Out-of-State Sales Tax Collection Obligations: Is Physical Presence Still the Standard?
Boll, Jennifer M., The CPA Journal
Sales tax collection obligations can be confusing to businesses selling products in multiple states. Today, even the smallest of sole proprietors may sell products in two, 20, or even all 50 states. When selling in more than just the business's home state, it is important to reconcile all sales activity with the laws of each state to confirm sales tax collection obligations.
The following is a review of the current status of nexus interpretations governing the obligations of out-of-state businesses to collect sales tax. These obligations have expanded in recent years through court cases and administrative interpretations. Accordingly, the most recent interpretations are not always readily available or straightforward to apply. Mistakes, however, can be extremely costly for businesses that fail to collect sales tax but are deemed to have been required to do so.
In most states, out-of-state vendors are required to collect a "use tax" rather than a sales tax. Collection obligations and rates of use tax are identical to those of sales tax. Generally, if sales tax applies, use tax does not, and vice versa. To avoid confusion, this article refers to both sales and use taxes as only "sales tax," although in many cases "use tax" is the precise tax at issue.
Forty-five states and the District of Columbia impose a sales tax. If a business should have collected sales tax from its customers but did not, the business (and, in many cases, its owners) may be required to pay the tax on all taxable sales made in the state from the inception of the business activity in such state, plus interest and penalties. In most cases, no statute of limitations applies because no returns were filed. State tax rates range from 5% to 9.35%. Penalties and interest rates vary from state to state, but they mount quickly and generally compound.
A business must collect sales tax from its customers when it has a direct or indirect physical presence in a state, known as "nexus." The standard for nexus is not difficult to articulate, but can be nearly impossible to apply.
In most states, a business (whether a sole proprietor, or organized as a partnership, limited liability company, or corporation) has a physical presence in a state if any employees or agents have had a physical presence in the state or if the business owns or leases property there. This is a direct physical presence. Many businesses assume that if they do not have a direct physical presence in a state, they have no sales tax collection obligations there. This is a common misconception, and it can prove costly in the case of a sales tax audit.
Certain types of indirect presence in a state, alone, will not trigger a sales tax collection obligation. A business owner can be comfortable that the mere selling of products over a website or by a catalog and shipping them to a state (by the U.S. Postal Service or common carrier) will generally not trigger a sales tax collection obligation because such activity does not constitute a physical presence. The U.S. Supreme Court confirmed that such activities do not create nexus in 1992 in Quill Corp. v. North Dakota (504 U.S. 298). Any other contact with a state, however, should be carefully reviewed because it might obligate a business to collect sales taxes.
Many forms of indirect physical presence often create nexus. Since the Quill decision in 1992, the scope of indirect physical presence necessary to create nexus has steadily lessened. Any individual or entity working on behalf of a business that physically enters a state may trigger a collection obligation, even if the individual or entity is an independent contractor. A common example is an independent sales agent or representative in the state; the presence of these individuals often triggers the obligation to collect sales tax. Similarly, contractors performing repairs, installation, or similar work on behalf of the business, or accepting returns for the business, may trigger a collection obligation in a state. …