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E-commerce businesses: Avoid costly state tax liability surprises

December 12, 2022 Article 4 min read
Authors:
Jason Parish Dean Feenstra Dipti Vaishnav Jamie Deibel
E-commerce taxes can be complex for online sellers and can lead to state tax liability and a hit to your bottom line. Avoid surprise tax liabilities and penalties later. Consider these key e-commerce business tax issues.
Person using calculator to help them fill out taxes.E-commerce growth is expected to continue for the foreseeable future. And whether you’re a seasoned e-commerce seller or newbie, whether you sell direct to consumers from your company’s website or through a third party or marketplace such as Amazon or Etsy, state sales and income tax issues can blindside business owners.

You don’t want to find yourself with an unexpected — and potentially large — state tax liability. Not only will you be responsible for paying any uncollected sales tax out of pocket; penalties and interest add up quickly. Contemplating a merger, acquisition, or exit? Buyers are increasingly aware of successor liability issues relating to state taxes, which can negatively impact the transaction, including the valuation.

With recent revised guidance on Public Law 86-272 (P.L. 86-272) “protected activities” and continual changes to state income tax and state sales tax rules, you might not be current on the latest e-commerce tax issues. Make sure you consider the following when making your state filing determinations:

1. Protected activities

In August 2021, the Multistate Tax Commission (MTC) updated its guidance on “protected activities” covered by P.L. 86-272. Protected activities are those that can be carried out in a state without creating nexus for income tax. Does your website use a chatbot to answer questions or provide customer service after a sale? Does your site allow candidates to apply for open jobs in the company? Either of those web-based activities, and a host of others, now have been deemed “unprotected.” E-commerce businesses that engage in unprotected activities may therefore create state income tax nexus in states where their customers (or job applicants, in the recent example) are located.

Time will tell us how states will adopt and enforce P.L. 86-272, including its potential retroactive application, but e-commerce businesses need to be aware of its provisions and implications.

2. Sales tax nexus

Every state with a sales tax has passed some type of economic threshold that requires e-commerce sellers to collect and remit sales tax above a certain amount of sales (often $100,000). Some also impose a number-of-transactions threshold (most commonly 200). If you’ve been assuming your sales aren’t high enough to require you to file a sales tax return in multiple states, you may need to reconsider. Further, even if all of your sales are exempt, some states may still have requirements to file a “zero return.”

If you’ve been assuming your sales aren’t high enough to require you to file a sales tax return in multiple states, you may need to reconsider.

3. State marketplace facilitator rules

Marketplace facilitator rules, much like economic nexus rules, exist in most states with a sales tax. These rules generally require the Amazons, Ebays, and Etsys of the world to collect and remit sales tax. But that may not remove all responsibility from you, the seller.

Take Washington, for example, which requires marketplaces such as Amazon to collect and remit sales tax on the sales you make. As the marketplace seller, you still must report the sales on your Business and Occupation tax return — and indicate that those sales occurred through a marketplace. You’re exempt from paying sales tax, but the sales still need to be reported and gross receipt taxes paid.

4. Inventory

Generally, property — including inventory — creates nexus for all types of state taxes. If you use a marketplace’s fulfillment service, such as Fulfillment by Amazon, you don’t control where your inventory is warehoused, and this can lead to creating nexus in multiple states without your direct involvement or intention. However, a recent case out of Pennsylvania has established that a taxpayer using these exact services, who had a de minimis amount of inventory in the state through a third-party marketplace, did not have nexus. While Pennsylvania is the first state to come to this conclusion, it shows that states are still figuring out e-commerce sales tax laws with rules continuing to change.

Most marketplaces enable you to generate reports that show you the states where your inventory is stored. Make sure you monitor — or inquire if you’re not sure how to access the information — on a regular basis to determine if you might be exceeding state tax filing thresholds.

Bottom-line benefits of compliance

Gone are the days when the location of your company’s headquarters or staff dictated where you needed to file various state tax returns. E-commerce, updated guidance on Public Law 86-272, and ever-evolving state tax laws have changed that.

If your business’s e-commerce website does more than display your products and allow visitors to place orders, you’re likely to cross into “unprotected” territory in terms of P.L. 86-272. This means you can be liable for additional state income tax in states that adopt and enforce the MTC’s revised guidance.

As an e-commerce business owner, you need to understand protected and unprotected activities and where and what types of nexus you may have created. Once you know that, it’s crucial to determine whether and where the products and services you sell are taxable and at what rate.

It’s crucial to determine whether and where the products and services you sell are taxable and at what rate.

Don’t let state tax mistakes hit your bottom line. Getting it right at the start is preferable to —and far less costly than — facing an unpaid state tax liability or having a buyer discover tax liabilities during diligence, which could reduce your transaction value. Work with your tax advisor to ensure you’re filing appropriate and timely returns.

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