Physical nexus is the tangible connection between your business and a state — created by people, property, or inventory located there — that gives the state authority to require you to collect sales tax and, in many cases, pay income tax. It is one of two independent ways a state can reach an out-of-state business. The other, economic nexus, is based on sales volume. Either one alone is enough to trigger obligations.
The constitutional basis comes from the Commerce Clause and Due Process Clause, which stop states from taxing businesses that have no meaningful ties to them. The Supreme Court’s 1977 decision in Complete Auto Transit, Inc. v. Brady requires a “substantial nexus” between the business activity and the taxing state before a state tax will stand.1Cornell Law School. Complete Auto Transit Inc v Brady Physical nexus is the traditional way to meet that standard: real, tangible ties to the state, as opposed to purely financial or digital activity.
What Creates Physical Nexus
Several ordinary business activities can establish a physical connection, and some catch owners off guard. Each of the following can independently trigger tax obligations.
Property and Office Space
Owning or leasing real property in a state is one of the most direct triggers. Offices, retail locations, warehouses, and distribution centers all count. A small leased storage unit or a single desk in a shared office can be enough if the business uses it regularly to operate in the state.
Employees and Sales Representatives
Personnel working within a state’s borders is one of the most common nexus triggers. That includes full-time and part-time employees along with traveling sales representatives who visit to solicit orders. In most states, a single employee working in the state is enough — including a remote worker based at home. Some states also treat independent contractors or consultants performing services on a company’s behalf as sufficient, particularly when those individuals are actively soliciting sales.
Inventory in Third-Party Warehouses
Storing goods in a state creates physical nexus even when the inventory sits in a fulfillment center owned by someone else. Businesses that use third-party logistics providers to hold products closer to customers often overlook this. The goods themselves are tangible property in the state, and their presence establishes the connection regardless of who owns the building.
Trade Shows and Temporary Presence
Attending trade shows, craft fairs, or conventions in a state can create physical nexus, though the rules vary widely. Some states exempt businesses that attend only one or two events per year, or that stay below a certain number of days or a dollar threshold in sales. Others treat any physical selling activity as sufficient to trigger registration and collection duties. If you plan to sell products at an out-of-state event, check the host state’s rules first. Some require a temporary seller’s permit even for a single weekend.
Affiliate and Click-Through Nexus
Roughly 15 states have enacted click-through nexus laws that treat a business as having a physical presence when it pays commissions to in-state residents who refer customers through website links. The theory is that the in-state affiliate acts as a physical extension of the out-of-state seller. These laws typically apply only when referral commissions exceed a specified dollar threshold.
Physical Nexus and Economic Nexus Are Separate Standards
For decades, a business needed physical presence in a state before that state could require it to collect sales tax. The Supreme Court overruled that bright-line rule in 2018 in South Dakota v. Wayfair, Inc., finding the physical presence rule “unsound and incorrect” and upholding South Dakota’s law requiring out-of-state sellers to collect sales tax once they exceeded $100,000 in sales or 200 transactions in the state.2Supreme Court of the United States. South Dakota v Wayfair Inc That volume-based standard is economic nexus.
After Wayfair, nearly every state with a sales tax adopted economic nexus thresholds, most following the $100,000 or 200-transaction model. But the decision did not eliminate physical nexus. If you have an employee or inventory in a state, you owe collection duties there even if your sales are only a few hundred dollars. The two standards operate independently, and hitting either one is enough.2Supreme Court of the United States. South Dakota v Wayfair Inc
Sales Tax Duties vs. Income Tax Duties
Physical nexus triggers different obligations depending on the type of tax, and the distinction matters. Sales tax nexus determines whether you must collect tax from customers and remit it. Income tax nexus determines whether the state can tax your business profits.
For sales tax, any tangible presence — an employee, stored inventory, leased space — means you must register, collect on taxable transactions, and file returns.
For income tax, many states apply broader standards. Some impose income tax based on economic activity alone, such as deriving revenue from in-state customers, without any physical presence. If your business has physical nexus in a state, you likely owe both sales tax collection duties and income tax filing obligations. Apportionment rules then determine how much of your income is actually taxable there.
The P.L. 86-272 Shield Applies Only to Income Tax
One federal law limits how far physical nexus reaches for income tax purposes. Public Law 86-272, codified at 15 U.S.C. § 381, prohibits a state from imposing a net income tax on a business whose only in-state activities are soliciting orders for sales of tangible personal property, as long as those orders are sent outside the state for approval and fulfilled by shipment from outside the state.3Office of the Law Revision Counsel. 15 US Code 381 – Imposition of Net Income Tax
The shield is narrower than it sounds. It applies only to net income taxes, not to sales tax, franchise tax, or gross receipts tax. It covers only tangible personal property, so businesses selling services, digital products, or licenses get no shelter. And it protects only solicitation. If your employees do anything beyond soliciting orders, such as making repairs, providing training, or collecting payments, the protection disappears.4U.S. Congress. The Evolution of PL 86-272s State Income Tax Immunity
The law extends to independent contractors soliciting sales, provided those contractors sell for more than one company and hold themselves out as independent agents in the regular course of business.3Office of the Law Revision Counsel. 15 US Code 381 – Imposition of Net Income Tax Several states have recently argued that certain internet-based activities, such as placing cookies on in-state customers’ devices, go beyond protected solicitation. The area is evolving, and businesses relying on the shield should review how each relevant state interprets it.
Registering, Collecting, and Remitting
Once you have physical nexus in a state, you need to register for a sales tax permit before making taxable sales there. Registration typically requires your Federal Employer Identification Number (or Social Security Number for sole proprietors), the legal name of the business, information about officers or owners, and a description of your activities and their start date in the state.
You can register directly through a state’s department of revenue, or through the Streamlined Sales Tax Registration System for participating states. The system currently covers 24 member states and allows you to register in multiple jurisdictions through a single free application.5Streamlined Sales Tax. Sales Tax Registration SSTRS For states outside the system, you register individually through each state’s portal. Fees range from nothing to around $100.
After registering, you charge the correct rate on every taxable sale, collect it from the customer, and send it to the state on the schedule the state assigns. The rate depends on where the sale takes place or where the product is delivered, and often combines state, county, and local rates. Filing frequency — monthly, quarterly, or annual — is generally based on how much tax you collect.
Collected sales tax does not belong to your business. States treat these funds as money held in trust until your filing date. When customers claim an exemption, such as buying for resale or for use by a tax-exempt organization, keep a valid exemption certificate on file. If an audit turns up an untaxed transaction with no valid certificate, you become liable for the uncollected amount out of your own funds.
What Noncompliance Costs
Failing to register, collect, or remit when you have physical nexus in a state carries real financial consequences. Late filing penalties across the states generally run from about 5 percent per month of the unpaid balance to flat penalties of 10 percent or more, with caps that can reach 25 to 50 percent of the total due. Most states also impose a minimum dollar penalty that applies even when the percentage calculation is small or no tax is owed for the period. Interest accrues on unpaid balances from the original due date.
If a state determines you should have been collecting tax but were not, it can assess you for the full amount you should have collected, plus penalties and interest, going back several years. Intentional evasion or fraud can bring criminal charges, jail time, and revocation of the right to do business in the state.
Personal Liability for Unremitted Sales Tax
Because collected sales tax is trust fund money belonging to the state, owners and officers face personal liability if those funds are not remitted. Most states have statutes allowing the state to pursue individuals, not just the business entity, for unpaid sales tax. That reach extends to anyone with control over the company’s financial decisions: corporate officers, managing members of an LLC, bookkeepers, and accountants who directed the use of funds.
The corporate shield that normally protects shareholders and officers from business debts does not apply to trust fund taxes. If your company collects sales tax from customers but uses the money for payroll or other expenses instead of remitting it, the responsible individuals can be held personally liable for the full amount owed, plus interest and penalties. This liability survives even if the business closes or files for bankruptcy.