Where You Owe and Who You Employ

Key takeaways

• Physical presence stopped being the test in 2018: South Dakota v. Wayfair upheld a law reaching sellers with more than $100,000 of sales or 200 separate transactions into the state, and every state wrote its own numbers afterwards.
• Sales-tax nexus and income-tax nexus are two different maps. California starts collecting use tax at $500,000 of sales, but treats you as doing business for income-tax purposes at $757,070 of California sales for 2025, or 25% of your total, whichever is lower.
• The federal shield that protects out-of-state sellers, P.L. 86-272, covers only solicitation of orders for tangible personal property. Under the MTC statement adopted August 4, 2021, a live post-sale chat window or a job-application form on your site defeats it, and it never covered software or services at all.
• BLS Employer Costs for Employee Compensation put private-industry employer costs at $46.60 per hour worked in March 2026, $32.60 in wages and $14.01 in benefits, so total employer cost runs about 1.43x wages. That ratio, not the 7.65% employer payroll-tax share, is the real bill when a contractor is reclassified.

Nexus is a map, and you are already on it

Nexus is the legal connection that lets a state tax you. For fifty years the rule was blunt and easy to work with: no physical presence in the state, no obligation to collect its sales tax. On June 21, 2018 the Supreme Court threw that away. South Dakota v. Wayfair upheld a statute reaching any seller that, on an annual basis, delivered more than $100,000 of goods or services into South Dakota or engaged in 200 or more separate transactions there. The physical-presence rule of Quill, the Court held, was 'unsound and incorrect.'

What followed was not one national threshold but fifty local ones. States copied South Dakota's numbers, doubled them, dropped the transaction count, or measured a different base: gross sales, retail sales, or taxable sales only. California's threshold is $500,000 of combined sales of tangible personal property delivered into the state by the retailer and all related persons, with no transaction count, effective April 1, 2019. The Streamlined Sales Tax Governing Board, 23 full member states plus one associate, publishes each state's threshold precisely because none of them agree. And in dissent, Chief Justice Roberts pointed out that over 10,000 jurisdictions levy sales taxes, each with different rates, exemptions and product definitions.

Illustrative only. A private-label brand ships $640,000 into California in a year and never registers, because nobody in the company has ever set foot there. It has crossed the $500,000 threshold. At an illustrative blended 8.25% state-plus-district rate, inside CDTFA's published range of 7.35% to 9.25%, that is $52,800 of tax it should have collected from customers and did not. It cannot go back and invoice them, so it pays out of margin. On a 12% net margin, that $640,000 of California revenue produced $76,800 of profit; one year of uncollected tax eats about 69% of it. Three years unregistered is roughly $158,400, before penalties and interest, which is more than two years of California profit.

The levers are unglamorous and they all run on one report: sales by ship-to state, refreshed quarterly. Register before you cross, not after. Where a state's marketplace facilitator law applies, the marketplace collects and remits on those sales instead of you, so know which of your channels are already covered and which are not. Where you are already exposed, ask about a voluntary disclosure agreement; many states run one, and the terms available to a seller who comes forward are not the terms available to one they find.

What breaks first is not the tax. It is the acquisition. A buyer's diligence pulls sales by state on day one, and an unquantified nexus liability becomes an escrow holdback or a walk. The exposure is open-ended in a way ordinary debt is not, because in most states the limitations period does not begin to run until a return is filed, and you never filed one.

The shield that no longer covers what you sell

There is one federal protection in this landscape, and it is narrower than most operators believe. Public Law 86-272, codified at 15 U.S.C. §381, bars a state from imposing a net income tax on a business whose only in-state activity is the solicitation of orders for sales of tangible personal property, where orders are sent outside the state for approval and filled by shipment from outside the state.

Read the words. Tangible personal property. If you sell software, subscriptions, streaming, data, consulting, design or any other service, P.L. 86-272 has never protected you: not once, not partially. A SaaS company with customers in forty states has no federal shield against any of those states' income taxes, and never did.

Even for sellers of physical goods, the shield has been narrowing. The Multistate Tax Commission's Statement of Information, in its fourth revision adopted August 4, 2021, works through internet activities one by one. A static FAQ page does not defeat protection. Regularly providing post-sale assistance through electronic chat or email that customers start by clicking an icon on your site does defeat it. So does inviting viewers to apply for non-sales jobs and upload a resume. So does soliciting applications for a branded credit card, remotely pushing firmware fixes to products already sold, and selling extended warranty plans. Cookies split the difference: cookies that remember a shopping cart are ancillary to solicitation and protected; cookies that gather search data to adjust production schedules or identify new products to offer are not.

The MTC statement is the position of the Commission and its supporting states, not a statute, and it has been litigated. But it is what a state auditor is reading. The practical lever is a website inventory: list every interactive feature your site offers residents of states you ship into, and know which ones you are trading for income-tax protection. A chat widget installed by a marketing contractor in an afternoon is, in several states' view, a decision to file corporate income tax returns there.

The naive version of this gets it exactly backwards. It assumes the shield covers everything until you put a person in the state, when in fact it covers almost nothing you do online and nothing at all you sell that cannot be put in a box.

The remote hire that filed you into a new state

Employees are the fastest way to acquire obligations you did not plan for. One person working from their apartment generally creates payroll-withholding duty in that state, often unemployment-insurance registration, frequently a workers' compensation policy, and in many states income-tax nexus for the company itself. California's own doing-business test names payroll directly: for 2025, California payroll compensation exceeding $75,707, or 25% of your total payroll, makes you a taxpayer there, alongside the $757,070 sales figure and the same 25%-of-total alternative.

Note the gap between those two California numbers. You can owe California sales tax at $500,000 of sales and not yet be doing business there for income-tax purposes at $757,070. They are separate regimes with separate registrations, separate returns and separate penalties. Treating 'we registered in California' as one event is how businesses end up compliant on one tax and delinquent on the other.

Residency adds a third layer. New York's rule for nonresidents whose assigned office is in New York is that days worked elsewhere still count as New York workdays unless the employer has established a bona fide employer office at the telecommuting location. An engineer who moves to Florida and keeps a New York-based role can therefore remain taxable to New York on that income, and Florida's absence of an income tax does not fix it.

The lever most operators miss is the pass-through entity election. Under IRS Notice 2020-75, an income tax that a partnership or S corporation pays directly to a state is deductible by the entity in computing non-separately stated income, and is not counted against the individual owner's SALT deduction limitation. California's version charges 9.3% of qualified net income, is available for tax years beginning on or after January 1, 2021 and before January 1, 2031, and gives owners a credit against their California personal income tax. Illustrative only: an S corporation with $400,000 of qualified California net income elects in, pays $37,200 at the entity level, deducts it federally, and its owners take a $37,200 credit against their California tax. The election is annual, must be made on a timely filed original return, cannot be made on an amended one, and once made is irrevocable for that year and binding on every owner, including the ones who did not want it.

What breaks first here is payroll. A state you never registered in sends a notice for unremitted withholding on an employee who has been there eighteen months, and the penalty is calculated on tax you should have taken out of someone else's paycheck and did not.

Classification: three federal tests that do not agree

The second question is who counts as an employee. There is no single answer, because at least three regimes ask it separately and score it differently.

The IRS applies common-law control, grouped into three categories of evidence. Behavioral: does the company control or have the right to control what the worker does and how they do it. Financial: are the business aspects of the job controlled by the payer, including how the worker is paid, expense reimbursement, and who supplies tools. Type of relationship: written contracts, employee-type benefits like pension, insurance and vacation pay. Either party may ask for an official determination on Form SS-8, which the IRS notes may take at least six months.

The Fair Labor Standards Act uses economic reality instead, and that standard is in open motion. On May 1, 2025 the Wage and Hour Division issued Field Assistance Bulletin 2025-1 instructing field staff to stop applying the 2024 rule's analysis in FLSA investigations and to enforce under Fact Sheet #13 (July 2008) as informed by Opinion Letter FLSA2019-6. The same bulletin is explicit that until further action, the 2024 rule remains in effect for purposes of private litigation. On February 27, 2026 the Department published a proposed rule to rescind 29 CFR part 795 and restore the January 7, 2021 analysis with modifications, extending it to the FMLA and MSPA; comments closed April 28, 2026. So a business can currently be safe from a DOL audit under one test and lose a private wage-and-hour suit under another.

States go their own way and mostly go harder. California Labor Code §2775 presumes employee status unless the hiring entity demonstrates all three ABC conditions: (A) the person is free from the control and direction of the hiring entity in performing the work, both under the contract and in fact; (B) the person performs work outside the usual course of the hiring entity's business; and (C) the person is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed. Prong B is the one that kills arrangements. A design agency that engages designers as contractors fails it on the facts no matter how the contract reads, because designing is the usual course of a design agency's business.

The lever is documentary and it must be built before the audit, not during it. Contractors who invoice on their own letterhead, carry their own insurance, serve other clients, set their own hours, use their own tools and are paid per deliverable rather than per hour look like contractors under every test. Contractors who have a company email address, a place on the org chart and a standing Monday meeting do not, and no clause reciting 'independent contractor' repairs that.

What reclassification actually costs, and the entity tree that follows

Operators reflexively price reclassification at the employer's payroll-tax share: 6.2% for Social Security and 1.45% for Medicare, 7.65% in total, on wages up to the Social Security wage base of $184,500 for 2026. That number is real and it is far too small.

Illustrative only. A contractor is paid $85,000 a year and is reclassified as an employee. The employer's FICA share is $85,000 x 7.65% = $6,503, and because $85,000 sits below the 2026 wage base, all of it is subject to the 6.2%. Now load the rest. BLS Employer Costs for Employee Compensation, which measures employer costs per hour worked for private industry workers averaged across all private industry rather than a quote for any one job, reported $46.60 per hour worked in March 2026, of which $32.60 was wages and salaries and $14.01 was benefits. That is a ratio of about 1.43 total employer cost to wages. Apply it and the same person costs roughly $121,550 rather than $85,000: a gap of about $36,550, of which the $6,503 of employer FICA is under a fifth. The rest is health coverage, retirement contributions, paid leave, unemployment insurance and workers' compensation. Back taxes, interest and penalties on prior years sit on top of all of it.

That cost is what should drive the entity conversation, and it runs the tree in an order most checklists skip. Start with footprint, not liability. If you sell physical goods into many states, your first question is registration and collection, and the entity form barely moves it. If you sell software or services, you have no P.L. 86-272 protection anywhere, so the question becomes which states you will file income tax returns in and whether a pass-through election is available in each.

Then let the multi-state facts constrain the form. An S corporation cannot have more than 100 shareholders, cannot have partnerships, corporations or non-resident alien shareholders, and may have only one class of stock, limits that bind quickly if you hire abroad or take on an institutional partner. A C corporation carries its own tax layer but opens section 1202: for qualified small business stock acquired after July 4, 2025, the gain exclusion is 50% at three years, 75% at four and 100% at five, capped per issuer at $15,000,000, and only for corporations whose aggregate gross assets do not exceed $75,000,000 before and immediately after issuance. Delaware incorporation is a real annual cost, not a free default: franchise tax runs from a $175 minimum under the authorized shares method or $400 under the assumed par value capital method up to a $200,000 maximum, plus foreign qualification in the state where you actually operate.

What breaks first is almost never the structure. It is the record. A business that cannot produce sales by ship-to state, payroll by work location and a contractor file with real invoices has no way to know which of these rules it is already breaking. Build that reporting first; the entity choice is the easy part once it exists. This is general education, not legal or tax advice: thresholds move with legislation and every state writes its own.

Put it to work

Pull twelve months of sales by ship-to state and twelve months of payroll by work location. Flag every state over its economic-nexus threshold and every remote worker creating payroll nexus. List each contractor, score it against the IRS behavioral, financial and relationship tests, and rewrite the weak ones. Then price registration, back tax and reclassification before choosing an entity.

Sources & references

Linked entries open the named source directly. Entries without a link say exactly what kind of reference they are — and how to check them yourself.

• South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018) — slip opinion
• 15 U.S.C. §381 — Public Law 86-272, limitation on state net income taxes
• Multistate Tax Commission — Statement of Information on P.L. 86-272, fourth revision adopted August 4, 2021
• California CDTFA — Use tax collection requirements after Wayfair
• California FTB — Doing business in California (sales, property and payroll thresholds)
• California FTB — Pass-through entity elective tax
• IRS Notice 2020-75 — deductibility of specified income tax payments by partnerships and S corporations
• IRS — Independent contractor (self-employed) or employee?
• U.S. DOL Wage and Hour Division — Field Assistance Bulletin No. 2025-1 (May 1, 2025)
• Federal Register — Employee or Independent Contractor Status proposed rule, February 27, 2026
• California Labor Code §2775 — the ABC test
• BLS — Employer Costs for Employee Compensation, March 2026 (USDL-26-0827)
• IRS Topic no. 751 — Social Security and Medicare withholding rates
• IRS — S corporations (eligibility requirements)
• 26 U.S.C. §1202 — partial exclusion for gain from qualified small business stock
• Delaware Division of Corporations — franchise tax calculation methods
• Streamlined Sales Tax Governing Board — remote seller FAQs and state threshold guide