I. What is sales tax?
Forty-five (45) states, plus the District of Columbia, impose a sales tax (only New Hampshire,Oregon, Montana, Alaska and Delaware do not). Within many of those jurisdictions, local governments have the authority to impose an additional sales tax, bringing the number of different taxing schemes in theUnited States to over seven thousand five hundred (7,500). In some states, the state collects the tax on behalf of its local jurisdictions. Often, however, the local governments manage their own tax collection responsibilities.
II. How do you know whether you are subject to tax in a state?
The first question to ask in determining whether a company is required to register in a state to collect and remit sales tax is whether the company has been actively engaged in its business within the taxing state to an extent sufficient to give the taxing state jurisdiction over it. This means an analysis of the "nexus", or connection, between the taxing state and the company. While the United States Constitution is the source of this restriction on the taxing authority's ability to require a company to remit that state's tax, the restriction has been interpreted more broadly by states in recent years.
A. Physical Presence.
Historically, the question of whether a minimum connection exists between the company and the taxing state has focused on the company's "physical presence" within that state. The easy case for the taxing authority is when a company has an actual permanent place of business (e.g., office or warehouse) within the state. Other examples of sufficient contact typically include the in-state presence of employees or independent contractors acting on the company's behalf. But how much time spent in a state constitutes sufficient nexus such that a taxing authority could impose the tax collection and remittance responsibility on the company?
The result is likely to be the same nationwide with regard to six visits per year. Once you get down to two or three, however, the answer seems to vary. Five years ago, the answer probably would have been no in most states, but states have become more expansive in recent years, with the result that any more than one day per year typically constitutes sufficient contact with a state so as to impose the tax responsibility on the company.
Another way in which the physical presence nexus analysis has become more expansive involves the type of activities taking place in the state. Originally, most (if not all) states only required the company to register as a vendor and to collect and remit the tax if its in-state agents were actually engaged in selling the company's product. In more recent years, however, many states have concluded that any activity that takes place in the state on behalf of the company, whether or not directly related to the sales process, will suffice.
B. No Physical Presence.
Many states have encouraged Congress to pass federal legislation that would impose sales tax on electronic commerce transactions. The Internet Tax Freedom Act (the "IFTA"), however, prohibits such taxation from happening, at least for now. The ITFA, which was passed in 1998, imposes a moratorium on the taxation of electronic commerce until November 1, 2007 . Some large national retailers, however, have begun to collect and remit sales tax on a voluntary basis in all states. The Streamlined Sales and Use Tax Act, which will be discussed below, would require most internet and catalog companies in participating states to collect and remit sales tax on sales made to customers in any participating state.
III. If you have nexus, what goods and services are taxable?
Sales tax is typically imposed on the sale of tangible personal property (unless specifically exempted or excluded) and certain specifically enumerated services. As a result, intangible property, as well as many services, are not subject to the tax. These lines of demarcation (tangible personal property versus intangible personal property; tangible personal property versus nontaxable services) are major sources of controversy in sales taxation.
A. Tangible personal property versus intangible personal property.
Tangible personal property that is subject to tax (barring some exemption or exclusion) includes various products, including but not limited to computers, books, toys, cards, etc. Intangible property, which is not subject to tax, includes (but is not limited to) products delivered solely by electronic means (e.g., a video game that is delivered solely via the internet and stocks, bonds, etc.). The line between the two types of property becomes blurred in cases such as sales of a motion picture film to a theater, where the film is conveyed via tangible property (the movie reels), but the value of what is sold is in the right, or license, to exhibit the film.
B. Services.
Typically, a state will not impose sales tax on services unless the services are specifically enumerated in the state's laws as being taxable. Examples of services that often are taxable include dry cleaning, custodial, security and landscaping services. Other services, such as legal, accounting, healthcare and construction services, are not taxed by most states. The controversy that often arises in this area is whether the "item" sold constitutes a service or tangible personal property. For example, if a company provides training seminars, the cost of which includes the attendees receiving written materials, is the charge for attending the seminar taxable? The answer in most states is likely to be no if one lump sum is charged. In that case, the "true object" of the sale is the provision of the training service, with the receipt of materials merely incidental to the true object. If, however, the seminar invoice contains two line items, one for the seminar and another for the materials, most states likely would expect sales tax to be charged on the materials (because they constitute tangible personal property), but not on the nontaxable service. In that case, the sale would be viewed as two-part, one taxable, one nontaxable.
C. Exceptions and exemptions from taxation.
The first obvious question in the area of exceptions and exemptions is why a company should care about the difference between the two, so long as the end result is that the sale is not taxable. The answer is that the burden of proof is different if the taxability were to be challenged. If a sale is not subject to tax because it is excluded from the tax, the burden is on the taxing jurisdiction to prove that the sale is taxable. If, however, the sale is not taxable due to an exemption from tax, the burden is on the taxpayer to prove that the sale is nontaxable.
1. Resale exemption/exclusion.
In order to avoid numerous sales of the same item from being taxed more than once, most states provide for an exemption from sales tax for sales made for resale (at least a few states deem this type of sale an exclusion (i.e., excluded from the definition of a "retail sale" that otherwise would be subject to the tax)). One very important requirement for a purchaser wishing to utilize this exemption/exclusion is that it must reasonably believe at the time of the sale that the item will be resold. The perfect example of this exemption/exclusion is the "middleman". When a manufacturer sells a product to a retailer, which in turn sells it to an end consumer, the sale from the manufacturer to the retailer is not subject to sales tax (provided that the retailer provides the manufacturer with a resale certificate that the manufacturer will keep in its records).
2. Manufacturing exemption/exclusion.
Many states also provide for an exemption or exclusion from sales tax for machinery, equipment, parts and materials used in a manufacturing process. The sale of the final product is likely to be taxable to its ultimate consumer, so the taxing authorities still receive their tax on the item at some point in the sale process.
3. Sales to exempt organizations.
Certain non-profit organizations are often exempt from sales tax when purchasing items for use in their non-profit mission. These organizations typically have tax-exempt identification numbers issued by the taxing jurisdiction, and sellers should obtain the numbers when making sales to these types of organizations.
4. Miscellaneous exemptions.
Many states also exempt from sales tax specific types of items, such as medical supplies, water and certain foods. Additionally, often exempt from tax are certain types of transactions, such as "occasional sales". While state laws vary widely on this topic, the typical scenario is one in which a company is selling all or substantially all of its assets. Many states provide that such a sale is exempt from sales tax as an "occasional sale".
IV. How will the Streamlined Sales and Use Tax Act impact you?
The dramatic growth of interstate sales in recent years has led to a cooperative effort by many states to slow the loss of sales tax revenues based on the increased use of catalog and internet sales. This effort is the Streamlined Sales Tax Project, which has resulted in the Streamlined Sales and Use Tax Act and its companion Streamlined Sales and Use Tax Agreement. By its own terms, the fundamental purpose of the Act is to "simplify and modernize sales and use tax administration in the member states in order to substantially reduce the burden of tax compliance." The member states, which currently consist of forty-one (41) states and the District of Columbia, have focused on the following areas of administration:
The Streamlined Sales and Use Tax Agreement, which was implemented by the member states, came into effect on October 1, 2005. Only those member states that have conformed their state law to the requirements of the Agreement (the "full member states") continue to have primary control over the Agreement's administration.
Sellers wishing to volunteer to collect and remit tax under the Agreement (and receive amnesty for uncollected or unpaid sales and/or use tax) can register to do so. Once registered, the seller is required to collect and remit tax for full member states. As of October 1, 2005, the full member states were Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota andWest Virginia. Sellers also can, but are not required to, collect and remit tax in the other member states (which will only become full member states upon sufficient compliance with the Agreement).
V. So what's the answer?
The answer, unfortunately, is that there is no one answer. Because individual state laws can vary so greatly (at least unless/until the Streamlined Sales and Use Tax Act and Agreement are applicable to all states), companies are wise to conduct research in the states in which they believe they might be subject to tax. In each case, both nexus and taxability inquiries should be made, as both affect the answer to the question of whether sales tax is due.