Last updated: October 25, 2023

Economic vs. Physical Nexus: Should Remote Sellers be Required to Obtain Business Licenses?

Here’s what you need to know about the economic vs. physical nexus debate and what municipalities are considering.
Posted by GovOS Team
A small business owner checking online orders to prepare to pack the boxes for customers

There are approximately 2.5 million e-commerce businesses operating in the United States. With how-to guides and easy-to-follow programs for starting online businesses flooding social media and people looking for ways to supplement their income online, the number of e-commerce businesses is expected to increase exponentially over the next several years.  

This exciting new frontier of e-commerce has presented a multitude of challenges and opportunities, not only for businesses but also for municipalities looking to regulate and tax commercial activities. In recent years, questions have been swirling around the legitimacy of applying traditional tax and licensing models to remote sellers, particularly in the wake of the landmark South Dakota v. Wayfair case. 

For municipalities, it will become critical to have an answer ready on whether remote sellers operating in your jurisdiction are required to obtain a business license. 

Here’s what you need to know about the economic vs. physical nexus debate and what municipalities are considering.     

What is “Nexus” and Why is it Important? 

First things first, it’s important to understand what nexus is. The term “nexus” refers to the connection between a seller and a local jurisdiction that obligates the seller to collect and pay sales tax. There are two primary forms of nexus: physical and economic. Physical nexus arises when a business has a tangible presence in a state, like a brick-and-mortar store, while economic nexus is related to the revenue earned or the number of transactions in a state. 

While it used to be fairly straightforward, the sharp rise of e-commerce and social media businesses over the last 15 years has greatly muddied the waters over which nexus an online business falls under. In 2018, the debate finally reached the Supreme Court in a landmark case.  

South Dakota v. Wayfair Sets a New Precedent 

In 2018, the Supreme Court ruled on a case that provided more clarity on the physical vs. economic nexus debate. The South Dakota v. Wayfair case established that states could mandate out-of-state sellers to collect and remit sales taxes, even without a physical presence in the state. This case introduced a renewed debate on whether states could or should impose local business license requirements on remote sellers solely based on economic nexus. 

However, the legalization of requiring remote sellers to adhere to local business license mandates based only on economic nexus still poses significant legal and ethical considerations. The Wayfair case primarily focused on sales tax collection, leaving the intricacies of business licensing largely unanswered. Thus, states and local jurisdictions remain in muddied waters, grappling with the implications of imposing local business licenses on entities operating in a virtual space. 

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The Pros and Cons of Requiring Business Licenses for Remote Sellers 

A primary benefit of requiring remote sellers to obtain business licenses is that municipalities can provide a level playing field for anyone operating in their jurisdiction. It guarantees that remote sellers benefitting from the state’s infrastructure and market contribute directly by obtaining business licenses and adhering to local regulations and standards. 

On the flip side, this requirement could quickly become an undue burden on remote sellers. Economic growth could be stifled, as the administrative and financial hurdles of obtaining a license in every jurisdiction where a remote seller has an economic nexus could be overwhelming. This is especially true for smaller businesses that lack the resources and time to get multiple licenses.  

How Can Municipalities Manage the Implications for Remote Sellers? 

There are a few main ways that requirements to obtain business licenses based on economic nexus could significantly alter remote sellers’ operational landscape. Obtaining business licenses in multiple jurisdictions can lead to a complex and fragmented compliance landscape, impacting business operations and necessitating additional resources for adherence to varied regulations. Municipalities need to clarify compliance early and have a system in place to help remote sellers remain compliant.  

Additionally, the financial implication of securing and maintaining multiple business licenses can be substantial, potentially impacting the profitability of small and medium-sized enterprises. The operational adjustments needed to comply with varied licensing requirements across states can influence business strategies, product offerings, and market presence. Municipalities need to have a streamlined process for remote sellers to secure and renew business licenses if they want to encourage economic growth.  

Should Municipalities Revisit Licensing Models? 

In light of the ongoing debates, it becomes imperative for municipalities to revisit and rethink licensing models, ensuring they are equitable and adaptable to the evolving legal landscape. Striking a balance between maintaining regulatory standards and fostering economic growth will play a factor in the long run in the economic success of a municipality. Should your municipality decide to require business licenses for remote sellers, it is essential to have a solid communication plan in place about the new requirement to ensure compliance.  

Will Your Municipality Be Proactive in the Physical vs. Economic Nexus Debate? 

As e-commerce continues to evolve, states and local governments need to embrace a decision that works for both the municipality and the remote seller. Your municipality must find the right balance between safeguarding local interests and fostering an environment that’s conducive to remote sellers. This can often be achieved by partnering with a technology partner that offers a trusted business licensing system that can meet the needs of your municipality.  

The discussions around economic vs. physical nexus and the subsequent requirements for remote sellers to obtain business licenses are far from over. The Wayfair case opened Pandora’s box of legal, ethical, and operational questions that are still being navigated. When it comes to requiring remote sellers to obtain a business license, what will your municipality decide?

For more business licensing resources, take a look at our Guide to Business Licensing for Local Governments.

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