Taxes used to be simple. If a business had a physical presence in a state, like an office, a warehouse, or employees, it had to pay taxes there. But things have changed.
Now, even without setting foot in a state, a business can be on the hook for taxes. One way this happens is through third-party nexus. When an outside party, such as an independent contractor, a vendor drop shipping orders, or an online affiliate, creates a tax connection between the business and the state, new tax obligations can arise. Suddenly, that business may need to register, file tax returns, and pay up.
States are getting more aggressive about enforcing these rules. More businesses are getting caught in the net. And the cost of getting it wrong? Penalties, back taxes, and a major compliance headache. If a company works with third parties, it needs to understand how those relationships might be creating tax obligations in unexpected places.
How Independent Contractors Can Create Nexus in Your State
Hiring independent contractors can be a smart move, but it might also create tax obligations in states where a business has no physical presence. Many states consider contractors an extension of the company, meaning their activities could establish nexus and trigger tax filing requirements.
It’s not just about sales. If a contractor solicits business, provides customer support, or even collects payments on behalf of a company, that can be enough for a state to claim a tax connection. Some states have tightened their rules to include remote workers performing back-office tasks, further expanding tax liabilities.
For example, a small e-commerce company based in Illinois hired an independent contractor in Texas to handle customer service. They assumed this wouldn’t impact their tax obligations. However, Texas determined that the contractor’s activities established nexus, requiring the company to register and pay state taxes—something they hadn’t accounted for.
The result is a complex web of tax responsibilities. A company could owe income tax, sales tax, or franchise tax in multiple states without realizing it. Businesses working with independent contractors should carefully review where those individuals operate and what they do to avoid unexpected tax bills or compliance issues.
The Rise of Click-Through Nexus
Once upon a time, selling online used to mean fewer tax headaches. Not anymore. Click-through nexus has changed the game, making businesses responsible for taxes in states where they have no physical presence.
Click-through nexus happens when a company generates sales through third-party affiliates who place links on their websites. When a customer clicks the link and makes a purchase, the affiliate earns a commission. Many states view this as a direct connection between the business and the state, triggering tax obligations.
This type of nexus has gained traction because states see it as an easy way to capture more tax revenue. More than 20 states, including Illinois, California, and Michigan, have enacted click-through nexus laws. Businesses that rely on affiliate marketing may be required to collect and remit sales tax, even if they have no physical presence in the state.
Ignoring these rules can lead to audits, penalties, and back taxes. Companies using online affiliates should assess their exposure and take steps to stay compliant.
Why States Are Targeting Third-Party Relationships for Taxation
States are always looking for ways to boost tax revenue, and third-party relationships have become a prime target. Traditionally, businesses only had to pay taxes in states where they had a physical presence. Now, many states argue that working with contractors, vendors, or online affiliates creates enough of a connection to justify taxation.
The rise of e-commerce and remote work has made it easier for companies to operate across state lines. Instead of hiring employees, businesses often rely on independent contractors, drop shippers, and online marketers. States see these relationships as a tax opportunity and have expanded their nexus laws to include them.
As a result, businesses that once had limited tax obligations now find themselves responsible for filings in multiple states. This shift means more businesses are getting caught in complex tax rules, sometimes without realizing it. Companies that work with third parties should take a proactive approach to understand their tax obligations before facing unexpected bills or penalties.
Navigating Tax Compliance with Third-Party Nexus
Many businesses are familiar with economic nexus laws, which require tax collection once sales in a state reach a certain threshold. Third-party nexus works differently. It is triggered by relationships with contractors, vendors, or affiliates, regardless of sales volume. As states expand their tax laws, companies may now owe taxes in places where they have no physical presence. Independent contractors, drop shippers, and online affiliates can all create tax obligations, often catching business owners by surprise.
Each state has different rules, making compliance a challenge. Some require businesses to register, file tax returns, and collect sales tax if they meet certain thresholds. Others impose income or franchise taxes based on economic activity alone. Failing to comply can lead to penalties, back taxes, and audits.
The key is staying informed. Businesses should regularly review their third-party relationships and monitor where they may have tax exposure. Working with a knowledgeable tax advisor can help identify potential liabilities and create a strategy to stay compliant. Taking a proactive approach can prevent costly surprises down the road.
How DHJJ Can Help You Manage Nexus-Related Tax Liabilities
Understanding third-party nexus is challenging, but ignoring it can be costly. Many businesses unknowingly create tax obligations in multiple states through independent contractors, drop shippers, or online affiliates. With states aggressively enforcing these rules, companies need a clear strategy to manage compliance and avoid unexpected tax bills.
At DHJJ, we help businesses navigate complex tax laws, identify potential nexus risks, and develop a plan to stay compliant. Our team stays up to date on evolving state regulations, ensuring you understand where and when you need to file. Whether you’re expanding operations, working with third parties, or unsure about your current tax obligations, we provide expert guidance tailored to your business.Don’t wait for an audit or penalty to find out where you owe taxes. Contact DHJJ’s SALT team today to review your nexus exposure and keep your business on the right track.
