Many companies that sell their products through online marketplaces struggle to determine when and in which states they must collect and remit sales tax. Forty-five states have a sales tax, and companies that sell products to customers within these states are required to collect sales tax on those sales if the company has a “nexus” with the state where the customer lives.
The United States Constitution and state laws determine what constitutes a nexus, and though these laws are slightly different in every state, they all hold that virtually any type of physical presence by the company in the state creates a nexus giving rise to sales tax obligations. Critically, these states also hold that nexus exists merely if some of a company’s products are stored within the state in warehouses owned by a third-party fulfillment provider that facilitates the company’s online sales, even if the company itself has no employees or offices within the state.
This has serious consequences for companies that sell products online with third-party fulfillment providers because these companies often do not know and have no control over where their inventory is stored by the fulfillment provider. Ignorance (whether willful or not) is no defense, however, and states will investigate and audit companies that they believe may have a nexus with the state but are not remitting sales tax. If a state determines that a company should have been remitting sales tax (but has not done so), it will calculate what the company should have remitted over a period of years and require the company to pay the state that balance even though the company never collected sales tax from customers. States will also impose penalties and charge interest on these back taxes, and the resulting cost to the company (especially if multiple states determine that the company should have been remitting sales taxes) can be catastrophic.
To avoid this risk, companies sometimes enter into “voluntary disclosure agreements” with states where the companies believe they may have considerable back taxes. A voluntary disclosure agreement (VDA) is a compromise in which a taxpayer agrees to register with the state to collect and remit sales tax (and/or other taxes) in the future, and the state, in turn, agrees to waive some of the past-accrued taxes the taxpayer failed to pay to the state before entering into the agreement. As a condition of these agreements, states will ordinarily still calculate and require the taxpayer to pay taxes that accrued for a certain period of time before execution of the agreement, but this “look-back period” (as it is called) is always less than the period of time the state could calculate back taxes for if the taxpayer did not enter into a VDA. Thus, the state benefits by collecting some of the taxes the taxpayer should have paid during prior tax periods and by knowing the taxpayer will pay taxes in the future, while the taxpayer benefits by not having to pay the full amount of back taxes it would have to pay if it were audited by the state with no VDA.
Current Amnesty Program
Whether a company chooses to pursue VDAs is a business decision that has various pros and cons, which are discussed more below. For companies that sell products online with third-party fulfillment providers, however, many states (and the District of Columbia) are currently offering an unusually good deal to these companies if they enter into VDAs between August 17, 2017 and October 17, 2017.
This deal is being offered through the Multistate Tax Commission’s “Online Marketplace Seller Voluntary Disclosure Initiative.” The MTC is an intergovernmental state tax agency that, among other services, helps coordinate VDAs between states and taxpayers. Under the Initiative, taxpayers that complete an application and then enter into VDAs with participating states by October 17 will generally have all of their past tax liabilities waived, with no look-back period used by the state to calculate and collect back taxes. Taxpayers may also choose to pursue VDAs with any number of the participating states, which are Alabama, Arkansas, Colorado, Connecticut, Florida, Idaho, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Minnesota, Missouri, Nebraska, New Jersey, North Carolina, Oklahoma, South Dakota, Tennessee, Texas, Utah, Vermont, and Wisconsin.
There are many details of the Initiative that restrict who can participate and which may otherwise affect a company’s decision to participate. First, a taxpayer may participate only if it “is an online marketplace seller using a marketplace provider/facilitator … to facilitate retail sales into the state and represents that it does not have any nexus-creating contacts in the state, except for the online marketplace seller’s inventory stored in a third-party warehouse or fulfillment center located in the state or other nexus-creating activities performed by the marketplace provider/facilitator on behalf of the online marketplace seller in the state.” Second, taxpayers must choose whether they will register to pay sales/use tax, income/franchise tax, or both, in return for the participating states’ agreement to waive the taxpayer’s back taxes for the type(s) of tax the taxpayer agrees to register to pay in the future. Third, taxpayers cannot apply for a VDA with a state participating in the Initiative if they have previously registered with that state to pay the type of tax they wish to have back taxes waived for, or if they have previously been contacted by that state about potential liability for the type of tax they wish to have back taxes waived for. Fourth, taxpayers must complete an application in which they have to provide, among other information, a good-faith estimate of the total back taxes they believe they owe over the past four calendar years (2013, 2014, 2015, and 2016) to each state with which they wish to enter into a VDA. Fifth, taxpayers that wish to waive past sales/use tax liabilities must begin collecting and remitting sales tax by December 1, 2017, and taxpayers that wish to waive past income/franchise tax liabilities must file an income tax return for tax year 2017. Finally, a few of the states that are participating in the Initiative have not agreed to waive all back taxes; these states will instead review applications on a case-by-case basis and determine whether they will use none, some, or all of their ordinary look-back periods.
These details create complications for companies that wish to take advantage of the Initiative. For example, although companies have the option of offering to register only to collect and remit sales/use tax and not to pay income/franchise tax, the MTC’s “Frequently Asked Questions” page for the Initiative warns that out-of-state companies that have inventory stored by a third-party fulfillment provider in the state generally have to pay income/franchise tax in addition to sales/use tax. As a result, a state may question and investigate a company that registers only to pay sales/use tax through a VDA entered into through the Initiative, and if the state determines that the company should have been paying income/franchise tax then the company’s back taxes of that type will not be waived by the VDA. Additionally, although the MTC stresses that the requirement of submitting a good-faith estimate of total back taxes for the last four calendar years is “primarily for tracking purposes” and will otherwise have no consequence for the taxpayer in the participating states that have agreed to entirely waive back taxes, preparing that good-faith estimate could be time-consuming and it is reasonable to suspect that states will use information they learn about estimated tax liabilities from prior years to identify taxpayers with large amounts of business to use in future tax collection efforts.
Despite these complications, there are procedural aspects of the Initiative that protect taxpayers and simplify the application process. Taxpayers submit completed applications to the MTC for as many of the participating states as they wish, and the MTC then prepares drafts of VDAs and submits them to the taxpayer for approval. If the taxpayer approves, the draft VDAs are sent to states and the states decide if they will sign the VDAs. If they do, the VDAs are returned to taxpayers who then have 30 days to either withdraw from the Initiative or to sign VDAs and register with states to begin collecting sales tax (these things must occur by December 1, 2017 or the VDA is void). Taxpayers are free to withdraw their applications to enter into VDAs at any time before they sign the final VDA signed by the state. Significantly, taxpayers are also permitted to submit applications anonymously, which is meant to remove fears that taxpayers will be at increased risk of being investigated by a state if they submit an application but then ultimately do not enter into a VDA.
When all of these factors are taken into consideration, it is not easy for a company that sells through online marketplaces to decide if it should pursue VDAs with any of the states participating in the Initiative. If a company believes it likely has (and has had for some time) a nexus with one or more of the participating states because its products have been stored in those states by third-party fulfillment providers, applying for a VDA through the Initiative could result in a significant savings as a result of the state not assessing back tax liabilities through its look-back period. Registering with these states to pay taxes could also quell fears that the company will one day be “caught” by the state and forced to pay a huge amount of back taxes, penalties, and interest. At the same time, however, companies may not have sold enough products to participating states (where they have a nexus) for it to be worthwhile to apply for a VDA. Although sales tax is a “pass through” tax that itself does not directly cost anything to the company (since the taxes the company remits to the state come from customers), it does take resources and employees’ time to make sure state taxes are properly collected and remitted once a state has registered to pay taxes in a new state. Accordingly, it may be wiser for these companies to not register with at least some states where they sell products and hope instead that they are never “caught” by those states, knowing that even if they are caught the cost will be less than it would take to register and begin managing new taxes. Several highly-populated states where many companies sell lots of products (such as California and New York) are also not participating in the Initiative, although Texas and Florida are participating.
The Vorys E-Commerce Group and Vorys State and Local Tax Group are available to answer questions about the Initiative and help you determine whether applying for voluntary disclosure agreements with participating states is a good decision for your business. For more information, please contact Tony Ehler by phone at 614.464.8282 or by email at firstname.lastname@example.org.
 Alaska, Delaware, Montana, New Hampshire and Oregon are the only states that do not have a sales tax.
 Colorado, Massachusetts, Minnesota, Nebraska and Wisconsin are participating but may not offer full amnesty.