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Should You Collect State Taxes For That Online Sale?

In July, the U.S. House of Representatives passed a bill that would extend the 15-year-old federal moratorium on internet-access taxes, which is set to expire on November 1, 2014.  The focus now turns to the Senate.  As part of the debate, some senators want to add legislation that allows states to collect taxes from online sales to any extension of the moratorium on internet-access taxes.

With Congress potentially focusing its attention on taxes and online sales, now is a good time to review the tax implications for selling goods over the internet.  We'll start by posing a hypothetical.

You are a company that is headquartered in Pennsylvania, makes its products in Pennsylvania, and ships those products from Pennsylvania.  But you sell your products online to customers in all 50 states.   Do you have to collect state sales taxes in each one of those states?

In short, no.

Thanks to a 1992 ruling by the Supreme Court, you only need to collect sales taxes in those states where you have a "substantial nexus."  

What constitutes a "substantial nexus"?  

Often times, it requires you to have a physical presence in the state.  If you have a distribution facility or a sales representative in a particular state, then you are likely to have a substantial nexus.  If your only connection to a state is the fact that one of the state's residents purchased your products online, then you do not have a substantial nexus.  In our hypothetical above, you would only collect Pennsylvania state sales taxes .

Many states and municipalities have complained about the decline in tax revenue that has resulted from residents purchasing goods via the internet and avoiding state sales tax.  Despite these concerns, Congress and the Supreme Court have yet to respond, either by permitting states to collect online taxes beyond a "substantial nexus" or by implementing a federal online sales tax.

Some states have taken it upon themselves to make up for the decline in revenue by passing "Affiliate Taxes," also known as "Amazon Taxes."  We'll cover those laws in a later ETT.  Until then, know that you only have to collect state sales tax for online sales in those states where you have a substantial nexus.

If you want to know whether you have a "substantial nexus" with a state or if you have questions about online sales and taxes in general, contact a member of our Emerging Technologies or Tax Practice Groups.