How to Avoid the Grinch This Holiday Season: Five Common State and Local Tax Pitfalls
Many states place the unwelcome burden of sales and use tax collection on retailers, who end up bearing the risk and cost associated with mistakes in administering the tax. In recent years, plaintiff lawyers have joined the states in monitoring retailers' tax collection policies. Thus, a retailer's good faith effort to collect state tax can easily turn into a tax assessment or a lawsuit alleging violations of consumer protection or other state law. Before the Grinch steals your holiday cheer, consider the following handful of common problems or pitfalls:
As most retailers know, Internet, mail order or other remote sales are not exempt from sales or use taxes. The only issue is whether the retailer can be required to collect and remit tax on those sales on behalf of the state of the customer. If not, the consumer remains liable for self-reporting the sale or use tax (although few do so). The principal limitation on the power of states to require sales or use tax collection is the "substantial nexus" requirement of the Commerce Clause. Quill Corp. v. North Dakota, 504 U.S. 298, 315 (1992). For sales/use tax collection purposes, "substantial nexus" requires that the retailer have a physical presence in the taxing state. The retailer's physical presence does not need to be "substantial" but must be more than de minimis. Retailers can establish such a nexus in a variety of ways, including the presence of retail stores, the maintenance of inventory, delivery in the retailer's vehicles, or the presence of employees or independent contractors who help the retailer establish and maintain sales in the state (e.g., sales representatives, installers, or repair people).
The price of being wrong about nexus can be steep. Retailers are liable for any sales/use tax that they fail to collect from customers as a result of their erroneous conclusions that they do not have the required nexus. While state law generally allows retailers to collect such taxes from their customers, most retailers end up absorbing the tax because of administrative or customer relations issues associated with seeking repayment from customers. In addition, plaintiff lawyers in a few states have filed false claim/whistleblower lawsuits on behalf of the states alleging that retailers have nexus with the taxing states and failed to collect tax. Retailers who wish to avoid sales/use tax collection on remote sales should engage in careful "nexus planning".
One of the biggest difficulties for retailers is sorting through the hundreds of different sales/use tax exemptions that exist in different jurisdictions. Some exemptions relate to the product being sold (e.g., food or clothing); other exemptions relate to the buyer (e.g., a nonresident, a nonprofit, etc.). Retailers need to take special care in maintaining appropriate records to document exempt sales. Many states require that retailers maintain records documenting exemptions. Retailers are occasionally targeted by individuals claiming exemptions that do not exist (e.g., sales to a Native American customer outside the customer's tribal reservation).
TAXATION OF WARRANTIES
The taxation of warranties varies widely among states. Most states impose sales tax on warranties that are included in the selling price of the tangible personal property that is subject to the warranty. Many states also impose sales tax on sales of optional extended warranties. For example, California generally imposes sales tax on "mandatory" warranties (i.e., a warranty that is always sold with the product, whether or not it is separately stated) and does not tax "optional" warranties. Washington state, on the other hand, specifically taxes all sales of extended warranties, even when the sale of the goods subject to the extended warranty is exempt from sales tax. Retailers should take care to understand the taxation of warranties in the states in which they have nexus and make sales.
TAXATION OF SHIPPING AND HANDLING
As with extended warranties, the taxation of shipping and handling charges varies by state. Washington state imposes sales tax on shipping, handling, and other "delivery charges" that are made in conjunction with a taxable sale. Delivery charges incurred after the customer takes delivery of the goods are not subject to sales tax if the seller is not liable for payment of the delivery charges. In contrast, California taxes "handling" charges but does not tax separately stated shipping charges provided the delivery is not made directly by the retailer (i.e., delivery is by U.S. Mail or a third party contract or common carrier).
GROSS RECEIPTS TAX PASS-THROUGH
Jurisdictions that impose gross receipts taxes generally impose the tax on the seller rather than the customer. For example, Washington law explicitly states that its business and occupation tax is intended to be part of the seller's overhead and not a tax on the customer. However, with the Department of Revenue's blessing, many retailers chose to increase the selling price of goods and services to include a separate itemized charge to the customer for the seller's B&O tax. A relatively recent class action lawsuit challenged a retail car dealer's practice of contractually passing its B&O tax cost on to its customers. In a surprising decision, the Washington Court of Appeals affirmed a trial court decision certifying a class action lawsuit against the dealer and concluding that Washington law prohibited the dealer's practice of itemizing and collecting B&O tax from customers. Nelson v. Appleway Chevrolet, Inc., 129 Wn. App. 927, 121 P.3d 95 (2005). The Washington Supreme Court is currently considering an appeal of this decision.
We hope this update is helpful and that you have a prosperous and successful holiday sales season. Happy Holidays!