This article was co-authored by Paul A. Zee-Cheng.
On October 3, 2016, Tennessee issued a proposed rule making it the third state to impose a sales tax collection obligation on certain out-of-state sellers with no physical presence in a State (Rule 1320-05-01-.129). Under the new rules, out-of-state sellers who make over $500,000 in sales to consumers in Tennessee during the previous twelve-month period automatically have substantial nexus with the state, and are obligated to collect and remit Tennessee sales tax.
The new rule requires out-of-state sellers meeting the sales threshold to register with the state by March 1, 2017, and begin collecting sales tax on July 1, 2017. If a taxpayer meets the threshold after the March deadline, then they must register with the state and begin collecting sales tax on the first day of the third month after the month that they meet the threshold. Taxpayers that do not comply with the new rule will be subject to penalties.
Tennessee’s economic nexus provision for sales tax, which is similar to recently adopted rules in Alabama and South Dakota, is in direct contradiction to the nexus standard established by the U.S. Supreme Court in the 1992 case of Quill Corporation v. North Dakota. In Quill, the Court held that a retailer must have a physical presence within a state to be obligated to collect sales tax. The new economic nexus rules that states are adopting attempt to pave the way for Quill to be revisited by the Court, through a challenge to one of the new rules. Justice Kennedy recently invited such a challenge in his concurring opinion in Direct Marketing Association v. Brohl. With pending litigation in Alabama and South Dakota, the physical presence nexus standard could be revisited sooner rather than later.
The Tennessee Department of Revenue did acknowledge the conflict with Quill in its response to public comments regarding the new rules. Despite the conflict, the Department maintains that the rule does not restrict interstate commerce for three reasons. First, as the Court observed in Brohl, the economy has experienced significant structural changes in the past 24 years. The use of online shopping means that a business may now be present in a state without a traditional physical presence. Second, the burden of tax compliance on out-of-state sellers has decreased with sophisticated new tax software. Third, despite pressure from Tennessee and other states, so far Congress has come up short in creating an alternative legislative solution for sales tax collection by remote sellers.
Tennessee’s new rule is still subject to review under the state congress Government Operations Rule Review Committee. This committee could theoretically vote to request the agency repeal, amend, or withdraw the rule. Retailers potentially impacted by Tennessee’s new nexus provision should plan on registering by March of next year, as well as monitor whether any challenges to the provision result in delayed enforcement.
If you have questions about your company’s sales and use tax obligations, please contact Aronson or Michael L. Colavito, Jr. at 301.231.6200.
Making assumptions when it comes to sales and use tax is ill-advised for any entity’s approach to compliance. This is especially the case for not-for-profits. Exemption from federal income tax can count for nothing in the sales and use tax world, and states are anything but uniform when it comes to exemptions available for not-for-profits. Even when there are sales and use tax exemptions available for not-for-profits, it’s essential to ensure that all administrative requirements are followed in order to properly claim the exemption.
At the very least, all not-for-profits need to ask themselves three questions when it comes to sales and use tax: What states? What purchases? What sales?
No entity, not-for-profit or otherwise, will have a sales and use tax payment or collection obligation unless a state has jurisdiction over the entity. In the state tax world, this concept is known as “nexus.” For sales and use tax, an entity needs to have a physical presence in the state before a state can have jurisdiction to tax it. Many taxpayers mistakenly interpret the “physical presence” test to mean a substantial permanent presence – for example, having an office in a state. Clearly, an office location in a state would be considered a physical presence by all states, but many other in-state activities can constitute nexus. For example, a physical presence can be established by having a telecommuter in a state, having employees temporarily in a state, or having independent contractors in a state performing services for the not-for-profit.
Once a not-for-profit determines that it has nexus with a state, it must determine if any of its purchases being made in the state are subject to sales tax. Many states have sales and use tax exemptions for purchases made by not-for-profits, but these exemptions vary significantly in terms of which not-for-profits are exempt and the scope of the purchases that are exempt. For example, California only provides sales and use tax exemptions for purchases made by entities meeting its rather narrow definition of a “charitable organization.” Further, if an entity meets that definition, the only purchases that are exempt from sales and use tax are those that are made for the purpose of donation by the organization. All purchases of supplies (such as tools and office supplies) are not exempt. Under these rules, most associations and membership organizations (i.e., non-IRC 501(c)(3) entities) would be taxable on all of its purchases.
Other states, such as Maryland and Ohio, have broader exemptions on purchases made by not-for-profits, but even in these states the exemption does not apply to all entities that may be exempt from federal income tax. Further, most states require not-for-profits qualifying for a sales tax exemption to obtain an exemption certificate from the applicable taxing authority, which must be provided to vendors at the time of purchase.
Not-for-profits also need to be aware if its sales of products or services are subject to a state’s sales and use tax. If a not-for-profit’s sales are subject to sales tax, then it must register to collect and remit sales tax to the state. Merchandise sold, training materials (i.e. tangible or digital), software applications, access to a database, and subscriptions to publications are items to which not-for-profits need to pay particular attention. States often have exemptions for certain sales of admissions to events hosted by not-for-profits and sales of food and beverages items. Sales of merchandise are typically subject to sales and use tax. This is especially the case when a not-for-profit has a permanent retail store, as opposed to sales that are isolated in nature. For example, Colorado, Georgia, Illinois, and Pennsylvania generally impose their sales tax on sales made by not-for-profits unless the sales meet the applicable rule pertaining to isolated/occasional sales.
It’s important for not-for-profits to be proactive in the area of sales and use tax. When activities are expanded to new states, whether from hiring an in-state employee or frequently hosting conferences or seminars in a state, not-for-profits should immediately look into whether it will be making any purchases or sales that may result in a sales tax compliance obligation. Being reactive can result in penalties, interest, and the practical in-ability to recoup uncollected taxes.
If you have any questions about sales and use tax, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.
A new sales tax regulation in Alabama directly contradicts the bright-line physical presence nexus standard created by the U.S. Supreme Court in Quill Corp. v. North Dakota. While Congress has debated (and been unable to enact) multiple versions of federal legislation that would limit the application of the physical presence nexus standard for certain retailers, the Alabama Department of Revenue has ignored these impediments by promulgating its own “economic nexus” rule.
The new regulation, which takes effect on January 1, 2016, establishes a bright-line sales threshold for nexus that is similar to Alabama’s recently enacted statute defining when a corporation is doing business for income tax purposes. However, Alabama is the first state to apply such a bright-line rule for sales tax.
The regulation provides that “out-of-state sellers who … are making retail sales of tangible personal property into the state have a substantial economic presence in Alabama for sales and use tax purposes and are required to . . . collect and remit tax . . . if the seller’s retail sales of tangible personal property sold into the state exceed $250,000” in a calendar year. The regulation also requires some form of activity that reflects purposeful availment to the Alabama market by a retailer. However, most of the activities listed in the regulation that will trigger the collection of tax do not require a physical presence in the state. These activities include solicitation of sales through television or print advertising, such as the distribution of catalogs. These are the exact types of activities that have been deemed not to create a “physical presence” under the current sales tax nexus rules established by the U.S. Supreme Court.
The Department’s expectation with respect to this new regulation is unclear. Most retailers meeting the requisite $250,000 sale threshold that do not have a physical presence in Alabama will likely not follow the new rule given its apparent inconsistency with federal law. It will be interesting to see if the Department of Revenue seeks to enforce the rule against non-compliant retailers, especially given the U.S. Supreme Court’s recent hinting at its willingness to reconsider the rule established in Quill.
If you have questions about your company’s sales and use tax obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298.
There is a growing list of states that have adopted a more aggressive income tax nexus standard. On August 11, 2015, Alabama added itself to the group of states that impose their income tax on out-of-state businesses solely based those businesses a certain level of sales to customers in the state. The trend is a natural response to the impact that technology has had on the ability of businesses to provide their services on a national (or even global) scale without having an expansive physical presence.
The legislation enacted in Alabama (H.B. 49), which will take effect for tax years beginning after December 31, 2014, is commonly known as a “factor presence” or “bright-line” nexus test. Under Alabama’s the new nexus rule, a business organized outside the state will have an income tax filing obligation if:
In the last year, New York and Tennessee have also adopted similar nexus rules. Other states that have a factor presence nexus rule for their income tax (or other business activity tax) include California, Colorado, Connecticut, Ohio, and Washington.
For years, state tax practitioners would typically advise their clients that they did not have an income tax filing obligation in a state unless they had a physical presence in the state. Thus, the fact that a state applied a destination-based sourcing rule for sales of services was irrelevant because the business did not have the requisite nexus with the state to have a filing obligation. Under a factor presence nexus rule, sourcing is front and center. An out-of-state business will have a filing obligation in the state by merely making sales to customers in the state. Service providers should pay close attention to this trend, as states that adopt a factor presence nexus rule typically change their rules to consider a sale of a service to be an in-state sale when the customer is located in the state. Thus, the location from which the service is performed is largely irrelevant in determining if the business has a filing obligation in the state. The result is that companies with very small physical footprints could have a much larger tax compliance footprint.
While the list of states imposing a more aggressive factor presence nexus rule is still relatively small, the fact that three states have enacted such a rule in the last year suggest that more will follow suit. Service providers should know where their large customer bases are located, and monitor legislation in those states to ensure they are in compliance.
If you are interested in learning more about how states are taxing the new economy, please register for our upcoming webinar on August 25th.