There has been a marked increase in sales tax audit activity of remote sellers and marketplace facilitators in the years following the U.S. Supreme Court’s landmark decision in the Wayfair case. The court held in Wayfair that U.S. states may require businesses to collect and remit sales tax even if the business does not have an in-state physical presence. It appears that five years post-Wayfair—and even after many states have enacted economic nexus laws—many companies still are not adequately prepared to undergo an audit by the tax authorities.
Based on Avalara’s June 2023 survey of 1,000 U.S. and U.K. businesses, approximately 42% of respondents stated that they are not compliant with both economic nexus and marketplace facilitator laws. Reasons cited for noncompliance include limited resources dedicated to monthly compliance, lack of expertise and experience with sales tax issues, a misunderstanding of the applicable rules and policies and the introduction of mistakes during the automation process. Regardless of the reason, failure to comply with sales tax laws can be costly, as businesses and their owners can become personally responsible for uncollected sales tax, including interest and penalties that may add up to 40% of tax due, in addition to other civil and criminal penalties, depending on the circumstances. Noncompliant remote sellers and marketplace facilitators with sales in the U.S. should take steps to get ahead of the next audit notice and try to limit their financial exposure by being proactive.
Economic nexus following Wayfair
Today, 45 of the 50 U.S. states have economic nexus laws that require remote sellers to register and remit sales tax if their sales activity exceeds a certain threshold (i.e., volume of sales (e.g., USD 100,000) and/or transactions (e.g., 200)), generally measured within the previous or current year (for prior coverage, see the article in the March 2021 issue of Indirect Tax News). In addition, marketplace facilitator laws now enacted in the same states require facilitators (i.e., third-party entities that create physical or virtual marketplace platforms connecting sellers and buyers) to collect and remit sales tax and other indirect and excise taxes and fees on behalf of retailers selling through the platforms and that in certain states directly or indirectly process or collect the customer payments (for prior coverage, see the article in the October 2022 issue of Indirect Tax News).
A marketplace facilitator can also establish economic nexus with a state if it facilitates sales on behalf of one or more marketplace sellers or has its own sales of tangible personal property, products transferred electronically or provides services that exceed the established threshold. In monitoring economic thresholds, both remote sellers and marketplace facilitators need to account for sales conducted through third-party platforms and their own independent sales through their e-stores or platforms. Remote sellers and marketplace facilitators can also establish nexus through physical means such as the presence of employees, agents or independent contractors, having leased space or equipment, a warehouse, inventory or other property in the state.
New audit areas
A majority of the states introduced economic nexus rules for remote sellers and marketplace facilitators by 2020. The risk of audit is now elevated as states can review compliance for the full period under the statute of limitations, which matches the three-to-four-year period when economic nexus provisions became effective in most states. However, the statute of limitations does not begin to run for unregistered taxpayers that did not file sales tax returns, and in these cases, states may conduct audits from the time the taxpayer first had nexus with the state.
Taxpayer audits aim to accomplish several objectives, including:
- To verify whether remote sellers and marketplace facilitators accurately represented when they established nexus by requesting and reviewing historical sales data to determine whether the volume of sales or transactions was under the prescribed threshold levels. The authorities can review and match a company’s payroll records against sales tax registration to determine if a remote employee was working or visiting the state. Further, the authorities obtain data through third-party audits and investigations, which helps to verify and establish a timeframe of a company’s activities in the state, including the location of inventory in warehouses, supplier shipping information, customer purchase data and attendance at trade shows. Gaps in timing and compliance present risks for companies that chose to comply with economic nexus rules prospectively, rather than from the date the company first established physical or economic nexus with the state.
- To verify whether remote sellers collected and remitted sales tax on taxable sales outside the marketplace platforms and before marketplace facilitator laws became effective. Marketplace facilitator laws have later effective dates than economic nexus laws in around 27 states, creating a potential compliance gap, where the retailer, and not the facilitator, was responsible for sales tax collection and remittance. Certain states also attempted to impose collection obligations on marketplace facilitators before enactment of marketplace facilitator laws.
- To confirm whether marketplace facilitators are properly collecting sales tax on taxable sales through their platforms, as well as applicable state gross receipts taxes, excises taxes and fees. States broadly define the scope of what constitutes a marketplace facilitator and a marketplace and apply the definitions to businesses that in a traditional sense would not consider themselves creating an infrastructure where third parties engage in transactions. In certain jurisdictions, such as Arkansas and the District of Columbia, the receipt of consideration is not required for the marketplace facilitator rules to apply.
- To examine whether remote resellers can issue valid exemption certificates to drop-shipping suppliers and collect proper exemption documentation from customers, such as resale certificates (for prior coverage, see the article in the April 2023 issue of Indirect Tax News). Around 10 states require remote resellers to be registered for sales tax to issue a valid exemption certificate. If an exemption certificate is invalid or cannot be issued, a remote seller may have use tax exposure to the extent it directed vendors to drop-ship products to states where it is not registered, and the sale was not otherwise exempt from sales tax.
- To expand and test the application of sales tax laws to evolving technologies, catching unsuspecting remote sellers and marketplace facilitators off-guard. Sales tax laws often lag behind new technologies and do not provide precise guidance on their scope. Marketplace facilitators may also misunderstand products or services sold through their platform and improperly characterise their taxability.
- To review whether the characterisation of products and services and their taxability determinations are properly mapped in compliance software. Human error in taxability configurations in the software may occur, resulting in an incorrect percentage of tax or full tax charged on a certain product or service. Both remote sellers and marketplace facilitators can make these mistakes. Software that is not regularly maintained/updated to take account of changes in the law, including tax rates, becomes obsolete and leads to mistakes.
Liability considerations
States generally relieve marketplace facilitators from penalties for failure to collect and remit the correct amount of sales tax if the facilitator can demonstrate to the tax authorities that the failure was due to incorrect or insufficient information given to the facilitator by the marketplace seller. As part of the request for relief, marketplace facilitators may be required to demonstrate that they made a reasonable effort to obtain correct and sufficient information from the seller. This relief provision generally does not apply if the parties are affiliated or related.
The amount and scope of relief may be limited by state law (i.e., 5% of total sales), thus exposing the marketplace facilitator, seller and purchaser to liability for unremitted tax. If the marketplace facilitator is relieved of liability for sales tax, the seller and the purchaser may still become liable for any amount of uncollected, unpaid or unremitted tax.
BDO insights
Audits by the tax authorities are on the rise at a time when sales tax compliance is more challenging than ever. The challenges arise for various reasons, such as:
- The economic nexus laws in all U.S. states that impose sales tax (and which are not necessarily homogenous);
- Broadly defined and ambiguous taxability rules—especially in the technology and software sectors;
- Confusion about responsibilities for compliance among remote sellers and marketplace facilitators; and
- A lack of dedicated internal resources to assist companies with compliance.
Potentially affected companies should act promptly to get ahead of and address potential notices and new areas for audits by working with an experienced sales tax professional and reviewing the company’s nexus profile, the taxability of their products and services, documentation supporting exempt sales and adherence to compliance obligations. If tax exposure is found, the company should attempt to mitigate the risk through voluntary disclosure, taking advantage of a tax amnesty or using negotiated settlement programs that may limit the look-back period of tax liability (generally three to four years) and provide for a full abatement or reduction of penalties and interest.
Angela Acosta
Ilya Lipin
BDO in United States
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