Reference periods are the specific time intervals where tax authorities in the US determine if a business has established an economic nexus in a particular state or jurisdiction.
Tax authorities will scan your business's sales, revenue, and transactions within this "reference period" to determine if you have met the economic nexus threshold in their state or jurisdiction. This guide will explain everything you need to know about the different types of economic nexus reference periods.
- The nexus reference period is the time tax authorities use to determine if your SaaS business has established economic nexus in their state or jurisdiction.
- Economic nexus occurs when a business exceeds a specific revenue or transaction threshold in a particular place. It precedes the business's collection and remittance of sales taxes to local tax authorities in that state or jurisdiction.
- Nexus reference periods helps you identify historical sales obligations before the tax authorities, navigate voluntary disclosure agreements, and carry out comprehensive internal audits.
- The most common nexus reference periods in the US states are the previous calendar year, previous or current calendar year, and preceding 12 months.
What is economic nexus
To understand nexus reference periods, you need to first understand economic nexus. In the United States, economic nexus is formed when a non-resident seller meets certain sales, transaction, or revenue thresholds in a particular state or jurisdiction over a specific period of time.
Before 2018, SaaS companies and other online businesses were only required to pay sales taxes in places with a physical presence. However, the status quo changed in 2018 after the US Supreme Court set a new precedent in the "South Dakota vs Wayfair" judgment.
Now, states and jurisdictions in the US can require out-of-state sellers to collect and remit sales taxes. Furthermore, local tax bodies set the rules and guidelines for sales tax collections. Some of these guidelines include the reference periods, remittance process, and trailing nexus periods.
How reference periods help SaaS companies with sales tax compliance
Tax authorities consider four major factors when checking to see if a SaaS company has established an economic nexus or not. These factors include sales/revenue, number of transactions, type/nature of sale and reference period.
To avoid the consequences of sales tax non-compliance, SaaS companies often conduct periodic re-evaluations using nexus reference periods as their guideline. As a result, they can determine if the business has met, and will continue to meet economic nexus thresholds in the future. Nexus reference periods are essential to SaaS CFOs because they:
- Help you identify when you hit economic nexus thresholds
- Tell you when to register with tax authorities
- Aid long-term compliance planning
- Identify historical sales tax liabilities
- Aid voluntary disclosure agreements
- Support with the sales tax audits
Identifying economic nexus thresholds
Like we said earlier, state and jurisdictional tax authorities monitor economic thresholds by referring to the nexus reference period. Consequently, SaaS companies have to do the same to keep up with sales tax compliance regulations and register with the tax authorities as and when due.
Registering with tax authorities
Nexus reference periods tell SaaS companies exactly when they need to register with tax authorities. When you hit the economic nexus threshold in any state or jurisdiction, your tax team will discover while reviewing reference periods and begin the process of registering with the relevant tax bodies.
Planning for long-term compliance
SaaS CFOs love planning for the long-term and nexus reference periods are essential for sales tax compliance planning. By referencing reference periods, SaaS businesses can conduct periodic re-evaluations to determine if their company will meet the economic nexus threshold or not.
If it becomes clear that the business will not hit the economic nexus threshold, then the leadership of the company can decide if it makes sense to surrender their permit once the trailing nexus period is over.
Checking historical tax liabilities
SaaS companies can quickly identify where they have historical sales tax obligations by studying the reference periods of states and jurisdictions where they've made market progress. After they identify these areas, your SaaS business can opt for a voluntary disclosure agreement (VDA) to get on the good side of the tax authorities.
Applying for voluntary disclosure agreements (VDAs)
A voluntary disclosure agreement is a pre-planned formal arrangement where a corporate entity reports historical tax liabilities to state or jurisdictional tax authorities. A SaaS business with tax exposure may approach the concerned tax authorities to work out an agreement that favors both parties.
By studying reference periods, SaaS businesses can identify where they have historical sales tax obligations and reach out to the tax authorities before they inevitably call for a sales tax audit.
Supporting tax audits
Tax audits are a natural part of doing business in the US. Sooner or later, you should expect tax authorities to knock at your door. Before tax authorities call for sales tax audits, proactive SaaS CFOs conduct internal audits to ensure all documents are in order.
Reference periods are essential for this process because they provide a focal point for the internal audit process. As a SaaS company, managing sales tax audits is easier when you know the reference periods of the states and jurisdictions involved.
Types of reference periods
A reference period is the specific time interval used by tax bodies to determine whether your SaaS business has established an economic nexus by meeting the sales and/or transaction thresholds in that state or jurisdiction. Most state and jurisdictional tax authorities in the US use previous calendar year, previous or current calendar year, or preceding 12 months as their nexus reference periods.
As a result, SaaS companies and their tax compliance teams have to research the nexus reference periods of over 11,000 jurisdictions, group them correctly and keep monitoring the sales data in these reference periods to identify when economic nexus has been established.
Previous calendar year
Some states in the US use the previous year as their nexus reference period. In October 2023, tax authorities Alabama and New Mexico use 2022 as their reference period. The major advantage of this system is that SaaS companies can easily do a yearly review to determine if they've established an economic nexus or not.
Previous or current calendar year
When the previous or current calendar year is used as the reference period, tax authorities will try to determine if you exceeded the economic nexus threshold from January to December of the preceding year and January to the current date in the ongoing year.
States that use the previous or current calendar year as their nexus reference periods include Arizona, Colorado, Georgia, Iowa, Louisiana, Maine, Maryland, Massachusetts, Nebraska, Nevada, etc. For context, a SaaS business operating in any of these states in October 2023 will have 2022 and January - September 2023 as its reference period.
Preceding 12 calendar months
States like Illinois, Minnesota, Mississippi, Missouri, Tennessee, and Texas determine if your business has hit the economic nexus threshold by referencing the sales and/or transactions over the preceding 12 calendar months. As a SaaS business operating in any of these states in October 2023, your reference period for identifying economic nexus will be October 2022 to September 2023.
Preceding 12-month period ending on September 30
Connecticut uses a 12-month period ending on September 30 to determine economic nexus. For example, Connecticut tax authorities will reference October 1, 2022 - September 30, 2023, to determine if a SaaS company operating in March 2024 has met the threshold for sales taxes.
Difference between nexus reference periods and trailing nexus
While nexus reference periods deal with the pre-establishment of economic nexus, trailing nexus comes into play when economic nexus no longer holds. As a SaaS business, you may be required to pay taxes where you once established an economic nexus even though you've ceased presence or operations in that state or you no longer meet economic nexus thresholds..
States and jurisdictions may continue to tax you for some time before you are finally free from sales tax obligations in that place. This period is called trailing nexus period; its duration varies from state to state. For example, California considers current and previous calendar years for its reference period.Similarly, its trailing nexus period is the calendar year threshold is met and the subsequent year.
If you hit the economic nexus threshold of $500,000 in California in March 2020, you are required to collect and remit sales taxes from March 2020 to December 2021. However, if you do not meet the same economic nexus requirement in 2021, you don't have to pay sales taxes in 2022.
Monitoring the nexus reference period for 11,000 jurisdictions in the US could be challenging for most businesses. As a result, most state tax authorities usually give a grace period for sales tax remittance. A grace period is a specific time interval where businesses are granted additional time to comply with sales tax obligations.
However, using an automation software that picks up on all the necessary details, like reference periods and economic nexus thresholds, is the best way to ensure sales tax compliance. Software solutions like Galvix consider reference periods when identifying economic nexus points, and preparing documents for internal audits.
In addition, automation software will help you calculate the right amount of sales taxes, register with concerned tax authorities, and remit the funds before deadlines. This way, you can avoid all the consequences of sales tax non compliance while getting deep insights into your market hotspots in the US. For SaaS companies, this is the best way to save time and money for your business.