Sales Tax Q&A: What Sellers in an Online Marketplace Need to Know
Are you a retailer using an online marketplace to sell your wares? Chances are you’re listed on a website like Amazon, Etsy or some other third-party fulfillment company. As state sales tax nexus requirements continue to zero in on e-commerce, consider these questions and answers:
What is a Third Party Fulfillment Company?
Third party fulfillment (“3PF”) and third party logistics (“3PL”) companies provide outsourced services to sellers. These services range from just drop shipping inventory on behalf of the seller to providing full-service order processing, shipping and billing services.
Does outsourcing logistics to third parties create sales tax nexus?
Nexus is established when the seller has physical presence in a state and/or has affiliates or agents that help the seller maintain a market in that state. Forty-five states and the District of Columbia levy a sales tax on goods and services. The legal obligation to collect sales tax falls on the seller in those states where the seller has established nexus.
Should I charge sales tax in the states where 3PFs and 3PLs hold my inventory?
It depends on whether state law provides that inventory in fulfillment warehouses establishes sales tax nexus (it usually does) and what the state’s registration requirements are for e-commerce sellers. The states want you on their tax rolls but state law must require it.
What if I do not know where my inventory is held?
Most 3PFs and 3PLs provide reporting tools to source inventory to a warehouse in a particular state. The presence of inventory in the same state where the customer resides is generally sufficient to establish an obligation to collect sales tax.
If I have established sales tax nexus, what should I do next?
Once nexus is established, the seller should register with the state and begin collecting sales tax. There may be a registration requirement even if the seller’s product is not subject to sales tax.
How do I bill and collect the sales tax?
Tangible personal property sold to the end consumer is subject to tax. Rules vary by state as to whether shipping and other ancillary charges are taxable.
Certain 3PFs and 3PLs provide turnkey services which may include billing of customers. Legal liability for charging and remitting the correct sales tax remains with the seller. The 3PF and 3PL contracts will specify that the seller is solely responsible for determining where sales tax should be collected and what products and fees are subject to sales tax.
How do I report the sales tax collected?
The seller should register as a vendor in every state where it collects sales tax. Some states require registration even if the product is nontaxable once nexus is established. 3PLs should provide reports which indicate the “ship-from” and the “ship-to” locations for each order.
3PFs should provide reports which contain this data and the billing data, including invoice, customer, product and billing data, and sales tax charged data. If the services include collection of funds electronically, it is extremely important that the data be sufficient to support that sales tax was collected in case of audit.
What happens if I don’t register?
Companies that have established nexus but have not registered are subject to audit for all open periods. The lookback period is not limited by the statute of limitations and can go back for as long as the seller has done business in the state. Under these circumstances, penalties and interest can be substantial. Certain states also have personal liability provisions for officers and directors for the unpaid tax. The collection but failure to remit sales tax is illegal and can result in substantial legal and financial penalties for the company and/or its officers.
Public companies are obligated under Accounting Standards Codification (ASC) 450 to disclose contingent liabilities for potential sales tax in states where it has not been collected. In addition, failure to collect sales tax has become a significant due diligence issue for technology companies being acquired. It can impact escrow and/or sales price, and may become a negotiating item for the buyer.
What if I have established nexus but have not registered or charged sales tax, or if I have not registered, have charged sales tax and not remitted it to the state?
There are various mitigation strategies that are dependent upon the facts and state law.
A seller who has not collected sales tax without being registered can:
1. Register, file returns, pay back taxes and pay interest and/or penalties on past due amounts;
2. Enter into a voluntary disclosure agreement and pay back sales tax for a period limited by the statute of limitations;
3. Participate in an amnesty program and pay back sales tax for a period limited by the statute of limitations; or
4. Enter into a negotiated settlement with the state.
Sellers who only recently established nexus and/or have minimal liability or sellers of nontaxable products generally go for option 1. Options 2 and 3 are generally chosen by sellers that have established nexus for longer time periods and/or have significant tax exposures. Option 4 is often reserved for sellers with special circumstances where terms must be negotiated between the state and the seller.
Option 1 is generally the most cost-effective option and can be performed by the seller. Both options 2 and 3 limit the periods for payment to either three or four years and penalties for failure to file are waived. Interest may also be reduced or waived in certain states. These options usually require assistance from a tax professional.
Option 4 is generally the only option for sellers who have collected sales tax but have not remitted it to the state. Certain states may allow sellers to opt for option 2 if state law does not preclude it.
These issues can be incredibly complex which is why it’s important to ask questions sooner than later.
What is a Third Party Fulfillment Company?
Third party fulfillment (“3PF”) and third party logistics (“3PL”) companies provide outsourced services to sellers. These services range from just drop shipping inventory on behalf of the seller to providing full-service order processing, shipping and billing services.
Does outsourcing logistics to third parties create sales tax nexus?
Nexus is established when the seller has physical presence in a state and/or has affiliates or agents that help the seller maintain a market in that state. Forty-five states and the District of Columbia levy a sales tax on goods and services. The legal obligation to collect sales tax falls on the seller in those states where the seller has established nexus.
Should I charge sales tax in the states where 3PFs and 3PLs hold my inventory?
It depends on whether state law provides that inventory in fulfillment warehouses establishes sales tax nexus (it usually does) and what the state’s registration requirements are for e-commerce sellers. The states want you on their tax rolls but state law must require it.
What if I do not know where my inventory is held?
Most 3PFs and 3PLs provide reporting tools to source inventory to a warehouse in a particular state. The presence of inventory in the same state where the customer resides is generally sufficient to establish an obligation to collect sales tax.
If I have established sales tax nexus, what should I do next?
Once nexus is established, the seller should register with the state and begin collecting sales tax. There may be a registration requirement even if the seller’s product is not subject to sales tax.
How do I bill and collect the sales tax?
Tangible personal property sold to the end consumer is subject to tax. Rules vary by state as to whether shipping and other ancillary charges are taxable.
Certain 3PFs and 3PLs provide turnkey services which may include billing of customers. Legal liability for charging and remitting the correct sales tax remains with the seller. The 3PF and 3PL contracts will specify that the seller is solely responsible for determining where sales tax should be collected and what products and fees are subject to sales tax.
How do I report the sales tax collected?
The seller should register as a vendor in every state where it collects sales tax. Some states require registration even if the product is nontaxable once nexus is established. 3PLs should provide reports which indicate the “ship-from” and the “ship-to” locations for each order.
3PFs should provide reports which contain this data and the billing data, including invoice, customer, product and billing data, and sales tax charged data. If the services include collection of funds electronically, it is extremely important that the data be sufficient to support that sales tax was collected in case of audit.
What happens if I don’t register?
Companies that have established nexus but have not registered are subject to audit for all open periods. The lookback period is not limited by the statute of limitations and can go back for as long as the seller has done business in the state. Under these circumstances, penalties and interest can be substantial. Certain states also have personal liability provisions for officers and directors for the unpaid tax. The collection but failure to remit sales tax is illegal and can result in substantial legal and financial penalties for the company and/or its officers.
Public companies are obligated under Accounting Standards Codification (ASC) 450 to disclose contingent liabilities for potential sales tax in states where it has not been collected. In addition, failure to collect sales tax has become a significant due diligence issue for technology companies being acquired. It can impact escrow and/or sales price, and may become a negotiating item for the buyer.
What if I have established nexus but have not registered or charged sales tax, or if I have not registered, have charged sales tax and not remitted it to the state?
There are various mitigation strategies that are dependent upon the facts and state law.
A seller who has not collected sales tax without being registered can:
1. Register, file returns, pay back taxes and pay interest and/or penalties on past due amounts;
2. Enter into a voluntary disclosure agreement and pay back sales tax for a period limited by the statute of limitations;
3. Participate in an amnesty program and pay back sales tax for a period limited by the statute of limitations; or
4. Enter into a negotiated settlement with the state.
Sellers who only recently established nexus and/or have minimal liability or sellers of nontaxable products generally go for option 1. Options 2 and 3 are generally chosen by sellers that have established nexus for longer time periods and/or have significant tax exposures. Option 4 is often reserved for sellers with special circumstances where terms must be negotiated between the state and the seller.
Option 1 is generally the most cost-effective option and can be performed by the seller. Both options 2 and 3 limit the periods for payment to either three or four years and penalties for failure to file are waived. Interest may also be reduced or waived in certain states. These options usually require assistance from a tax professional.
Option 4 is generally the only option for sellers who have collected sales tax but have not remitted it to the state. Certain states may allow sellers to opt for option 2 if state law does not preclude it.
These issues can be incredibly complex which is why it’s important to ask questions sooner than later.