The “Internet Tax” — Two Common (But Wrong) Beliefs About Marketplace Fairness and Sales Tax Nexus

When the Senate overwhelmingly passed the Marketplace Fairness Act (“MFA”) (S. 743) on May 6, 2013 tax professionals and other CPAs naturally took notice. Many journalists and bloggers have taken notice, too, writing prolifically about the so-called “Internet sales tax.” This is the closest such legislation has come to being enacted, and so naturally it is newsworthy. However, many in their excitement have begun talking about the passage of this Act as if it is a foregone conclusion. So far the MFA has passed the Senate. But some say it has a tough road ahead in the House and that it may even be dead-on-arrival in the Republican-controlled House.

Will it pass? We don’t know and can’t predict. The only thing we can be sure of is that whether the MFA passes or not, sales tax nexus is and will continue to be a very relevant, complex issue demanding attention by businesses large and small and their CPAs.

False Belief Number One: If The Marketplace Fairness Act Passes, Everyone Will Have Nexus Everywhere. Nexus Will Be Obsolete.

We are actually hearing this statement in one form or another from many CPAs and other professionals. While we could agree that the physical presence aspect of nexus has been under pressure since the Quill case and that the pressure appears to be increasing every year, we can not agree that nexus would be obsolete. The MFA still has many questions that need to be answered. For example, if the MFA does pass in the House, what modifications will be made and what will the final version look like? Will all the states participate? What will be the minimum threshold? (Ebay has proposed increasing it to $10,000,000 rather than the $1,000,000 that passed the Senate.) Will the states be able to pursue companies who may have had nexus in the past but were not previously registered? Will there be amnesty for prior nexus? What will the definition of a remote sale be? The answers to these questions all will impact nexus.

The MFA, even if it passes, will not invalidate all of the traditional tests of whether you have nexus. It will only add more tests to the mix. For example, if you fall under whatever the threshold turns out to be, or if you sell into a state which has opted out of the MFA, you could still have nexus in those states for other reasons. Therefore, by no stretch of the imagination, will the determination of nexus be rendered obsolete by the MFA, it would just get more complicated. We have also not mentioned nexus for income and franchise taxes. Among the many unanswered questions about the MFA, one thing’s for sure: In almost all cases when the government proclaims they will simplify anything, that is when things get complicated. Unfortunately nexus will be an issue for the foreseeable future for many companies.

False Belief Number Two: If the Marketplace Fairness Act Does Not Pass, You Only Have Nexus Where You Have A “Physical Presence.” Like an Office.

In conversations with many CPAs and other tax professionals we hear time and again that nexus is created by having a “physical presence,” and they add the modifier, “like an office or a warehouse.” This may sound like a true statement, and in part it is, but the added words “like an office or a warehouse” could convey a dangerously false sense of security. The fact is there are many other types of physical presence that create nexus. Too many people relate physical presence to a place, but physical presence is actually much more. Physical presence can also be created by activities; not just the activities of your employees, but even those of unrelated third parties. That’s right, nexus can be created by the actions of independent third parties acting on your behalf. This issue has gone to the Supreme Court twice (Scripto in 1960 and Tyler Pipe in 1987) and upheld both times. For more detailed information you may want to read our white paper, Nexus: It’s All about Physical Presence. Or is it? For some specific examples of nexus creating activities like the activities of independent contractors or third-party installers you can see either of these lists: Ten Common Nexus Creating Activities  or Ten State Specific Nexus Creating Activities.

Therefore, So What?

Whether MFA passes or not, states have been busy passing more aggressive nexus laws all along. MFA just makes it tougher on certain types of businesses (for more on how we believe the MFA could be devastating to small business see here). Therefore, if it passes or not, you ought to take steps to address the issue proactively.

The worst time to find out you have nexus is when a state is inquiring about your activities. At this point your options are limited. When it comes to nexus, it is better to be proactive rather than reactive. For those who are proactive, there are programs that can limit the amount of their exposure by reducing the lookback, waiving the penalty, and in a handful of states some or all of the interest. In a nutshell, here are your next steps.

Step One: Determine your nexus footprint. There are a number of ways to determine where you or your client has nexus. First, take our Nexus Stress test on our website. If you answer yes to any of these five common activities you probably have nexus in each state where these activities are performed. The stress test is not an all-inclusive list, but it is a great place to start. We also provide Nexus Consultations for you or your clients where we discuss your activities at no charge. If you wish a more formal process, you may want to have a Nexus Review or Study performed. Another great resource is the free webinar Nexus Determination and Next Steps. 

Step Two: Determine your Taxability. If you have determined you have nexus then your next course of action is to figure out if what you sell is taxable. For companies that only sell tangible personal property this may be easy. For other companies it may be harder, for example digital goods, software, and services can vary widely by state. We can provide you with some free charts which are a great place to start your research, or you may want a matrix created.

Step Three: Determine your exposure. If you have nexus and you have taxable sales. You then need to determine your exposure. If you have never been registered in a state than there is generally no statute of limitations. In theory, if a state finds you they can go back to the date you started doing business in the state. In reality they routinely go back seven to 10 years. Before you run out and register you must know what your exposure is.

Step Four: Evaluate your options. Once you have completed the first three steps it is time to choose a course of action that works best for you. If your exposure is minimal looking backward and you don’t anticipate a lot of sales going forward, you may choose to do nothing. If your past exposure is minimal but you project your sales to continue to grow in a state you may choose to do a normal registration. However if your past exposure is meaningful then you will want to use a mitigation program like an amnesty or a voluntary disclosure agreement (VDA). You may also want to view the free webinar Nexus Determination and Next Steps. 

Step Five: Automate your process. There are literally thousands upon thousands of jurisdictions across the united states. Each of these jurisdictions has its own rates and these rates can be constantly changing. Keeping track of the correct rates manually can be a daunting task. In addition staying on top of the taxability of what you sell in each state is complex since it is different from state to state and again subject to change. Fortunately there are a number of technology solutions that can make your life easier and these solutions have become very affordable.

Summary

There are two thoughts that we hope you take away from this article: Nexus is and will be vitally important whether or not the MFA passes, and it pays to be proactive. When it comes to nexus, if you are not proactive, then you may be setting yourself up for what we call the “Biggest Tragedy in Sales Tax.” This is when a state finds you four or five years down the road and asserts you have nexus. You will then be subject to paying out of your own pocket all of the back taxes plus penalties and interest. This is a tragedy because if a company knew it’s nexus footprint it could have registered and then its customers would have willingly paid the tax.

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