Before the advent of the Internet, a business’s location was generally limited to its brick-and-mortar office or storefront. The Internet has created new options for operating a small business, making it possible to operate a multimillion-dollar global business from one location or from a computer network. As a small business expands its operations across new taxing jurisdictions, that expansion may trigger obligations to report and pay sales and use tax, franchise tax, income tax, and property tax to a number of state and local taxing authorities.
“Nexus” is defined as a significant physical presence, but in terms of sales and use tax, the definition is more mutable and vague. Regardless, the term is used to describe a business’s presence within a jurisdiction in order to determine its tax payment and reporting requirements. With the expansion of commerce through the Internet, authorities have developed alternative definitions of nexus. Consequently, online sales and marketing can activate a type of nexus referred to as an “attribution nexus,” which occurs when businesses in different states link their websites together to direct online traffic to each other through affiliate or reseller programs.
Unfortunately, many business managers are unaware that simply paying to link their business website to an affiliate website can create “clickthrough nexus” in the state where the affiliate has nexus. Furthermore, selling products and services through online resellers such as Amazon.com and Overstock.com complicates the determination of nexus. When a business sells products through Amazon.com, those sales create nexus in all 28 states where Amazon has warehouses; therefore, the business is required to collect and remit sales tax on sales to customers located in the states where the warehouses are located.
Even those small businesses confident about their understanding of the current nexus requirements and applicable sales tax laws may experience some upheaval if two pieces of legislation pertaining to Internet-based sales become law. The proposed Marketplace Fairness Act of 2015 and the Remote Transactions Parity Act would override the need for a business to have nexus in the states that are members of the Streamlined Sales and Use Tax Agreement (SSUTA). According to Guy J. Nevers in his article, “In Defense of Quill: Even in this Age of Electronic Commerce, Quill Still Matters,” in the Fall 2015 issue of the Journal of State Taxation, the Marketplace Fairness Act and Remote Transactions Parity Act specifically negate traditional nexus requirements for remote sellers to collect tax on sales to member states. An exemption may apply to a business if it and its related entities have combined nationwide remote sales of less than $1 million. Of course, there are exceptions to the exception.
The Online Sales Simplification Act (OSSA) would require remote sellers to collect a minimum sales tax on all online sales and remit the funds to the taxing jurisdiction in which the sale originated. The idea may seem simple, but OSSA doesn’t allow an exemption for small businesses and requires that a minimum sales tax be collected in states that don’t have a sales tax. Furthermore, if a state chooses not to participate in OSSA, it’s prohibited from collecting sales tax on Internet-based sales. The burden then falls on the business to determine which jurisdictions are participating and how the inconsistent application affects its reporting requirements.
None of the proposed legislation actually simplifies the sales tax process for businesses. The regulations merely add a new layer to compliance: In addition to determining the existence of a physical and economic presence, businesses must also stay current on new legislation as it applies to online sales and be aware which states are participating in the new agreements.
Once nexus has been determined, tax rates and the taxability of the transactions become relevant. Sales tax at both the state and local levels results in multiple tax rates. Local jurisdictions aren’t necessarily defined by ZIP code, so businesses must investigate each address to determine the rate to apply. Nearly 10,000 different state and local sales tax jurisdictions exist, and each jurisdiction adds to the complexity of compliance. Taxability of transactions varies from state to state, and thousands of changes are made each year.
The first step in preparing a compliance plan is to determine where the business may have nexus. The manager needs to assess the locations and logistics of income-producing assets and map the client base, strategic alliances, marketing strategies, and physical presence. For remote sales or those sales that fall within the traditional definitions of nexus, the business will identify the applicable taxing jurisdictions. A business manager must check regularly for both changes in nexus and for updates to states participating in the SSUTA. Since laws are constantly changing, a system for obtaining news on tax legislation should be integrated into the plan. The state department of revenue or secretary of state office can provide the most comprehensive information about reporting requirements.
The next step is to set up a reporting process in each of the jurisdictions where nexus is probable. When it’s determined that the business has an obligation to report and pay taxes, each transaction is scrutinized for taxability. The business verifies that sales tax exemptions are allowed and updates its records of sales tax exemption certificates. Presently, five SSUTA-approved software solutions and six approved service providers are available to facilitate sales tax compliance. Resources are listed at marketplacefairness.org/compliance. Many software providers also offer automation and full-service solutions to ease the burdens on small-business managers. Alternatively, a business manager can hire a firm that specializes in the various types of tax areas if resources within the company are limited and doing so provides a cost-effective solution. Ultimately, the business is accountable for its tax-compliance obligations. As a business branches out into new territory, planning proactively with respect to sales and use tax conserves valuable resources and may make the difference between success and failure.
This column is published quarterly by the Research and Education Subcommittee of the IMA Small Business Financial and Regulatory Affairs Committee. If you have knowledge of an issue pertaining/of interest to the small business community and/or would be interested in writing about such an issue, please contact Linda Devonish-Mills, IMA director of advocacy, at firstname.lastname@example.org.