By Kyle Pennacchia
If your company conducts business in a number of states, you understand how convoluted the sales tax process can be. Traditionally, you started with figuring out how to adhere to the tax collection standards of your own state, then you determined in which other states you were deemed to have a legal presence and, therefore, a tax obligation.
Then came the Internet.
Ecommerce is a great way to find customers globally that you couldn’t have in the bricks-and-mortar-only days. However, ecommerce also presents new taxation challenges.
Here are three terms that explain what you’re up against.
- Physical nexus. The term for determining where and how your business has a footprint. Nexus is determined by the business having a physical presence in a particular state. Once established, the business will be liable for collecting sales or use tax on sales in and into the state. Physical presence can be determined by factories, warehouses, employees and any other physical presence within a given state. But don’t stop there. If your only presence in a Midwestern state is an employee working from home in Peoria, in all likelihood, you have an “office” (or a presence) in Illinois.
- Virtual or economic nexus. In certain states, if you strategically run an online ad that generates customer sales on a specific website, you have nexus in the state that hosts the website where the ad was placed. It’s called the click-through clause. An example is a company that places a banner ad on the New York Times website and generates a sale based on the buyer clicking the ad and purchasing the product/service through the corresponding site. Under the clause, nexus is created in the state in which the server that houses the NYT website is located. Therefore, nexus would be created in New York, assuming the New York Times server is located in New York. Essentially the business owner has created a New York state nexus through its deliberate actions to sell on that site. However, if you placed the ad through a vendor such as Google AdWords — one that could generate responses from various places — you’re generally not considered to have created a nexus out in any particular state.
- Exclusions. There are numerous industries, markets and transactions in which a company is not liable to collect sales tax. For example, only select states impose click-through nexus laws and sales thresholds which trigger filing rules vary by state. The threshold figures range from $5,000 to $50,000 per year. If your annual sales exceed that threshold, you need to charge and collect sales tax in that state. If they don’t, filing is not necessary. Two real-life physical nexus examples to consider in order to better understand its complexity are in the prepared food and software industries. A bagel shop that does not slice or put butter on your bagel would not collect sales tax, but a store that did would be required to collect and remit. Another example is a business owner who develops and sells software. The out-of-the-box product on the shelf would trigger sales tax, but generally, any separate custom modification service or training would not.
Getting an audit request from the IRS is bad enough, but imagine every state in which you do business requesting an audit if it feels your company may not have complied with its sales tax laws. It’s highly unlikely that you could retroactively charge taxes to customers on sales that occurred years ago, so unfortunately, you’d have to pay out of pocket — along with whatever penalties and interest charges are tacked on. This is why, as your company’s Web presence grows and your marketplace broadens, it’s critical that your accounting firm is experienced and adept at navigating the ever-changing online sales tax landscape. Every company should have a partner to grow with.
As an audit manager at Wiss & Company LLC, Kyle Pennacchia specializes in providing audit and tax advisory services to middle market commercial clients. Reach him at firstname.lastname@example.org.