New Rules for Collecting Sales Tax Over the Internet
Buying goods over the internet has become a part of life for most Americans. But the increase in e-commerce has come at a cost to state tax revenues. This is because the constitutional rules relating to the collection of sales tax on purchases from remote retailers were set by a U.S. Supreme Court decision (Quill v. North Dakota) in 1992, well before e-commerce became a major factor in the American economy.
Quill held that a retailer must have a physical presence in a state before the state may require the retailer to collect sales tax. As a result, most states may not require companies like Amazon (which have intentionally limited their physical presence to a handful of states) to collect their sales tax.
Nevertheless, sales taxes are still owed on goods sold over the internet. As a result of Quill, however, states have been forced to rely on consumers to self-report their internet purchases and pay taxes owed on those purchases. This “honor system” for paying sales taxes has failed. Few consumers actually report their internet purchases. The lost sales tax revenue to the states from having to rely on consumers to self-report their internet purchases is estimated to total $12 billion per year – a particularly substantial loss given the states’ severe budget problems.
Several states that are now requiring sales tax collection for online businesses that use affiliate marketers. Whether you use affiliates, or are an affiliate marketer yourself, learn more about the changing regulations and how to find out the rules for your state.
Understanding “Physical Presence” Nexus Rules
In 1992, the Supreme Court ruled that states cannot require mail-order businesses including online retailers to collect sales tax in a state unless they have a physical presence there (Quill v. North Dakota, 504 U.S. 298, (1992). In legal terms, this physical presence is known as a "nexus." Each state defines nexus differently, but all agree that if you have store or office of some sort, a nexus exists. Remember that each state defines what constitutes a physical presence differently. If you are uncertain whether or not your business qualifies as a physical presence, contact your state's revenue agency.
Instead of collecting sales tax from remote retailers, many states required the consumer to pay a “use” tax on their online purchases. Unfortunately, many consumers were either unaware of this requirement or chose to ignore the use tax, and enforcement was cost-prohibitive for revenue agencies.
Role of Affiliates
Affiliate marketing is a commission-based referral partnership, typically between a website owner and an online retailer who wants to promote their product. In most affiliate agreements, a website owner puts links or ads on their site that promotes the retailer’s product to the visitors of the site, ideally potential customers for the retailer. In exchange for the promotion, the retailer agrees to share a percentage of the profit with the website owner (or affiliate), if the transaction generates a lead. Learn more about affiliate marketing.
Affiliate-advertiser relationships are at the center of the “physical presence” nexus debate. In an effort to collect previously un-reported sales tax, some states are using an advertiser’s affiliate network as a means of establishing physical presence in a state, and thus making the advertiser eligible to pay sales tax there.
States Begin to Revise Nexus Rules
Under-collected use taxes coupled with industry concerns have caused many states to recently re-evaluate the definition of physical presence as it applies to online sales. Proponents for reform call for a level tax-collection playing field between online retailers and traditional brick-and-mortar businesses; while those against reform argue that affiliates are essentially an advertising method - a non-taxable activity.
New York, Colorado, North Carolina, Rhode Island have enacted legislation that counts an online affiliate as a method of establishing physical presences in a state, although the content of the statutes include varied exemptions and income thresholds. Several other states have attempted to pass legislation aimed at collecting sales tax for online businesses that use affiliate marketers, including California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, Mississippi, New Mexico, Tennessee, Vermont, and Virginia.
The Bottom Line for Affiliate Marketers
New taxes requirements don’t necessarily add additional burden to small affiliates (affiliates don’t pay sales tax because they are not “selling” anything - they essentially just receive a commission from the advertiser(seller), and the advertiser(seller) is the one ultimately responsible for paying the tax), however the changing tax laws do have other implications. In some cases, high-profile advertisers have dropped affiliates in certain states where they could be considered a tie to establishing a physical presence (Amazon.com LLC v. New York State Department of Taxation and Finance (N.Y Sup. Ct. No. 601247/08)). If you are an affiliate marketer, or are considering becoming one, it would be wise to stay up-to-date on your state’s laws through your state's revenue agency.
The Bottom Line for Advertisers
If you are an advertiser that uses affiliates, it would be wise to stay abreast of changing tax requirements in the states where your affiliates are located. Recently, several states have banded together to develop the Streamlined Sales and Use Tax Agreement (SSUTA), which aims to standardize Internet sales taxation and encourages online retailers to collect taxes from customers in the states where the agreement is valid, and the Main Street Fairness Act is calling for Congress to enact the SSUTA.
Related Resources
· States Making Inroads at Taxing Online Sales - 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.
· Collecting Sales Tax Over the Internet - Information for online retailers on the rules and regulations for collecting sales and use taxes from your customers.
· International Online Sales - Selling your products online allows for immediate entry into the global marketplace. However, shipping your product overseas presents a few challenges if have little experience with taxes, duties, customs laws, and consumer protection issues involved with international commerce. If you are just getting started, the following resources will help understand legal and regulatory requirements when shipping overseas.
TheTaxTranslator, Steve Hoffman
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