By Bill Fay

Small Businesses and Nexus Rules

If your business is involved in online sales and you don’t have a legal representative interpreting whether you should or should not be collecting sales tax, now would be a very good time to “lawyer up!”

Not satisfied that business owners have enough head-spinning rules to deal with on a daily basis, Congress has come up with something called the Marketplace Fairness Act (S.336). It passed through the Senate 75-24 on March 23. The vote is purely symbolic because it was non-binding and only indicates the Senate supports the legislation.

A similar bill exists in the House. Interpreting the wherefores and whereases of this legislation is going to take experienced legal skills … and some really good guesswork! More on what “might” lie ahead in a moment.

First, let’s take a look at the rules as they currently exist. They are a tad confusing, but not nearly as complicated as what may or may not be coming, based on the whims of Congress.

Right now, you must collect and remit state taxes based on your “business nexus,” a term subject to some interpretation, but which generally speaking means you sold to someone in the state where you have a physical presence. That physical presence could be your office, property you own or lease, or people you employ to do work in that state.

Court-Ordered Interpretation

That is based on a 1992 Supreme Court ruling (Quill Corp. vs. North Dakota) that said that a business had to be physically present in a state before that state could require it to collect taxes. Having customers in another state was not enough.

The Quill Corp. vs. North Dakota ruling originally involved catalog sales. Internet sales weren’t around in 1992, but once they sprang up, it was decided the same rules would apply.

When Internet sales boomed, some states created a gray area in the law by interpreting “physical presence” their own way. People realized that they could buy items online, especially large appliances, and avoid the sales tax. The $2,000 refrigerator at Amazon cost $2,000. If you bought it down at the street and added sales tax, it was $2,120. States were losing out on that $120.

That did not sit well with state governments, but there was little they could do. Twenty-four states did form a group that tried to make online retailers voluntarily collect and remit the sales taxes, but that has had very limited success. Their average collection for the period from 2005 to 2010 was a mere $30.7 million, or about $5 million a year.

E-commerce growth kept skyrocketing, but the states knew they had to wait for Congress to come up with a law that gave them business nexus over Internet transactions across state lines. It took a while, but the federal government appears to be coming through with the Marketplace Fairness Act.

New Rule is a Doozy

The MFA would allow states to force Internet retailers to collect state and local sales taxes, if they do more than $1 million in sales, and remit the money to the appropriate place, just like the brick-and-mortar stores do. States would have to implement provisions of the Streamlined Sales and Use Tax Agreement (SSUTA) or meet the minimum specifications spelled out in the SSUTA, including providing retailers with free and regularly updated software to collect and remit sales taxes.

Huh? As tangled as that is, it only gets more puzzling as you go along.

There are approximately 9,600 taxing districts across the United States, each with its own requirements for registering and filing. There also are an incredible number of definitions of what is a taxable good and what isn’t, and let’s not forget the special “tax-free holidays” some states sponsor.

Imagine trying to keep up with all that! Or, as the legislation suggests, hoping your state provides “free and regularly updated software” to do so.

This purpose behind this is a noble one. It’s aimed at leveling the playing field for brick-and-mortar stores, which complain that customers window shop merchandise in their outlets, then go home and buy the item over the Internet because they don’t have to pay sales tax.

States obviously lose money when that happens. How much do they lose? Estimates vary, with one source putting it at around $12 billion for 2013. Whatever the amount, you know no government wants to miss out on a chance to spend/waste that kind of tax money.

What’s Next?

So what should small business owners selling online do? And no, punting is not an option.

For now, all you can do is check your business nexus – i.e., Do you have a physical presence in that state? If you do, collect sales tax when you sell to customers of that state … then sit back and wait on Washington.

The good news is, given the pace of play in D.C., you should have plenty of time to find a lawyer who can effectively interpret whatever Congress ultimately produces.