Forty-five states and the District of Columbia impose sales taxes; Alaska, Delaware, Montana, New Hampshire, and Oregon do not. Sales tax must be collected on the state’s sales tax base.
Generally, sales of tangible personal property are subject to the tax. Most states also tax res- taurant meals, rental car usage, hotel room rentals (often at higher tax rates than general sales), and some services (which vary by state). Purchases of inventory for resale are exempt from the sales tax.7 For example, Wild West’s rafting equipment purchases for resale are ex- empt from sales tax because inventory is taxed when sold, but its office furniture purchased for use in the business are taxable because they represent final sales. Taxable items that are included in the sales tax base vary from state to state. Many states exempt food (except pre- pared restaurant food) because taxing food is considered to be regressive; that is, it imposes a proportionally higher tax burden on lower-income taxpayers, who spend a greater propor- tion of their income on food and other necessities. Most states also exempt sales of real property, intangible property, and services. However, many states are expanding the types of services subject to sales tax in order to increase their sales tax revenue.8
LO 23-2
THE KEY FACTS Sales Tax Nexus
• Nexus is the sufficient connection between a business and a state that allows a state to levy a tax on the business.
• Sales tax nexus is estab- lished through the physical presence of salespeople or property within a state.
TAXES IN THE REAL WORLD Is It Candy or Is It Food?
Items subject to the sales tax vary from state to state. Historically, New York taxed the sale of large marshmallows but exempted the sale of small marshmallows. Large and small marshmal- lows were treated differently because large marshmallows were considered to be candy, which was included in the sales tax base, while small marshmallows were considered to be a food ingredient and therefore excluded from the
sales tax base. Currently, all marshmallows are taxed as a food ingredient.
The Washington state legislature passed a law subjecting candy to sales taxes a few years ago.
Any item containing flour was considered a food item, not candy. As a result, Twix bars were ex- empt while Starburst candy was subject to sales tax. Within a year, Washington voters repealed the tax on candy through a ballot initiative.
Sales Tax Nexus
Have you ever wondered why sometimes you pay sales tax on goods purchased over the Internet and sometimes you don’t? The answer is it depends on whether the seller has sales tax nexus. A business is required to collect sales tax from customers in a state only if it has sales tax nexus in that state. For example, if you purchase a book from a local bookstore you paid sales tax, but if you purchased the book from an online seller you didn’t pay sales tax (unless you live in a state where the seller has sales tax nexus). While Amazon now col- lects sales taxes in all states having sales taxes, Exhibit 23-4 explains how Amazon’s prior position on sales tax collection could result in a substantial sales tax liability if a state successfully asserts that Amazon’s position was wrong.
Businesses that establish sales tax nexus with a state but fail to properly collect sales tax can create significant liabilities that may need to be disclosed for financial reporting purposes.9 As a result, understanding when a business has sales tax nexus can be ex- tremely important for profitability, business modeling, and compliance.
Businesses create sales tax nexus (the sufficient connection with a state that requires them to collect sales tax) when they have a physical presence in the state. Businesses have a physi- cal presence in the state if (1) salespeople (or independent contractors representing a business)
7Most states grant a reseller’s certificate, which exempts purchases of inventory for resale from sales tax.
8For example, Connecticut taxes services such as tax preparation.
9Sales tax liabilities are ASC 450 contingencies.
EXHIBIT 23-4 Excerpt from Amazon’s 2016 Annual Report From the Form 10-K
We Could Be Subject to Additional Sales Tax or Other Indirect Tax Liabilities
An increasing number of states and foreign jurisdictions have considered or adopted laws or administrative practices, with or without notice, that impose additional obligations on remote sellers and online marketplaces to collect transaction taxes such as sales, consumption, value added, or similar taxes. We may not have sufficient lead time to build systems and processes to collect these taxes. Failure to comply with such laws or administrative practices, or a successful assertion by such states or foreign jurisdictions requiring us to collect taxes where we do not, could result in substantial tax liabilities, including for past sales, as well as penalties and interest. In addition, if the tax authorities in jurisdictions where we are already subject to sales tax or other indirect tax obligations were successfully to challenge our positions, our tax liability could increase substantially. In the U.S., Supreme Court decisions restrict states’ rights to require remote sellers to collect state and local sales taxes (although some states are seeking to have the Supreme Court revisit these decisions). We support a federal law that would allow states to require sales tax collection by remote sellers under a nationwide system.
We are also subject to U.S. (federal and state) and foreign laws, regulations, and administrative practices that require us to collect information from our customers, vendors, merchants, and other third parties for tax reporting purposes and report such information to various government agencies.
The scope of such requirements continues to expand, requiring us to develop and implement new compliance systems. Failure to comply with such laws and regulations could result in significant penalties.
enter a state to obtain sales or (2) tangible property (such as a company-owned truck making deliveries) is located within a state.10
The physical presence requirement is a judicial interpretation of the Commerce Clause of the U.S. Constitution. Designed to encourage interstate commerce, this clause gives Congress power “to regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” Because Congress has never exercised its right, the courts have determined the sales tax nexus threshold. In National Bellas Hess, the U.S. Supreme Court held that an out-of-state mail-order company did not have a sales tax collection responsibility because it lacked physical presence (even though it mailed catalogs and advertised in the state).11 The mail-order industry used this decision as a competitive advantage for several decades. In Quill, the U.S. Supreme Court reaffirmed that out-of-state (nondomiciliary) businesses must have a physical presence in the state before the state may require a business to collect sales tax from in-state customers.12
Wild West sends promotional brochures from Idaho to its Colorado clients. Wild West generated cur- rent year sales of $75,002 to Colorado customers, but it has never collected Colorado sales tax or filed a Colorado sales tax return. Wild West has neither employees nor property in Colorado. Does it have sales tax nexus in Colorado?
Answer: No. Wild West lacks the physical presence required for Colorado sales tax nexus and there- fore doesn’t have Colorado sales tax collection responsibility.
Example 23-1
10Scripto, Inc. v. Carson, Sherriff, et al., 362 U.S. 207 (1960). Scripto hired independent salespeople to repre- sent the company in Florida. The Supreme Court held that these salespeople were agents of Scripto, who es- tablished the physical presence necessary to create sales tax nexus.
11National Bellas Hess, Inc. v. Department of Revenue of the State of Illinois, 386 U.S. 753 (1967).
12Quill Corporation, Petitioner v. North Dakota, 504 U.S. 298 (1992).
What if: Assume that in addition to mailing promotional brochures, Ken visits Colorado on promo- tional trips. Does Wild West have sales tax nexus in Colorado under these circumstances?
Answer: Yes. The physical presence of Wild West’s representatives, even for promotional trips, creates Colorado sales tax nexus.
What if: Assume Wild West’s representatives (independent contractors), rather than employees, visit Colorado retail stores to solicit additional sales orders. Does Wild West have sales tax nexus in Colo- rado under these circumstances?
Answer: Yes. The physical presence of Wild West’s representatives creates Colorado sales tax nexus.
Thus, the result is the same for employees or independent contractors.
TAXES IN THE REAL WORLD Sales Tax Nexus
On January 12, 2018, the United States Supreme Court agreed to hear the case of South Dakota v.
Wayfair Inc. This sets the stage for possible changes to the physical presence requirement for sales tax nexus. The Court’s decision likely will address whether the state can impose a sales tax collection and remittance obligation on sellers that do not have a physical presence in the state, effectively either reaffirming or over- turning the long-standing precedent established in National Bellas Hess v. Illinois and reaffirmed in Quill Corp. v. North Dakota.
A few states have recently passed legislation creating economic sales tax nexus (imposing sales tax nexus on businesses without physical pres- ence), which contradicts current law but is done in anticipation of a successful challenge of Quill Corp. v. North Dakota.
The Supreme Court will hear oral arguments in South Dakota v. Wayfair Inc. during April of 2018 and issue an opinion in the months following. Businesses should stay current with this ruling and other economic sales tax nexus issues.
Sales Tax Liability
Typically, sellers with sales tax nexus collect customers’ sales tax liabilities. For example, Wild West collects sales tax on river rafting equipment it sells from its retail store but not on river guiding services it provides. If the seller doesn’t have sales tax nexus, then the customer is responsible for remitting a use tax (at the same tax rate as sales tax) to the state in which the property is used. If the buyer is charged a sales tax in another state, the buyer will have a use tax liability for an incremental amount if the state where the prop- erty is used has a higher sales tax rate.
Wild West received $3,500 from a customer named Casey Jarvie residing in Sacramento, California.
Of this amount, $500 was for personal rafting equipment shipped to Sacramento, where the sales tax rate is 8.25 percent. The remaining $3,000 was payment for a four-day river raft adventure on the Salmon River in Idaho. Wild West has neither salespeople nor property in California. Does Wild West have a responsibility to collect sales tax from Casey?
Answer: No. Wild West lacks physical presence and does not have sales tax nexus in California; there- fore, it has no California sales tax collection requirement.
Because Wild West has no sales tax collection responsibility, does Casey have a use tax liability to the state of California? If so, in what amount?
Answer: Yes. Casey is responsible for remitting $41.25 of use tax ($500 × 8.25%) on his personal California state income tax return for the purchase and use of the personal rafting equipment in California. He is not required to pay California use tax on the river raft adventure purchase because Wild West provided an out of state service (no sales tax is due on the services in Idaho either).
Example 23-2
(continued on page 23-8)
Large companies often must file sales tax returns in all 45 states that have sales taxes and the District of Columbia.13 This administrative burden is further complicated by the fact that more than 7,500 tax jurisdictions (including counties, cities, school dis- tricts, and other divisions) impose sales taxes, and several hundred rates change annually at various times during the year.14 The sales tax administrative burden can also be large for small businesses. For example, a local pizzeria that delivers can sometimes be sub- ject to a half-dozen sales tax rates if its delivery services cross city, county, or school district boundaries.
What if: If Casey had Wild West hold the goods until he arrived in Burley, Idaho, to pick them up at the time of the trip (assume the sales tax rate in Burley, Idaho, is 6 percent), would Wild West have sales tax collection responsibility? If so, what is the sales tax amount?
Answer: Yes. Because Wild West has physical presence in Idaho, it is required to collect $30 ($500 × 6%) of sales tax and remit it to Idaho. Casey would also have an $11.25 California use tax liability ($41.25 reduced by the $30 remitted to Idaho) in this scenario.
ETHICS
Jill is a Virginia resident who purchased $1,500 of personal use items from Overstock.com and other Internet retailers during the year. While com- pleting her personal tax return using a popular software package, Jill was asked to report her on- line purchases. After entering these purchases,
she noticed that $75 of “use tax” was added to her state tax liability. Jill has never paid this in the past. She decided to delete the online pur- chase information she had previously entered.
What do you think of Jill’s failure to report her Virginia use tax?
ETHICS
In 2010, Colorado became the first state to require nondomiciliary businesses without sales tax nexus to report all the necessary information to the Colorado Department of Revenue so that Colorado could collect its use tax from its resident individuals and domiciliary businesses. Assume you are responsible for resolving sales tax issues for an
online retailer from another state. You believe the Colorado tax is unconstitutional based on a seminar you attended and the advice of your accounting firm. Would you recommend that your company comply with the Colorado law? Would your opinion change if the court issued an injunction prohibiting the state from enforcing the new law?
13Some counties or political subdivisions of states without state sales taxes (such as Kenal Peninsula Borough in Alaska) impose a county or local sales tax.
14Software companies provide sales tax solutions that help companies with the administrative burden. How- ever, they generally fail to indemnify or compensate businesses against errors in their software that result in uncollected sales taxes, which creates a liability for the business.
Recall from Exhibit 23-1 that Wild West has sales in Arizona, California, Colorado, Idaho, Tennessee, Washington, and Wyoming. Also recall that it has property and employees in Idaho, Tennessee, Washington, and Wyoming. In which states does Wild West have sales tax nexus and, therefore, sales tax collection responsibility?
Example 23-3