FBA Sellers Ask: How Can I Have Sales Tax Nexus?

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By Michael J. Fleming

 

In our many webinars, individual conversations and review of community forums, the question of nexus is perhaps one the most misunderstood and hotly debated topics. There are usually a series of question that range from what is nexus to how can states have the right to force me to collect their taxes. We touched on some of these topics in our white paper entitled, Where Should FBA Sellers Register to Collect Sales Tax. Today we will address the following questions:

 

  1. What is nexus?
  2. What creates nexus for FBA sellers.

 

What is Nexus?

 

States do not have the power to tax just anyone they want. In order for a state to tax you, you must have some sort of connection, tie or link with that state. This connection link or tie is referred to as “nexus.” Once a sufficient connection with the state exists, then you fall under the state’s power to tax you or force you to collect taxes on its behalf.

 

When it comes to sales tax nexus the connection or link must have some physical component. However what you and I consider to be “physical” and what the states or US supreme Court consider to be physical are often two different things. The US Supreme Court in two different decisions, (SCRIPTO v. CARSON, 362 U.S. 207 (1960), TYLER PIPE INDUSTRIES v. DEPT. OF REVENUE, 483 U.S. 232 (1987)), has said that even the activities of unrelated third-parties acting on your behalf could be enough to create nexus if they are helping you to “establish or maintain” a market.

 

There is no national law that tells us what does or does not constitute nexus. Instead, we have a patchwork of state laws that are influenced by the US Constitution and US Supreme Court decisions. There are some activities that all states agree on and some activities that vary widely amongst the states as whether they create nexus or not. In this article we will discuss the two most common nexus creating activities for FBA sellers.

 

What creates nexus for FBA sellers?

 

While are there are many activities that can create nexus, we are going to concentrate on the two areas that should be of most concern to FBA sellers.

 

First, let’s consider your own activities. Wherever you have your base of operations would be a link or connection with that state. Whether you are conducting business from your home or from an office, storefront or other location, you are creating a physical link with that state. This link allows the state to force you to pay its taxes and collect taxes on its behalf.

 

The second activity to think about is where you own property. One of the most overlooked issues when it comes to property is owning inventory in a state. Inventory is your property. You own it and having it in another state is a nexus creating activity, one way or another, in every state. This comes as a shock to many FBA sellers. You may be shipping your inventory to one or two locations, but then Amazon is moving it around the country to their other locations. Everywhere they move your inventory you have nexus.

 

It does not matter if Amazon moves your inventory around or you move it around. Nor does it matter if they move it without your knowledge. It is still your property and it creates a physical presence for you wherever it is. I often hear that, well I only have a little inventory there. While it is true, that you have to have “more than the slightest physical presence” in a state according to Quill (Quill Corp. v. North Dakota, 504 U.S. 298 (1992)), the Court did not define what more than the slightest physical presence meant.

 

Quill, for you old timers who remember what a diskette is, had a total of 3 diskettes in the state of North Dakota. So we know that you must have more than 3 diskettes, but is the magic number 4, 5, 100, or 1000. We just don’t know, so we are at the states’ mercy and therefore suggest being conservative.

 

Summary

 

Having said that you should be conservative when approaching nexus, we need to mention that you should also take materiality into consideration. We discuss materiality in greater depth in “Let’s Not Panic and Go Overboard – A Case Study in Materiality” . However we would like to add that just because you have nexus in a state does not necessarily mean that you need to take action. There are costs involved in becoming compliant and you need to weigh these costs against the taxes, fines and penalties if a state does find you. If the cost of compliance is greater than the cost of non-compliance then we suggest waiting until your business grows before taking action. However, don’t wait too long as the costs of non-compliance grow with each year.

 

Amazon FBA and Arizona Local Taxes

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If you sell through Amazon’s FBA program, then you know that it can be great for your business. You know the importance of no negative reviews. You know it’s critical to maintain a profit margin on what you sell. Much of the back-end fulfillment headaches have been erased by Amazon and that’s a great thing, but there are plenty of other issues you still have to address just like any other business. If you just had your own website selling whatever you sell, there’s probably no way you could reach as many buyers as you do through Amazon. But there’s one major problem that using Amazon’s FBA program has created for you that you wouldn’t have just selling on your own. And that is you now have sales tax collection obligations that you didn’t have before. And sales tax in the US is very complicated. It’s somewhat akin to a Value Added Tax (VAT) in other countries, but so much more complex. The VAT is a country-wide uniform rate and it’s due on virtually everything you sell and you get an input credit on virtually everything you buy, so it’s relatively simple. On the other hand, the sales tax is determined at the state level (and sometimes even county or city level) with many different rates that could apply, and it is not applicable to everything you sell, and you owe tax on everything you buy, usually, unless it is for resale or otherwise exempt. Yes, it’s a pain.

Sellers have a vested interest in avoiding all of this complex mess, if they possibly can. Unfortunately with the FBA program, they are thrust into having to deal with many different state and local taxes. Why is this? The main reason FBA sellers have this problem is because they ship their inventory to Amazon which then relocates it to its various fulfillment centers across the US. State law requires sellers who own inventory in their state to register and collect sales tax on product shipments to customers in these states. The fact is that owning inventory in a state creates “nexus” or an obligation to collect the tax in that state. Some FBA sellers dispute this, but nonetheless, the fact remains inventory creates nexus. The tricky part is what about local taxes.

What makes the local taxes tricky for FBA sellers is that Amazon has an all-or-none policy on collecting local taxes. If you opt to collect any local taxes, then you collect them all. This is not a big deal in most states, where the state Department of Revenue administers both the state tax and the local taxes. But it is a problem in other states like Louisiana, Colorado, Alabama and Arizona, for example. These states allow at least some counties/parishes and cities to administer their own taxes. Which means in these states, you register separately with these self-administered (sometimes called home-rule or non-program) jurisdictions. Once you register with them separately, you also file separate returns with these jurisdictions. All of these separate jurisdictions mean only one thing to FBA sellers — it costs more to deal with them. Collecting the tax is not the hard part. Amazon makes that easy. It’s dealing with the taxes you collected after the fact that causes the problems and the cost.

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Arizona is a good example of some of the problems you will encounter as an FBA seller. You have to make a decision in your setup whether you will collect the local taxes in AZ. You can opt out of collecting the local tax, but do this at your own peril. If you sell to AZ customers, it’s a good bet that a high percentage of your shipments will originate from an Amazon fulfillment center in Phoenix. Phoenix is a “non-program” city which means it administers its own sales/use tax. If you own inventory in Phoenix, you have nexus in Phoenix and must register with them and file the privilege tax (like sales tax) returns there. Local sales tax on sales shipped from Phoenix to an AZ customer are sourced to the origin, not the destination. Therefore, Phoenix local tax is due on those sales.

Let’s say you don’t want to hassle with local tax in AZ. Well, then you can elect to collect only the state rate, but you’d be electing not to apply the 2% on sales shipped from Phoenix. That could be a huge exposure for you. If the city audits you, which is highly possible, then they would assess you that local tax that you could have collected from your customer at the time of the transaction. And you would owe it out of your own pocket. This is what we call the biggest tragedy in sales tax — it’s a tragedy you can and must avoid in our opinion.  

Okay, so let’s just collect the Phoenix tax then, right? Well, that’s the problem for FBA sellers in Arizona. You can’t pick and choose which local taxes to collect. You either collect them all or you collect none. You don’t want the exposure of collecting none because of the Phoenix example, but there are costs associated with collecting and filing in all the jurisdictions. Unfortunately, there’s no easy answer in Arizona. We certainly don’t recommend not collecting the local tax, but we understand the costs created by having to register in a bunch of non-program cities.

We do have recommendations for sellers according to their particular circumstances. Everyone is different. So give us a call to discuss.

Amazon FBA Sellers Ask, When Should I Start Collecting Sales Tax?

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We have recently been doing a number of webinars about sales and use tax implications for online sellers. During the webinars and in our ensuing conversations, one of the most frequently asked questions is: “when should I start collecting tax”? This is actually a great question, and not just for online sellers, but for anyone beginning to do business in a new state.

The short answer is that you should consider collecting tax in any state where the following conditions are met:

1.     You have nexus in that state;

2.     What you sell is subject to sales tax in that state; and

3.     Your liability would be “material” if the state becomes aware of you.

Let’s discuss in some greater detail.

Nexus

A good definition of nexus is, the link or connection you must have, before a state can require you to collect or pay its taxes. For sales tax purposes this link must have a physical component. However, you may be surprised at what the states and in some cases the United States Supreme Court, consider to be physical presence.

It is important to note that there is no national rule, but rather each state has statutes, rules, regulations or guidance as to what creates nexus in their state. There are certain activities which the states all agree create nexus and many where the states have differing opinions. For the purposes of this article, we cannot possibly address all the activities in all of the states. However, we have a number of great webinars , white papers and charts that go into detail about nexus, important court cases involving nexus and numerous activities that states consider to be nexus creating. To keep it simple, here are ten very common activities that will normally create nexus in all states. 

  1. Employees or real property in a state.

  2. Independent contractors and/or subcontractors in a state working on your behalf.

  3. Employees and/or third-parties traveling into state on your behalf.

  4. Inventory that you own stored in a state.

  5. Personal property that you own in a state.

  6. Propery that you leasing or rent present in another state.

  7. Trade show attendance.

  8. Click through relationships.

  9. Delivery of property in seller-owned trucks.

  10. Employees who telecommute.

For the Amazon FBA seller, we commonly see at least two of the above nexus-creating activities. The activity that most commonly creates nexus issues for FBA sellers is that you may own inventory in a number of states. When you ship your inventory to Amazon, you may shipping it Amazon in one state, but Amazon reserves the right to move your inventory to any of their warehouses. Since Amazon currently has warehouses in 16 states from where they ship, your inventory could actually be in 16 different states. This means you could actually have nexus in all 16 of those states. The good news is that two of those states, NH and DE do not have a sales tax, so we are actually looking at potentially 14 states where you have nexus. That’s better than 16 states, but much worse than only one state.

The one state that many FBA sellers forget about is their home state. Remember that we said that having employees in a state is a nexus-creating activity. Well, that includes you! So if you live in a state where there is not an Amazon warehouse currently, you could be looking at having nexus in potentially 15 states. If you need help figuring out where you have nexus we can help you work through it.

Taxability

Once you figure out if and where you have nexus, the next step in determining when you should start to collect sales tax, is figuring out if what you sell is taxable. In order to do this lets look at some basics.

The first thing to know is that, in general, most states say that an item of tangible personal property (TPP) is, by default, subject to the tax. TPP (as opposed to real property or intangible property) is always taxable, unless there is a specific exemption and there are lots of different exemptions for TPP. For example, many states exempt certain types of machinery and even repair parts sold to a manufacturer. There are lots of specific rules that come into play on these exemptions and they vary widely by state.  

In general, the majority of what you sell on Amazon will be taxable. However, there are certain products or groups of products that may be exempt in some states. Examples of some products that can differ from state to state are dietary supplements, clothing, certain medical equipment, and food. It is important to note that when a state exempts a product it usually does so on a very limited basis. So, even if you are selling food in a state that generally exempts food, your product may or may not be exempt depending on the definitions. If you have questions about your specific products there are firms, like Peisner Johnson, who can assist you with these determinations.

The good news is, once you are registered in a state you can have Amazon track the taxability and collect the right rates through their systems. The key is to match what you sell with the correct category. It is a fairly simple process, but again there are firms that can assist you should you need help.

Materiality

Once you have determined you have nexus and what you sell is taxable, the next step is to look at materiality. Just because a state would assert that you have a technical obligation to collect sales tax does not mean that you absolutely should. You should consider the cost of compliance and make a business decision. The cost of compliance should never be greater than any potential liability you may have if a state found you 2, 3, 4 or even 5 years down the road.

For example, lets say that you have sales into a state of $200 a month. If we use a hypothetical tax rate of 8% we are looking at $16 a month in tax. Prices to file a sales tax return can range from $20 to $250 depending on who you work with. If you do your own return there is no monetary cost but there is opportunity cost as your time is money. Lets say a state find you 36 months down the road. Well 36 months times $16 of sales tax per month would mean you owed $576 of back taxes. Hypothetically, lets assume that penalty and interest total another 25% or $115.20. That would mean you would owe the state a total of $691.20. If you collected the tax every month and paid someone $20 a month, to  do your returns, it would have cost you $720 to be compliant. In other words it would have been cheaper for you to pay the state the back taxes, penalty and interest out of your own pocket rather than collect the sales tax. Your cost of compliance would be greater than your potential liability.

Now the example above is oversimplified, but I hope you get the point. You do not have to run out everywhere and start collecting taxes. Wait until your business in a state grows to the point where the potential liability would hurt if a state asserted you owed back taxes.

For example if you are selling $1,000 a month into a state and we use the same hypotheticals of 36 months, an 8% tax rate and penalties and interest totaling 25% the total amount you would owe the state is $3,600. Even if we bump the amount of compliance to $40 a return, the cost of compliance would be $1,440. you would actually owe the state $2,160 more if you were not compliant. In this case, it makes sense to start thinking about registering to collect sales tax.

Now, $2,160 is material to me, but it may not be to you, which is why everyone needs to determine what is material to them. As your sales volume rises though, you can reach a point where it is probably no longer a smart business decision to postpone registering to collect says tax — then it becomes more of a gamble. The thing about gambling is that lucky streaks don\’92t go on forever and the house usually wins in the end. States are becoming more aggressive and audit companies of all sizes. Many a business has faced disastrous consequences after letting their sale tax liabilities get away from them.

Many FBA sellers want us to make the decision as to what dollar threshold they should use. As we mentioned there are a lot of variables to consider, but the more limited your capital and the lower your margins, you probably want to start looking at a threshold of $300 of taxable sales per month into a state. While this may seem like a low amount to some, a volume as low as $300 a month in a state could negate years of selling and put someone in a financial bind, especially if you have two or three or even more states find you in quick succession 3-4 years down the road. If you have larger margins and greater capital you have more flexibility and may want to examine what is material for you.

Summary

In summary, the time to get registered is when you have determined you have nexus, and if what you sell is taxable and your sales volume has grown to a level, where if a state found you at some point down the road, your exposure is material. That is, it would hurt! Everyone should  decide what is material to them, but if you would like to discuss or require some guidance with your nexus and taxability determinations please let us know.