sales and use tax liability
Key Tax Considerations for New Business Owners
DISCLAIMER. This is not legal or tax advice. Speak to counsel.’
Table of Contents
Tax Liability 2
Legal Liability 2
Income Tax and your LLC. 3
Step 1: Are you a US person or a foreign person?. 3
Step #2 Determine your entity classification. 3
Sales Tax Liability for Remote Sellers (FBA/Drop Shippers) 4
Table of Sales Tax Models. 4
Are you at risk? The following questions will help you determine when and where sales tax is owed, and whether or not a reseller certificate should be submitted. 5
The New York Question. 5
Multi-state transactions sales and use taxes 7
Who has a duty to collect and pay sales and use taxes?. 7
Sales and Use Tax Registration. 7
As a business registered in, operating in, or selling to Americans, you’ve got two pressing considerations: Tax Liability and Legal Liability. Outside of having no sales, these risks are the #1 killers of small business. We’ll walk you through key considerations that you should discuss with legal counsel.
You have the power to decide how you want to be taxed and there are also things that you can do to help reduce, or even eliminate, the tax that you pay.
The Internal Revenue Service (IRS) is responsible for collecting federal income tax revenues and enforcing federal income tax laws. In addition to the federal income tax, each of the 50 states and the District of Columbia impose some or all of the following: individual income tax, corporate income tax, sales tax, real estate transfer tax, gross margin tax, and franchise tax.
You likely established a US business in one of a few states.
Most states have a corporate income tax that works in conjunction with federal income tax law, and those taxes are generally lower than the federal income tax. However, sales and other taxes imposed by states and localities can vary greatly and may play an important role in determining how an investment should be structured.
As a business owner, one of your biggest dangers is a lawsuit. Even if you could win, your priority should be avoiding this at all costs. The next best thing to avoiding lawsuits, is to make sure that if you are sued, you don’t lose absolutely everything that you own.
Income Tax and your LLC
If your US pass-through entity generates revenue from sales inside and outside the US. You may have income tax and sales tax obligations. Here’s a two-step process to assess your exposure at the federal tax level.
Step 1: Are you a US person or a foreign person?
| United States person
|· A citizen or resident of the United States
· A domestic partnership
· A domestic corporation
· Any estate other than a foreign estate
· Any trust if:
· A court within the United States is able to exercise primary supervision over the administration of the trust, and
· One or more United States persons have the authority to control all substantial decisions of the trust
· Any other person that is not a foreign person.
|A foreign/Non-US person
|· Nonresident alien individual
· Foreign corporation
· Foreign partnership
· Foreign trust
· A foreign estate
· Any other person that is not a U.S. person
· Generally, the U.S. branch of a foreign corporation or partnership is treated as a foreign person
Step #2 Determine your entity classification.
Generally, a US business entity will have one of the following default classifications:
- A “C” corporation. All US corporations are “C” corporations by default.
- A partnership. These are non-corporate business entities with more than one owner.
- A disregarded entity. These are non-corporate business entities with one owner, such as single-member limited liability companies (LLCs).
Generally, non-US persons and non-residents are taxable only on their US source income. If you have a pass-through entity, such as an LLC, you’ll have to arrive at adjusted gross income by starting with gross income, subtract certain deductions, such as trade or business expenses, and unreimbursed business expenses, for taxable income.
Sales Tax Liability for Remote Sellers (FBA/Drop Shippers)
Many states are attempting to tax the popular Fulfillment by Amazon (FBA) and drop shipping business model. Used by remote/online sellers (i.e. retailers that sell over the internet) by enacting sales tax laws that have become known as the “Amazon Laws” or “Click-Through Nexus” provisions.
Table of Sales Tax Models.
|Type of Law
||Require a remote/online seller to collect sales tax from customers located in a state if the seller has an association with any of its in-state marketing affiliates with links or ads through which customers buy from the seller’s online store.
|Affiliated/Related Party Nexus
||Creates a nexus in a state if the remote/online seller uses a subsidiary or some other commonly owned members of its group to perform in-state services in connection with the retailer’s sale of tangible personal property; owns or leases a storage or distribution center or warehouse in the state; uses common trademarks or any activities that enhance the remote/online sellers’ sales position in the state.
Remote/online seller collects sales tax
||Requires the remote/online seller to report their sales transactions to the state’s tax authority and notify their in-state customers about their responsibility to pay use tax.
For smaller businesses, the myriad of differing regulations carries a very high risk of sales tax errors; sales tax errors lead to more aggressive audits and expensive fines and penalties. Moreover, this scenario is expected to get worse before it gets better if a federal proposal to allow states to require out-of-state sellers to collect sales tax becomes law. Under the Marketplace Fairness Act, states that don’t currently require out of state manufacturers, distributors, wholesalers, or drop shippers to collect sales tax would likely begin to.
Are you at risk? The following questions will help you determine when and where sales tax is owed, and whether or not a reseller certificate should be submitted.
1) In a drop shipping scenario, when is there a sales or use tax obligation?
2) Do states consider drop-shipping a nexus-creating activity?
3) Do you have a valid resale certificate?
Generally, businesses must have a nexus to the state to be liable for sales and use tax. However, the definition of nexus isn’t clear cut. Let’s take a look at New York for example.
The New York Question
As an attorney that practiced litigation in New York, I was in my element when the question of liability turned on the “substantial nexus” issue. An out-of-state seller must have substantial nexus with New York before it can be required to collect sales tax. Although New York’s standard requires that some amount of physical presence is required to establish substantial nexus, some New York courts have interpreted that standard so liberally that virtually any form of physical presence within New York, combined with sales within New York, can create nexus for an out-of-state seller.
Activities that could give rise to substantial nexus with New York include:
Maintaining a place of business within New York, either directly or through a subsidiary, including:
- a distribution center;
- a credit and collection office; or
- an administrative office; (20 NYCRR § 526.10(a)(2).)
- Soliciting business through employees, independent contractors, agents, or other representatives.
Distributing catalogues or other advertising material in New York if combined with additional connections, including:
- the presence of employees, sales representatives, independent contractors, or agents in New York;
- the maintenance of a post office box in New York to receive orders relating to the catalogue or advertising;
- the maintenance of an office in New York even if not connected with the sales being solicited; or
- regularly and systematically soliciting business within New York through these materials.
- Participating in trade shows, even sporadically.
- Maintaining inventory or other tangible personal property in New York.
Out-of-state sellers with no physical presence in New York are considered to have substantial nexus with New York if the seller either:
- Maintains links on websites maintained by New York residents and pays commissions on sales made by those links unless the seller proves the in-state company engaged in no active solicitation other than hosting the out-of-state company’s link on its own website (Y. Tax Law § 1101(b)(8)(vi)).
- Has an affiliate that conducts activities in New York and:
- the out-of-state seller uses the same trademark, service mark, or trade name in New York as that used in New York by the in-state affiliate; or
- the in-state affiliate engages in sufficient activities in New York that benefit the out-of-state affiliate in developing and maintaining a market in New York.
To determine whether your activities might have a nexus, contact counsel at email@example.com
Multi-state transactions sales and use taxes
Under New York’s law, out-of-state sellers with no physical presence in New York (for example, internet-based retailers) are presumed to have sales tax nexus with the state if they both:
- Maintain links on websites maintained by New York residents.
- Pay commissions on sales made through those links.
- New York has also adopted criteria by which an out-of-state seller with no physical presence itself can become subject to sales tax collection obligations because of the in-state activities of a separate but affiliated company.
Who has a duty to collect and pay sales and use taxes?
Both the sales and use taxes are ultimately imposed on the purchaser. However, a vendor who makes sales of tangible personal property or taxable services within New York and has the requisite nexus must collect the sales tax from the purchaser at the time of the sale unless the purchaser presents documentation of a valid exemption.
- If salestax has not been paid on a taxable transaction, New York can assess the vendor or the purchaser for unpaid sales tax,
Sales and Use Tax Registration
A vendor must obtain a certificate of registration from New York before commencing sales if it both:
- Sells tangible items (clothing, electronics, etc.) in New York
- Has sufficient nexus with the state.
A vendor registers with the New York Department of Taxation and Finance within 20 days of commencing business or making sales. Thanks for Avalara for some of the content.
DISCLAIMER. This is not legal or tax advice. Speak to counsel.’
Learn more @ Scotch & Palm Private Client Law Group
 The laws governing the imposition of the federal income tax are generally found in the Internal Revenue Code of 1986, as amended (1986 IRC), which is located in Title 26 of the US Code. In addition to the 1986 IRC, sources of law include the regulations promulgated by the Department of Treasury interpreting the 1986 IRC, rulings interpreting the 1986 IRC and case law.
 New York provides a special exemption for out-of-state sellers whose presence in New York is limited to the use of an in-state fulfillment service to handle inventory and shipping, even if inventory is stored at that location. These sellers are not required to register as vendors in New York unless the fulfillment service is affiliated by ownership with the out-of-state company (N.Y. Tax Law § 1101(b)(8)(v)