Online Retailers Beware: States Broaden the Tax Net
While the stock market has rallied, state tax revenue collections continue to come in at dismal levels compared to a year ago. A recent survey by the nonprofit Nelson A. Rockefeller Institute of Government shows that state income tax revenue in the first four months of 2009 fell 26 percent vs. the same period of 2008. With collections from sales and property tax on the decline, states are under great pressure to raise additional revenue from new sources. One target squarely in the sights of legislators: internet sales.
The debate over whether online retailers are required to collect sales tax has traditionally focused on whether the online retailer has a physical presence in the state. Without having to resolve this constitutional question, states have identified a common business arrangement that they now assert results in sales tax nexus, requiring collection of tax, even when the seller has no physical presence in the state. This business arrangement is the use of affiliate programs to generate internet sales for out-of-state online retailers.
New York was the first state to adopt such “affiliate nexus” legislation, doing so in 2008. The New York law provides that an online retailer that makes sales of taxable property or services in New York will be presumed to be vendors required to collect sales tax if it enters into an agreement with a New York resident under which a commission or other consideration is paid for directly or indirectly referring potential customers to the seller’s website. Exceptions to the new “affiliate nexus” standard apply if the party providing the link to the seller’s website doesn't engage in any solicitation activities on behalf of the online retailer, or if the gross receipts as a result of referrals by all of the seller’s representatives don't exceed $10,000 in the previous four quarters.
Amazon.com and Overstock.com each contested New York’s affiliate nexus legislation. They argued that despite having thousands of New York-based affiliate websites, the online sellers themselves didn't have any physical presence in the state. Amazon.com and Overstock.com lost their case in court, and an appeal to the state Supreme Court was dismissed.
Now commonly referred to as the “Amazon Bill,” states across the country are looking at the precedent set in New York and considering their own legislation to expand sales tax collection requirements to online sellers. North Carolina and Rhode Island have enacted legislation modeled after the New York law. In other states, the debate has generated much attention. California Gov. Arnold Schwarzenegger issued a press release in July saying that he would veto any such legislation after Overstock.com announced it would pull all of its affiliate programs from California if an “Amazon Bill” was adopted there. A similar result played out in Hawaii, where its governor vetoed an “Amazon Bill” under pressure from online retailers. As legislative sessions gear up for another round of potential revenue raisers, the possibility of extending sales tax collection responsibility to out-of-state online retailers will continue to generate a great deal of interest.
How Online Retailers Need to Respond
Sales tax collection responsibility is an issue that no online retailer wants to hear about for the first time during a state tax audit. In almost every state, the party responsible for payment of a sales tax isn't the company that's made the sale. Ultimate responsibility lies instead with consumers making purchases. When a seller has sales tax nexus in a state, its role is limited to collection and remittance of the tax. If a seller doesn't have sales tax nexus, it has no obligation to collect tax. The consumer in this case is obligated to self-assess a “use tax.”
More and more state tax audit resources are being devoted to the discovery of taxpayers who aren't registered to collect sales tax. Traditionally these “nexus discovery” units focused on finding taxpayers with some physical presence — e.g., an employee or sales representative — in the state. But now with the expansion of the affiliate nexus concept, even sellers with no physical presence whatsoever in a state may be found to have sales tax nexus and, therefore, a liability for uncollected sales tax.
A business that should have collected sales tax but didn't, in effect, assumes a liability that belongs to its customers. The end result? The sales tax, which in many states can run as high as 6 percent to 8 percent of the sale price, becomes an expense of the seller and may eliminate all or a large portion of the net profit from the sale.
What should online retailers do to avoid being surprised by a large assessment for failure to collect sales tax? First and foremost, review your business practices to determine which, if any, activities could result in sales tax nexus in states outside of your home state. Sales and marketing programs change quickly and frequently with online retailers. It's important that whenever a change takes place that sales departments communicate the change to those responsible for administering companies’ tax functions. This allows tax professionals to make informed decisions about collection responsibilities.
If your business has a collection obligation, it must evaluate its tax compliance process. Typically this is a joint effort between tax and IT professionals. Sales tax compliance can be extremely complex. Each state, and many local counties and cities, have their own laws regarding taxable and exempt sales, sales tax holidays, tax rates, and procedures for filing returns and paying the tax. While 45 states impose sales taxes, the number of unique taxing jurisdictions in the U.S. exceeds 7,500 when counties and municipalities are considered.
The sales tax landscape is drastically changing. Continuously test all of your business activities against the new and emerging requirements for sales tax nexus. Failure to respond to these new state tax requirements could have drastic consequences if you, by default, absorb sales tax liabilities that never should have been your expense.
Peter Harris, CPA, is a tax consultant for Braver PC, a Newton, Mass.-based accounting and professional services firm. Peter can be reached at pharris@thebravergroup.com.
