Historically, federal laws have prevented states from interfering with interstate commerce. Specifically, the interstate commerce clause in the U.S. constitution, statutes like P.L. 86-272 and the Supreme Court’s 1992 decision in Quill v. North Dakota, prevented some other state from making your business pay income taxes or collect sales taxes on mail-order or website sales to customers in that other state.
Example: If your business operates in California, yes, you have to collect and remit California state sales taxes on California sales. You also have to pay California income taxes on the profits your business earns. But you don’t have to collect New York state sales taxes on sales you make to New York residents. And you also don’t need to pay income taxes to New York state on the profits you make selling stuff to New York customers.
In 2011 and 2012, however, two proposed pieces of legislation suggested changing the historical arrangement. Specifically, the Marketplace Fairness Act (S. 1832) and Marketplace Equity Act (H.R. 3179) would allow states to require out-of-state sellers to collect and remit sales taxes.
Because this change represents a significant new cost and accounting requirement for small businesses—and seems increasingly likely given the political environment and the economy—any small business with significant out of state sales (including bricks-and-mortar retailers with healthy web sales or solid mail-order operations) needs to plan ahead.
Marketplace Equity/Fairness Act Requirements in a Nutshell
The specific details of the two proposed laws differ. But they both work in the same general way. In each case, states who follow some basic rules get permission to force out-of-state businesses to levy and collect sales taxes when selling stuff to people in that state.
Both proposed laws require the states to administer their sales tax systems in an efficient manner. And both proposed laws exempt the smallest retailers from complying with the law. The Senate’s exemption, for example, excludes businesses if in the preceding year, the business generated less than $500,000 of remote sales. The House’s exemption excludes businesses if in the preceding year, the business generated less than $1,000,000 of remote sales.
Example: A Washington state business generates $1,000,000 in sales revenue in year 1 and 60%, or $600,000 of this revenue, stems from out-of-state sales to residents in other states. In year 2, according to the Senate’s version of proposed law, this business would be required to calculate, collect and remit sales taxes on sales to the roughly four dozen states that levy sales taxes.
Impact of Out-of-state Sales Tax Accounting on Remote Sellers
Even though the “Marketplace” acts are only proposals at the time I’m writing this (summer of 2012), I think small businesses need to confirm their accounting systems track customer sales by shipping or billing addresses if remote sales will exceed or approach $500,000. Otherwise such a firm may find itself breaking tax laws at the point of either proposal becoming law simply because the accounting system is inadequate.
Further, small businesses will upon passage of either proposal need to store and keep up-to-date records of several thousand sales tax jurisdictions so that firms can calculate the appropriate sales tax rate when invoicing a customer.
Note: Some people may assume that with roughly 45 states levying sales taxes only 45 sales tax rates need to be stored and maintained by the accounting system. Unfortunately, that’s not true because many states use blended sales taxes that combine a general “state” tax with numerous “local” rates. Washington State, for example, actually has roughly 250 different sales tax rates because the state rate gets combined with local rates. (In fact, in an op-ed piece in the July 24th, 2012 edition of the Wall Street Journal, the CEO and chairman of overstock.com suggested that the number of sales tax jurisdictions exceeds 9,600, painfully noting, for example, that the Dallas Fort-Worth airport alone falls into six separate taxing jurisdictions.)
One other “accounting department” issue is this. Sales tax returns are typically prepared and filed on a monthly basis. Accordingly, small businesses who find themselves subject to remote sales tax will need to either hire additional staff or budget substantial sums for outsourcing the sales tax return preparation work.
With perhaps forty state sales tax returns to prepare each month, a good guess at required staffing might be an additional half-time tax accountant if the person can be supervised by someone more skilled in tax law.
If a business wants to outsource the sales tax return preparation, a good guess at a cost per state return might be $200 per month per state. For example, if small business prepares 40 monthly state income tax returns, the outsourcing cost might run $8,000 per month or nearly $100,000 a year.
One other comment to share about this reporting burden: Sales tax returns typically require very quick turnaround times. In Washington State, for example, the excise tax return for a retailer is usually due on the 25th of the following month for a monthly filer. In a situation where a month ends on a Friday and then the weekend lasts three days due to a holiday, businesses may find themselves scrabbling to timely prepare returns. (If this doesn’t make intuitive sense to you, think about a situation where you begin to collect items like your W-2 on January 4th but need to have your individual tax return prepared and in the mail by January 25th.)
Closing Comments on Remote Sales Taxes
With the preceding material as background, let me also share a handful of additional planning thoughts related to the possibility that either “Marketplace” act becomes law:
1. Some remote sales businesses will need to close if either proposed law goes into effect. Take the case of a business with $500,000 of revenue (all of it from remote sales) and $80,000 of profit. That business will not find the tax return preparation costs bearable.
2. Some of the remote sales businesses that can’t bear the cost of monthly sales tax returns may be able to either merge or combine with other remote sales businesses and “survive” as a result. In effect, the $100,000 a year in annual, fixed sale tax return preparation costs represents a fixed “tax” that doesn’t change just because the revenues and profits go up or down. Ten, small $500K a year website businesses could combine and then “share” the cost of preparing the monthly sales tax returns.
3. Businesses (including brick and mortar retailers) with remote sales close to the threshold should probably look at intentionally falling short of the cutoff point. Such a business, for example, might discontinue its least profitable products or end relationships with its least profitable customers or affiliates. One might even imagine “shutting down” the website in November if continuing into December adds a $100,000 in tax return preparation costs to the next year’s budget.
4. Finally, while the House version of the “Marketplace” act isn’t very detailed (or thorough), the more thoughtful Senate version of the law does combine related parties for purposes of the threshold test. Accordingly, if you own or have interests in several retail businesses with remote sales, be aware of the possibility that an aggregation of remote sales could cause you to “cross” the threshold into taxable territory without you even realizing it.