Given the remarkably rapid rise of internet commerce, it is no surprise that cash-strapped states are looking for ways to tap into (i.e., tax) Internet commerce. To do so, states will expand the “nexus” of their taxing authority to reach online sales.
Nexus is a basic constitutional limitation on each state’s ability to require a “remote” seller—a seller located outside of the state—to collect and remit sales and use tax on sales made within such state. Nexus generally means the minimum level of contact a remote seller must have with a state before such state can legally require the taxpayer to collect sales and use taxes.
The U.S. Supreme Court has ruled that the Commerce Clause requires “substantial nexus” to any state (outside the seller’s primary residence) before any such state may force a seller to collect sales and use taxes. Courts traditionally defined “substantial nexus” in terms of physical contact, or direct in-state presence. Certain activities clearly fit within this traditional definition:
• Employing or sending a sales person to a nonresident state.
• Having a phone number in the nonresident state that is forwarded to a headquarters located in the resident state.
• Maintaining a post office box in a nonresident state.
• Installing or delivering products in a nonresident state.
• Attending a trade show in a nonresident state and having sales in that state.
• Hiring independent contractors in the nonresident state to provide warranty services on property sold in that state.
The explosion of internet sales and the rapidly advancing technology that makes it easier for remote sellers to sell into a state (without any physical contact or engaging in any of the activities listed above) makes it increasingly difficult to apply traditional concepts of nexus in the world of e-commerce. From the taxing state’s perspective, such difficulty translates into lost sales and use tax revenue.
A number of states have passed so-called “Amazon” or “click-through nexus” laws in an attempt to cast a wider net on the types of activities that create “substantial nexus” to a particular jurisdiction. Generally, such laws create a presumption of nexus for out-of-state sellers that compensate in-state residents for sales made via links on their (in state) websites. Some states further establish a threshold minimum amount of sales that the remote seller must make before the nexus provisions presumptively apply and provide whether that nexus presumption is rebuttable or irrebuttable.
Depending on the state, certain Internet activities could create “substantial nexus,” triggering an Internet seller’s obligation to collect sales and use tax in the non-resident state, provided that any applicable minimum sales thresholds are met. Substantial nexus could potentially be created by an Internet seller if it has any of the following:
• A web link to a third party in the non-resident state.
• A “per impression” agreement with a company located in the non-resident state.
• A “per impression” or “per conversion” agreement with a company located in the non-resident state.
• An Internet server in the non-resident state.
• A third-party Internet server under lease, either exclusively or through a shared-use agreement.
• A server run by a paid webhosting service in the non-resident state.
In light of the fact that sales and use taxes are a creature of state rather than federal law, the nexus laws vary from state to state, creating additional complexity. For instance, some states, including California and New York, provide that substantial nexus is not created merely by “advertising” online.
Other states, such as Connecticut, have established an irrebuttable presumption in finding nexus if a remote seller makes more than $2,000 in in-state sales within four consecutive quarters, if such sales are made through an agreement where the remote seller pays a person located in Connecticut a commission or other sales-based compensation for referring, directly or indirectly, potential customers to the remote seller. Additionally, as sales and use taxes are typically charged primarily on tangible personal property. However, the definition of “tangible personal property” varies by state, resulting in inconsistency in whether, for example, digital products are subject to sales tax. From the Internet retailer’s perspective, state law variations create a seemingly endless web of confusion and potential traps for the unwary.
The Streamlined Sales Tax Initiative (SSTI) represents an effort by revenue departments of various states to create uniformity among sales tax systems. Under the SSTI regime, a remote seller volunteers to pay sales tax in return for participating in a sales tax regime with uniform provisions at easing compliance. Such uniform provisions are codified in the Streamlined Sales and Use Tax Agreement (SSUTA). However, not all states are members of the SSUTA and some member states have only adopted portions of the SSUTA. Moreover, the SSUTA contains only the “model” provisions—individual states statutes continue to control the particular state’s tax system, leaving the door open to variation even in member states.
Much has changed in the more than 200 years that have passed since Benjamin Franklin coined the oft-quoted phrase, “In this world, nothing can be said to be certain, except death and taxes.” So much so that, in our modern landscape of e-commerce and sales taxes, the world seems anything but certain. For merchants engaged in e-commerce and their advisors, the importance of thoroughly evaluating these issues and staying up to speed on this rapidly changing area of law cannot be overlooked.
Kathryn P. Jones is an attorney at the law firm of Forster Boughman & Lefkowitz, The Wealth Protection Group. She practices in the areas of general corporate law transactions, tax law and tax controversy resolution, and intellectual property matters. She can be reached at (407) 255-2055.
