E-Commerce can create interesting sales tax liabilities

The Wall Street Journal has an interesting article about Amazon today, entitled Will Amazon Get a Visit From the Tax Man?.

It appears that Amazon has a number of large distribution warehouses in some states, such as Texas, Pennsylvania and Indiana, but doesn’t pay sales taxes in those states. Amazon is trying to skirt the issue by saying the distribution warehouses are wholly owned subsidiaries of Amazon. Amazon’s theory is: The subsidiaries don’t sell products to consumers, so they don’t need to pay sales tax, and since Amazon itself doesn’t own the warehouses (it’s subsidiaries do), it doesn’t need to pay sales tax either.

The article does a good job talking about the issue regarding Amazon, but could go into better detail on the tax issues an e-commerce company must deal with. My standard disclaimer: Please consult with a CPA or tax attorney, as what I am about to discuss may be incomplete or inaccurate for your particular situation.

Note that many e-commerce businesses don’t fully understand The Internet Tax Freedom Act, which doesn’t prohibit all taxing, per se. What it does is prohibit taxing Internet access, imposing discriminatory Internet-only taxes and multiple taxes on electronic commerce. Contrary to popular belief, it does not prohibit state sales or use tax.

Sales taxes can be somewhat complex, depending on the subject matter. The easiest case is a typical product, like a book or DVD. If a business has a “sufficient nexus” within a state, it generally has to collect sales tax from the residents in that state. The “sufficient nexus” requirement is met by physical presence (i.e. the business has an office or warehouse in the state), but “sufficient nexus” can also be met without physical presence. And, this is one area where things can become tricky. The “sufficient nexus” requirement could be met, if a business has a “close relationship” with third-party contractors.

Things become murkier still, regarding some products or services. Let’s look at services for a moment: Instant Gift Certificates are becoming a popular way for service-based businesses to “sell” their services on the Internet. Some states, like New Mexico, charge a “gross receipts tax” (or GRT) on services. If a business in New Mexico sells a dollar-based gift certificate (i.e. a $100 gift certificate), there is no tax to charge until the gift certificate is redeemed. However, if the business sells a service-based gift certificate (i.e. “one Swedish massage”), the purchaser should be charged GRT upon the sale of the gift certificate.

Worse still, some states (like New Jersey) charge a tax on just some services. So, for example, massages are taxed but facials are not (both facials and massages are typically provided by the same business). So, a business selling a service-based gift certificate needs to keep track of what services are taxed and which are not, and make sure the tax is properly applied at the time of sale.

For products, things become murky, depending on the subject matter and location of the consumer. As it relates to location, some major cities have different sales tax rates than the overall state (i.e. Chicago or New York). So, if a business has “sufficient nexus” in the State of New York, it must keep track of all the tax schedules within that state, and know exactly which tax schedule to apply to which consumer in that state. As it relates to subject matter, all sorts of products will suffer various restrictions or tax exceptions. For example:

• Gift cards and gift certificates have various restrictions on maintenance fees, expiration dates (depending on where the consumer sits) and escheatment (depending on where the business sits).
• Wine and other alcoholic beverages have restrictions or varying tax implications, depending on the state, county or city in which the consumer sits.
• Chemicals, paints and industrial solutions have many restrictions, permit requirements and tax implications.

The problem for an e-commerce company, is that it’s sometimes difficult to identify all the tax laws and burdens, create the programming logic to identify which products or services have a sales tax burden to which customer, and then keep the tax schedules (and treatment) up-to-date.

The trick is, to be careful on which state you create a “sufficient nexus” for sales tax purposes, and to do your research BEFORE you start selling your product or service on the Internet, because your business could be liable for back-taxes going back many years.