Why States Will Chase YOU, and Not Your Customers, for Internet Sales Tax

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There’s never a dull moment when it comes to the ever-shifting mess that is state attempts to tax Internet sales! Today we’ve got just a couple of tactics that financially-strapped states are using to try and bring in extra tax dollars from Internet-based sales.

Nexus Based on Virtual Location

You’re a website designer, who lives and works in Los Angeles, CA. You’re creating a website design for someone in New York, using software that resides on a server in Nevada. You would prefer nexus to be in Nevada for lower income taxes. California, on the other hand, will insist that because you own the business, worked on the design personally, and live in California, you have both personal and business nexus in that state for sales and income tax. But as far as the state of New York is concerned, you’ve provided a taxable service to a resident, and you should collect New York sales tax on that sale, and send it to them.

And, depending on where your website is hosted, you could have a third state after a share of the action. Recently, Texas was in the news after issuing a new tax bulletin that seemed to indicate that simply having your website hosted on a Texas-based server would be enough to create tax nexus in that state. The state has since backed off on that position. However, if you owned a server that was part of a Texas based server bank that is still enough to create sales tax nexus. Texas-based hosting company, HostGator, recently received a $500,000 tax bill from the state for not charging sales tax on hosting services provided to in-state businesses and residents.

Not clear on where you stand? Come and learn more, by signing up for our next teleseminar, Nexus Strategies to Reduce Tax, on Saturday, November 20th, at 9am PST. The seminar is absolutely free, and it may give you answers to tax questions you never even knew you had!

Nexus Based on Affiliate Marketers

You may have heard of this hotly contested nexus creator. It’s also known as the Internet Sales Tax or the Amazon tax. It happens when you start an affiliate marketing program to try and grow your business. An affiliate is someone who advertises for your business on their own website. They have links and banner ads that point to your website and your products. Every time someone goes through one of those links and buys something from your business, that affiliate gets a commission.

Depending on where your affiliates are located, you may have brought another state into your nexus mix without even knowing it. New York, North Carolina and Rhode Island have all taken the position that if you have an affiliate in their state you’ve got a relationship with that state, unless you can prove you don’t, something called a “rebuttable presumption” argument. Those affiliates may not be employees, but they are providing a service that you are benefiting from. That’s enough to create sales tax nexus for your business, meaning you’ve now got a new tax state to worry about. If a New York customer goes through a New York affiliate website to buy from you, your business is now responsible for collecting New York sales tax on their purchase, and sending it into the state.

The law is commonly known as the Amazon law, because Amazon.com was one of the first Internet retailers to get caught in this new tax trap. The online retailer sued, arguing that passive advertising activities by casual affiliates wasn’t enough to create nexus under Federal law. The state has defended its law, saying that the law contains a rebuttable presumption process for online sellers who truly don’t think they meet its nexus standards, and therefore New York is not in conflict with federal interstate commerce laws.

So far, the courts have sided with New York. In the most recent ruling (November 4, 2010), the Appellate Division of the New York Supreme Court concluded that the state did not overstep, and that it was permitted to pass a law creating nexus when a New York resident solicited sales to state residents on behalf of a remote retailer. But the Appellate Division also said that further review was necessary on the potential conflict between federal and state law. It referred the case back to the lower courts, to hear additional evidence. In the meantime, Amazon is collecting sales tax under protest, but thousand of other retailers have severed their relationships with NY-based affiliates, rather than risk being dragged into the state.

Why Your Business is a Target for Internet Sales Tax

So why the push towards retailers, not end consumers for sales taxes? Well, for the most part, it’s much easier (and cheaper) for you to do the work. Imagine the financial and political cost of a state having to potentially audit thousands of its (voting) citizens for unpaid use tax. It’s much easier to try and get a remote seller to collect that information for them, as Colorado and North Carolina are trying to do. By requiring retailers to serve up customer names, addresses and itemized purchase lists on a silver platter, you’re doing the work for the states. They can decide who to target for an audit, and who to let go with a warning letter.

Plus, if a state targets your business with the threat of a sales tax audit and the potential for a huge bill for unpaid sales taxes, interest and penalties, they can use the position you’re being forced into as a bargaining chip.

That’s what the state of North Carolina has done with Amazon.com. After some creative reinterpretation of its existing sales tax nexus laws, the state audited Amazon for unpaid sales taxes to NC-based consumers, going back to 2003. Amazon was given a choice: either turn over purchase data, including names, addresses, amounts of purchase and items purchased so the state could chase down residents for unpaid use tax, or pull out its own checkbook and write a check for unpaid sales tax. Amazon took the state’s department of revenue to court, looking to block the release of explicit purchase data and won (sort of). Amazon is allowed to obscure exactly what was purchased (i.e., “book” instead of the book title), but is still required to turn over all the other information: names, addresses, and purchase amounts.

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