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.

Objective, transparent decision making …

As an executive and consultant, I’ve run into many points in my life where I’ve had to make a complicated decision based on a number of competing objectives. In most instances, I can make a decision fairly quickly after doing my research or evaluating my options.

In some situations, a quick decision isn’t practical, possible or best. Have you ever had situations where:

• It’s not clear which option would be best?
• A decision is politically charged (i.e. Transparency is essential, because the stakes are high and everyone concerned wants to know the decision is fair)?
• Someone important — perhaps a family member or client — wants to know you’re being professional and being through in your decision (or recommendation)?

Well, I have just the thing! I call it a “Comparison-based Decision Matrix”. It’s a simple, great looking, spreadsheet that enables you to compare competing options on an apples-to-apples basis. The spreadsheet takes the difficulty out of making a decision, although creates a new difficulty: figuring out what the factors in your decision really are, and assigning weights to those factors.

Download the spreadsheet. It contains a simple decision as an example: “How should we process Credit Cards today?” It compares three possibilities.

How to use the Comparison-based Decision Matrix

1. What is the issue to be decided? Put this in B6. In my example, I have “How should we process Credit Cards today?”
2. What are the decision factors that influence your decision? Nothing is too small or unimportant. Put it all down. Insert additional lines, as you need them. In my example, I have “Best for Customer Satisfaction,” “Cheapest Long-Term” and “Cheapest Short-Term” amongst others.
3. Now comes the hard part: assign weights to each of your factors. Some are more important than others, so you need to weigh each factor against the others. Give each a weight, so that all your weights total up to 100. The spreadsheet will help you. If one factor is weighted 20 and another 10, the one weighted 20 is twice as important as the one weighing 10.
4. Put in the options. In my example, I have three. Replace those with your options. If you one have two options, ignore the third column of options. If you have more than three options, I’ve put instructions in the spreadsheet on how you can increase the number of options. (It requires you to insert a couple of columns and copy some formulas).
5. Rate each option against each other for each factor, with 3 being the best and 1 being the worst. In my example, let’s look at “Best for Customer Satisfaction”. Option A is the worst option, so it gets a “1″. Option C is the best options, so it gets a “3″.
6. Finally, look at the final score for each option. The one with the highest score wins!

It’s actually a lot easier than it sounds. Try it out, and see how it works.

Ideas for the Comparison-based Decision Matrix

This can be a tool for a number of really interesting decisions:

• Selecting the best candidate for an open employment position.
• Selecting the best political candidate, when trying to determine who to vote for.
• My personal favorite: I’d love, love, love to see a political figure (i.e. such as a senator, member of congress, or other legislator) use such a tool in determine what bills, statutes and other laws they vote on. If nothing else, to specifically enumerate what they stand for (i.e. what’s on the list of factors), and how those factors weighed into their decision on whether to support or reject a certain piece of legislation. Could you imagine such a world??!?
• Selecting whether to buy or lease your next vehicle, as well as what vehicle to select.
• Any decision you feel you run the risk of making a decision based on emotions.
• A career move.
• Selecting which university you wish to obtain your degree.
• And thousands of other decisions, when you have more than one or two factors, with multiple options.

Good luck to you and your decisions! If you hear of any politicians, whether they be Republican, Democrat or independent; conservative or liberal; at the federal, state or local level; that uses such a method to introduce transparency into their decision making, PLEASE let me know about it!