICPA Wayfair resource page

Wayfair Client Notification Letter

SALT Roadmap — State and Local Tax Guide

For Tax Section members

2021 State Tax Nexus Guide

2021 State Tax Nexus Checklist

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