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States Making Inroads at Taxing Online Sales

States Making Inroads at Taxing Online Sales

Published: September 15, 2009

States that impose sales tax generally require vendors to collect the levy on the sales that they make. In some cases, the vendor's obligation is clear cut. When a customer walks into a store and purchases a taxable item, the vendor must collect a sales tax in addition to the purchase price. But what about the vendor's obligation to collect sales tax on a remote sale? A 'remote sale' is a transaction in which a vendor sells an item via the internet or a catalog to a customer in another state.

Remote sales are generally not taxable if the seller lacks a physical presence in the state in which the item is purchased. But this area of the law has become increasingly complex as a result of recently enacted state laws aimed at imposing sales tax on certain types of online retailers.

In 1992, the U.S. Supreme Court established the 'physical presence rule,' which states that a vendor is not required to collect sales tax unless it has a physical presence within a jurisdiction's borders. A physical presence has been defined to include in-state property, employees, or an independent sales representative.

Example. For example, if ACME Sporting Goods is based in Maryland and sells a soccer ball via its web site to a customer in Illinois, ACME would be required to collect Illinois sales tax if it had a store or employees in Illinois. However, if ACME lacked a physical presence in Illinois, the state could not require it to collect its sales tax.

As more remote sales transactions have been conducted online over the past decade by retailers such as Amazon, states have looked for ways to tax online sales in a manner that satisfies the physical presence rule.

Most states cannot impose sales tax on their residents' purchases from Amazon or other online retailers because many times the companies are not physically present in their jurisdiction.

Independent Affiliates. However, several online retailers have come to rely on independent web sites known as affiliates to promote sales. An affiliate will place a link on its website to the retailer's site and receive a commission if someone follows the link and buys something from the retailer.

Last year, New York enacted a law that presumes that an online retailer is subject to the state's sales tax collection requirements if it collects more than $10,000 in annual revenue from a New York-based affiliate. The law does not merely impose tax on the commissions earned by the affiliate, but the online retailer's total in-state sales.

Other states have taken note and have followed suit. Rhode Island and North Carolina have enacted similar measures this year.

What does all this mean to you? Depending on the circumstances, online sales can be subject to sales tax.

Think carefully about your sales tax obligations when selling products online or earning commissions through an 'affiliate relationship' with a retailer.

For an informative guide to starting an online business, check out this primer.

Steven Roll is a senior tax law editor with BNA Tax & Accounting (bnatax.com)

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