Even in the days before the Internet, businesses operating across state lines had a hard time understanding their tax obligations. Most states collect some form of sales and/or use tax on transactions made within the state, provided that the vendor possesses substantial “nexus” with the state. That is, if a vendor has substantial enough business contacts in a particular state, it can be obligated to collect and remit sales taxes to that state’s government.
The rise of mail-order businesses, where buyers, sellers, distributors and other parties to a transaction could be located in different states, substantially complicated the issue of nexus. The rise of e-Commerce compounded these issues even further. Even as state governments began to realize that they were losing millions of dollars in tax revenue to sales made over the Internet, the Commerce Clause of the Constitution limited their ability to enforce collections across state lines.
Unfortunately, there is no single rule to determine when and where online vendors must collect sales taxes. State sales taxes are governed by a confusing patchwork of statutes and case law. Some states, such as Oregon and Delaware, have no state sales tax. Other states have attempted more ambitious sales taxes. Kansas, for example, enacted a law in 2004 imposing a tax on all goods sold into the state, regardless of where the sale took place. Many other states, including Ohio, only require out-of-state sellers with substantial nexus to collect and remit sales taxes.
The concept of nexus is generally defined by case law. Although the definition varies from state to state, a retailer with an office, employees, or a physical retail store in a particular state is typically considered to have nexus with that state. See Quill Corp. v. North Dakota 504, U.S. 298 (1992). Also relevant is the Internet Tax Freedom Act (ITFA), which prohibits “multiple and discriminatory” taxes on online transactions. In the context of online retailing, the ITFA ensures that vendors cannot be obligated to remit sales taxes to more than one state for a single transaction.
Beyond these few matters, however, the definition of nexus becomes much less distinct. Utilizing a web server in a particular state may or may not establish nexus in a state, sometimes depending on whether or not the company also fills orders in that state. Some state codes also define and tax services differently from goods, and intangible goods differently from tangible goods. Further difficulties arise from the fact that online, consumers can often choose to conceal or misrepresent their physical location.
Legislators, as well as efforts such as the Streamlined Sales Tax Project (SSTP), have had some success in making sales and use taxes simpler and more uniform among the states. However, it is unlikely that these difficulties will be resolved definitively in the near future. For smaller online retailers grappling with this issue, it is probably best to seek out the advice of a qualified tax professional.