E-Commerce Sales Tax: Seller’s Beware!

The U.S. Census Bureau reported an estimated $92.8 billion of e-commerce revenue was generated during the first quarter of 2016. This represents 7.8% of total retail sales for this period. For the same period in 2007, the total e-commerce revenue was $31.7 billion or 3.2% of total retail sales. The growth in e-commerce sales is made possible by better technology, better marketing strategies, better cooperation between vendors, and a more robust network of vendors and drop-shippers to support this business model. There are very few barriers to entry for e-commerce companies. Along with this growth in e-commerce revenue has comes a growth in lost state sales tax revenue because remote vendors are not obligated to charge tax and a growth in the need for the states to capture this missing revenue. The lack of a nationwide online sales tax platform is creating tension between the states, the federal government, “Main Street” retailers, and other remote vendors. There is even growing tension between remote sellers that are charging tax and remote sellers that are not charging tax.

The growth in e-commerce revenue and the loss of e-commerce sales tax revenue has not escaped the state departments of revenue or the state legislatures. With changes to state laws and improvements in information sharing between the states, many e-commerce companies are quickly finding themselves in serious trouble with respect to their failure to collect and remit sale tax on taxable sales in states where they did not think they had an obligation to collect tax. E-commerce sales tax collection is the most important issue that state revenue officials are dealing with at this point.

Remote commerce and e-commerce sales tax evolution

Remote commerce has existed in one form or another for decades; starting with mail order catalog sales, then remote shopping clubs, then cable TV shopping networks and shopping infomercials, then web-based retailers. The remote sales tax issues arising from remote commerce also date back decades when states were aggressively pursuing companies like Lilian Vernon and Quill to collect and remit tax on the sales they made from their catalogs. Next came state tax challenges against QVC and The Home Shopping Networks for their failure to collect and remit tax. During this time several U.S. Supreme Court cases were settled which established the basic ground rules for when remote sellers needed to register to collect sales tax. The most notable is Supreme Court case on this topic is Quill Corp. vs North Dakota (“Quill”) which was issued in 1992. This decision established that remote sellers must have some minimal physical connection with the destination state before that destination state can force the remote seller to collect and remit sales tax. At the time of Quill, web based e-commerce was just a dream. Now that 7.8% of U.S. retail sales occur via e-commerce, the internet sales tax impact of Quill is being felt by the states and they are being very aggressive in their response.

Nexus

Perhaps the most significant internet sales tax rules for e-commerce companies to be alert to is the concept of ‘nexus’. Nexus is the term used to describe the situation when a company is under an obligation to register for the collection and remittance of sales tax in one or more states. Nexus is a binary decision; your company either has nexus in a state or it does not have nexus in another state. There is no such thing as “a little nexus”! Without nexus, the state departments of revenue cannot compel nonresident retailers to register and collect tax. Once nexus has been created, the states will treat remote sellers in the same way that they treat retailers with buildings in their state. Remote sellers with nexus in a state have the same online sales tax obligations as a Wal-Mart does when it sells property from its website. .

The current nexus standard as expressed by the U.S. Supreme Court in Quill requires that the remote seller have some physical connection with the taxing state before the taxing state can compel the remote seller to collect ecommerce sales tax. This physical connection can be established directly or indirectly. Direct nexus with a state occurs when the retailer has employees living or working in the taxing state or when the retailer has inventory or other property stored in the state. Renting real or personal property to customers in the taxing state, delivering property in company vehicles, or performing services in other states will also create direct nexus with the state. Many companies only focus on these types of activities when they evaluate their nexus footprint outside their domicile state. Ecommerce sales tax requires a more comprehensive evaluation.

In many cases, remote sellers won’t have direct nexus, but they will have indirect nexus. This occurs when the remote reseller uses third-parties to perform tasks that the retailer elects not to perform.   This may include using third-party sales representatives, commissioned salesmen, third-party installation companies, third-party training providers, and other similar companies to provide the work that the retailer would do. Almost all state statues related to nexus include language that encompasses these indirect activities. The nexus created by these indirect activities is just as significant as the direct nexus creating activities. Regardless how nexus is created, companies selling across state lines need to know how to charge tax on online sales.

Fulfillment by Amazon

Amazon.com provides a program called Fulfillment by Amazon or FBA which allows remote sellers to have their products listed on Amazon.com and showcased along with other property owned by Amazon. Under the FBA program, sellers arrange to have their inventory shipped to one or more of the Amazon warehouses where it will remain until sold. However, at the discretion of Amazon, that property may be moved from one warehouse to another or to multiple warehouses depending on projected demand. The retailer pays Amazon a fee of 15% to provide a wide range of services. These include showcasing the product on the Amazon website, accepting orders, accepting payment, picking the property from inventory, and shipping the product. These issues have significant impact on the internet sales tax obligation imposed on the seller.

According to materials on Amazon.com, the inventory remains owned by the seller, and not Amazon, throughout the entire sales process. Amazon is just accepting and fulfilling orders and is not the seller under the FBA program. Companies that use the FBA should carefully evaluate whether any of these activities create nexus for them in states where Amazon has warehouses. Companies with nexus in states via the FBA program must know the internet sales tax rules that apply to these transactions

Third Party Drop shipment

One of the most common ways for remote sellers to fulfill orders for the purchase of their products is by using their suppliers to directly ship the property directly to their customers. This is called a third-party-drop shipment. These transactions can take a multitude of forms and involve a number of different states. In most cases, the drop-shipment transaction does not pose any immediate problem to the remote seller, however there are some situations where state specific rules may create some unexpected ecommerce sales tax obligations.

As with all internet sales tax transactions, the e-commerce sales tax obligations of remote sellers are governed by the laws of the destination state. For example, if a remote seller located in Georgia receives an order for a product from a customer located in Texas, the Texas rules govern what sales tax rules must be followed. If the retailer has not nexus in Texas and ships the property from inventory located in Georgia, then the retailer would not have any obligation to collect Texas sales tax.

If the retailer does not own inventory at the time the order is taken, they can request their supplier ship the property directly to their customer. This is considered a drop-shipment. For purposes of this example, let’s assume that the supplier was also located in Texas which would give that seller nexus in Texas.

A drop-shipment is really two separate sales that occur simultaneously.   The first sale is from the suppler to the retailer and the second sale is from the retailer to the ultimate customer. The first sale is a “sale for resale” and the second sale is a “retail” sale. As with any sale for resale, the seller must obtain a valid resale certificate from its customer. In our example, the Texas based supplier must obtain from the retailer a resale certificate that is valid in the state of Texas. This is because the supplier has nexus in Texas and because the ship-to address is in Texas. Failure of the retailer to provide a resale certificate to the supplier would legally require the supplier to charge the retailer tax on the wholesale price of the materials sold. Thankfully, the state of Texas will allow the Georgia based retailer to use its Georgia resale number on the Texas exemption certificate to avoid being charged tax.

If in the example above, the supplier was located in Alabama and did not have nexus in Texas, there would be no obligation for the Georgia based supplier to provide any resale certificate because the Alabama seller does not have nexus in Texas and would not be obligated to collect tax if the remote seller does not provide a resale certificate.

In several states, such as California, the rules are a bit different that that expressed above. Assume that the Georgia remote seller accepts an order from a California customer and uses a California based supplier to drop-ship the property directly to the customer. As above, the sale from the California supplier to the Georgia retailer is a “sale for resale” that must be supported by a valid resale certificate. In California, though, a valid resale certificate must contain a California registration number. This will require the Georgia based retailer to register with the California Board of Equalization. Once registered with the Board, the Georgia retailer will then collect tax on all California sales even though it does not have nexus in the state.

If the Georgia retailer does not provide the California drop shipper (supplier) with a valid resale certificate, the sales will not be a sale for resale; rather, it will be a retail sale and taxable. In that case, the California retailer will charge the Georgia retailer California sales tax on the retail sales price of the product or cost plus 10% if the sales price is not known. This puts the retailer in a real bind and can force them to register in California even if they don’t have nexus. This is a very cleaver tactic used by California to force companies without nexus to register in the state. Retailers using drop-shipments as a way to fulfill sales should be alert to these rules and may need to know where their suppliers are registered for sales tax before the commit to using these suppliers.

Federal and State Legislation

Economists have estimated that over $20 billion a year of internet sales tax is not being collected on taxable remote sales. Using an average sales tax rate of 7 percent would mean that over $285,000,000,000 in untaxed remote sales occurring annually. This total does not seem reasonable or realistic to me given the large number of companies that are collecting tax on their remote sales. Regardless of the precise amount of lost ecommerce sales tax revenue, there is a significant amount of internet sale tax that is not being collected by retailers that do not have nexus in the ship-to state. Even though purchasers are supposed to pay use tax on these purchases if the retailer does not charge tax, this is virtually non-existent when looking at non-business purchasers.

Under the Quill decision issued by the U.S. Supreme Court, the U.S. Congress was given the responsibility pass legislation that could require remote sellers to collect sales tax in states where they do not otherwise have nexus. Congress has had this charge since 1992 and for the past 24 years it has done nothing to resolve this issue. The states are tired of waiting and have started to act.

For at least a decade, there have been bills in Congress that contain titles like “Main street tax fairness” or “sales tax fairness” or “remote sales tax fairness”. These have stalled in committee under pressure from the business lobby. As I’ve studied these bills, they don’t provide much fairness to the remote seller and impose enormous costs and tedious procedures for remote sellers in order for them to comply with the law. One bill would even impose sales tax based on the rules of the state of origin but use the tax rate of the destination state.

States have also attempted legislation such as the Amazon nexus laws that would require Amazon to register in any state where it had relationships with local businesses or agents and where those agents linked their website to the Amazon website. New York started this many years ago and succeeded in court as taxpayers challenged this law. As New York became successful that this, more state also adopted this same strategy. This produced little revenue as Amazon simply cancelled the arrangements it had with these agents.

The next legislative effort was directed as bypassing Quill directly in what would be called “economic nexus”. The states of Alabama and South Dakota have lead the way on this effort. In Alabama, the law says if the remote seller has over $250,000 of annual sales in the state, it is deemed to have nexus even though the remote seller has no physical connection with the state. Both states have issued assessments against taxpayers and are quickly forcing this issue to court. The Tennessee Department of Revenue is also proposing rules to implement some type of economic nexus standard.

The goal of these economic nexus laws is to force the U.S. Supreme Court to review (and overturn) the Quill decision.   The goal of these laws is to bypass Congress since it has failed after 24 years to make any meaningful attempt to allow states to force remote sellers to collect tax even though they don’t have nexus in the state.

Conclusion

The environment for internet sales tax collection and other related ecommerce sales tax issues has changed dramatically over the past decade. The Internet sales tax revenue lost by the states is significant and is having an impact on the states’ ability to provide the required services. Remote sellers that can operate without having inventory outside of their home state or by using drop-shippers may be the only ones who can truly claim they only have a sales tax obligation in their domicile state. Other remote sellers that use the FBA program or use drop shippers, or have relationships with out-of-state representatives may have sales tax collection obligations in multiple states. If these companies are audited or are identified for audit, they could be liable for tax, interest, and penalties. As a remote seller, you must carefully review your business operations and seek qualified help to determine whether your business has any sales tax collection obligations in other state. The internet sales tax rules are complex and should not be taken casually.

Many remote sellers who have contacted me have indicated that they were trying to “surf the web” to get the Internet sales tax help they needed and were just reading blogs and random information from people who had no professional background in tax. This led them to registering in states that they did not need to and not registering in states that they should have; neither is a good situation. When it comes to understanding Internet sales tax rules, be careful as to what information you get from the Internet.

Interstate Tax Strategy Services

If you have questions or need help understanding the internet sales tax rules affecting your business, please call me for a free and no obligation 30 minute discussion about your business and sales tax situations. When it comes to e-commerce sales tax, every business situation is unique. The services we provide to e-commerce companies around Internet sales tax are designed and priced to meet your particular situation. If you are just starting and looking for some general information direction about ecommerce sales tax, we can provide that at a very low cost. If your business is an active player in e-commerce and has a network of referral partners and drop shippers, then your needs will be more demanding. For companies such as yours, we can assist with nexus studies, drop-shipment analysis, resale certificate management, and tax automation. If your company is under audit or is receiving notices from states about your sales tax obligations, then we can assist you with these also.

There is no reason not to call to discuss your situation. My number is 404-403-6540. The Internet may be a great place for you to do business, but it’s no place to get the expert assistance you need to understand your company’s sales tax obligations. The states assume that you know the tax rules, there is no such thing as “ignorance of the law” when it comes to sales tax. Don’t let a tax auditor be the first ones to tell you about your sales tax obligation in their state.

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For a FREE discussion about your sales tax audit defense issues, please contact us at info@salestaxstrategies.com or 404-403-6540.