Amazon FBA Sales Tax Amnesty or Tax Man Scare Tactics?
The Online Marketplace Seller Voluntary Disclosure Initiative
The Multistate Tax Commission (“MTC”), thinks it has finally solved the Amazon seller sales tax problem by placing the burden of state tax law complexity on small businesses through its amnesty program.
I am talking about the kind of tax complexity where fortune 500 companies pay millions in legal fees for opinions on possible legal outcomes, and even with those analyses, still don’t end up any closer to knowing if what they are doing is ultimately the right answer in terms of complying with state law.
Bravo MTC! Small business thanks you for sending them down the rabbit hole that is state and local tax. Now if I could only find my Bruce Willis Die Hard meme that says, “Welcome to the Party, Pal!”
What the MTC is attempting to do here in terms of placing this unnecessary burden on small business, and trying to beef up the income tax base should invoke outrage as an Amazon Seller. Especially when, if you look at the typical FBA transaction, Amazon is obviously the one who should be collecting and remitting the sales tax, not the seller.
The Multistate Tax Commission is an intergovernmental organization funded by its member states to promote efficiency in administering state tax law.
Why Should Amazon be Responsible for Collecting and Remitting Sales Tax?
The best way to explain this is to paraphrase an analogy I heard during a talk given by the head of the tax division for a major northeast state:
FBA works like an online consignment shop. Amazon takes possession of the inventory and manages the logistics of where to store it, sales are made through the Amazon website, Amazon, ships the items to the customer, and then Amazon pays the seller less their cut. Therefore, just as a local consignment shop is charged with the duty to collect and remit sales tax in the physical world, why wouldn’t Amazon be charged with the same duty to collect and remit sales tax in the online world?
It seems simple enough, and would certainly save small businesses from a lot of headache. So why on earth is the MTC trying to burden the small seller, when it could easily accomplish all that it wants in terms of collecting sales tax (technically it’s use tax, but we won’t go there) by placing the collection burden where it belongs, on the shop owner, aka Amazon?
Do States Really Fear the Wrath of Amazon?
One reason I suspect the MTC is going after the seller and not Amazon is that states fear retaliation by Amazon. If states aggressively pursue Amazon in this context, Amazon could retaliate by closing distribution centers, or blacklisting states from future expansion programs. While this sounds a bit silly to someone who may be suddenly going through a crash course in state tax, speaking from experience, I can tell you it’s very real. States compete for corporate jobs all the time. Look at GE moving to Boston from Connecticut. Once GE announced it was leaving Connecticut, states were coming out of the woodwork trying to court GE. The state of Indiana actually paid for a FULL PAGE Wall Street Journal ad stating friends don’t let friends pay high taxes. (I’m not making this up, I actually cut it out and hung it in my office.)
So, given the fact that most of the states taking part in the amnesty program have FBA distribution centers, (otherwise why would they be involved in an amnesty program targeting FBAs inventory in their state?), the decision to go after out of state small business, and not Amazon, may actually be motivated by fear the political fallout of potentially losing Amazon.
Oliver Stone Tax Theories Aside, Could This Have Anything To Do With Getting Sellers to Pay Income Tax?
One other reason states would want to go after the sellers is to get sellers to pay income tax.
By bringing FBA sellers in under the sales tax amnesty program, sellers will be forced out of hiding and, in the state’s view, also be required to pay income tax to all their nexus states, not just their home state.
Oh and it’s not just about paying income tax on your FBA/Amazon earned income in that state. In fact, depending on the state and/or your business entity structure, you will likely be taxed, proportionally (emphasis on proportionally), on all of your seller income, all states and all sources to each FBA state.
Why do I say proportionally? The Supreme Court has essentially blessed what is known as the unitary business principle. This allows states to tax all of the income of a business, or a combination of related businesses, regardless of where the income is earned. The flip side to that is that the states are constitutionally required to divide the combined income tax base using a ratio that is meant to roughly approximate what percentage of your business activity is in the state, relative to your total business activity.
Tell Me More About How the States Can Potentially Tax All of My Seller Income, But Not Really All of it Because of the Constitution
The way states determine how much of your total income they get to tax is by what is generally known as an apportionment factor. Unfortunately, many states “apportion” income differently, and depending on how your FBA state(s) divide income, that could be good or bad.
The clear trend among the states is to take in-state sales, divide that by total sales and multiply it by your federal taxable income. The result of that number becomes your tax base to which the state tax rate is then applied.
While looking at sales in state relative to out of state is the latest trend in apportionment, the original “MTC” apportionment methodology involves taking into account sales property and payroll using weighting (? Sales, ? Property, ? Payroll), or some variation such as double weighting the sales factor (½ Sales, ? Property, ? Payroll). Many states still follow the MTC rule, or a variation of that rule.
Unfortunately, to the extent your FBA state(s) follow the older MTC rule, or any variation that involves property in the state, your income tax liability will likely be higher in those state(s).
NO MAS! I CAN’T TAKE ANY MORE OF THIS!
I can only imagine what you are going through right now as a seller, in terms of all that you struggle with every day, and having to add this to your pile of stress.
If this all seems like too much, take a moment and acknowledge that you are trying to get up to speed on concepts that take people years to grasp. Using the law class I teach at Pace University as a benchmark, I dedicate about three 2-hour classes to nexus alone, and could easily spend more time on it.
How you are supposed to understand it, process it and make an important decision within a two-month time frame is beyond me.
Maybe I’m being too cynical, but I also can’t help but feel that perhaps one of the strategies to ensure the success of the amnesty program was to overwhelm sellers into submission with information overload, fear mongering and tight deadlines. It just seems cruel to me that you only have two months to figure it all out.
Because this is direct action by the government, as opposed to Amazon, maybe this is where the seller community needs to band together, reach out to your politicians and let them know how you feel about this so called amnesty. There are organizations that can help you, and I’d be happy to cover that in another post if there is interest.
Final Thoughts
Despite the feelings of being overwhelmed with all of this new chaos in your life, and the mad rush to figure it out before the October 17th amnesty deadline, I urge you not to simply chose to participate because you feel trapped, or that it’s clearcut and this is the best way out.
Every taxpayer has unique facts and circumstances. Therefore, the best thing to do right now is to work with an advisor, particularly one who truly understands multistate tax (hint hint).
Let me reiterate that last point of how important it is that you work with an advisor that is experienced in multistate tax.
The first thing you need to understand is that, in context of State and Local tax, your local CPA or “tax guy” probably won’t cut it. This is because the key qualifications of a state and local tax advisor include, among other things, understanding of key principles of constitutional law (commerce clause, due process and equal protection), familiarity with the LONG line of case law, knowing how to manage the interplay between the the various state tax laws, as well as understanding the interplay between federal and state tax laws.
So, just as you wouldn’t go to your family doctor for open heart surgery, in cases like this the best thing for you to do is work with an experienced multistate tax professional.
Another reason to work with a state and local tax specialist is that there is a lot more grey than meets the eye.
People unfamiliar with state tax might conclude in an almost boolean like fashion, that FBA inventory = true, therefore physical presence. However, as a multistate tax professional, I see a lot of grey here with lots of opportunity to make distinctions between FBA facts and established case law. Just to belabor the point of why it’s important to work with a mutlistate tax specialist (this is not legal advice), as someone with 12 years of experience in state and local tax, I can already see a potential argument with FBA features like inventory commingling.
While I’m even not sure FBA inventory qualifies as true ownership, or if perhaps there is an exception to the law that would exempt businesses whose only activity in the state is FBA, inventory commingling is a fact that, from a 50,000 ft view, could potentially poke a hole in the state’s basis for asserting nexus over sellers. Consider what happens if you send a laptop to Amazon for FBA, and assume that laptop is commingled. (Note from the editor: Please don’t ship a laptop to FBA as commingled inventory.)
If Amazon sells the laptop you shipped the next day, and you sell a laptop 30 days later, but it’s fulfilled using the same laptop model, different serial number, and different fulfillment center than the one you originally shipped to, I’m starting to question if you ever legally owned the inventory at any point after Amazon received it.
Maybe the legal reality is that you sold that inventory to Amazon in exchange for a receivable, like an IOU for payment upon the sale of the laptop. And, when the sale was actually made Amazon really didn’t transfer the inventory back to you, they just made good on their IOU payment. Therefore, if you could establish through that fact pattern that there was never any ownership of inventory by the seller in the state, then the state has no basis for arguing that your business has nexus in the state.
Again, this is not something you should rely on, as it’s just my legal pontification, but it helps illustrate the importance of why you should work with state and local tax attorneys and advisors. Only state and local tax advisors are going to understand state tax well enough to know how best to distinguish your facts in order to poke meaningful holes in the state’s arguments.
Regardless of whether you heed my warning about working with experienced state and local tax advisors, I strongly urge you not to attempt to go it alone in the amnesty process. Anonymity is key to how the voluntary disclosure process works.
While I’m sure the MTC is genuine in their promise to maintain confidentiality, knowing that their organization’s mission is in part to help state governments collect revenue, I can’t help but feel there is a conflict of interest here that could potentially come back and bite you. Work with an advisor who knows how these programs work (again Hint Hint) and how to ensure your anonymity is fully protected.
Now here is the part where I blatantly plug myself: As a former state tax attorney for Microsoft, Wal-Mart and GE, with over 12 years of experience in State and Local Tax, I’d be happy to help you with your tax questions. If your question is outside of my realm of expertise, I can still help you find the right advisor, as I’ve been involved in some form of tax dispute in just about every state (unfortunately not Hawaii), so I know how to find the right advisor to address your specific concerns.
In addition, whether you work with me directly or with a suggested colleague, I can help you through the process to make sure all the billing is upfront, straightforward and fair, no surprises.
*The MTC Amnesty program for 3p sellers runs from August 17th 2017 to October 17th, 2017. You can learn more about the program here.
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Paul Rafelson
State Tax Attorney
Paul Rafelson has over 12 years of experience in handling State and Local Tax Matters. As a former State Tax Counsel for General Electric Company in Stamford, CT Paul was responsible for state income and franchise tax audits, appeals and litigation. Prior to GE, Paul held similar roles at Wal-Mart Stores, Inc. in Bentonville, AR and at Microsoft Corporation in Redmond, WA. Paul is also an adjunct professor at Pace Law School where he teaches State and Local Tax Law.