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Marketplace Fairness: Small Seller Exception Definitional Flaws

author photo of Annette Nellen

Since at least 1994, Congress has proposed to change the result of the Quill decision to allow states to require remote (non-present) sellers to collect sales tax from customers in their state (such as S. 1825 (103rd Congress) and S. 545 (104th Congress)). In recent years, a few hearings have been held and there has been a lot of debate among vendor and state government groups on various aspects of this issue.

Basically, the competing arguments on this topic of whether states should be able to make remote vendors collect sales tax are:

  • Main Street Vendors – all vendors should have to collect sales tax in order to level the playing field among all retailer such that sales tax is charged on all taxable sales, whether purchased in-store or online.
  • Internet Vendors – remote vendors should not have to college sales tax in states where they do not have a physical presence due to the costs of doing so, the harm that will ensure to e-commerce, and because states can find other ways to collect the tax owed on the sales.

S. 743, H.R. 684 and S. 336 (113th Congress) are the current versions of the Marketplace Fairness proposals of the 113th Congress. S. 743 has been in the spotlight because on May 6, 2013, the Senate passed it by a vote of 69-27.

While there are many aspects of this legislation that can be analyzed, I'm going to focus on the small seller exception. This exception is worded as follows in S. 1832:

(c) Small Seller Exception- A State is authorized to require a remote seller to collect sales and use taxes under this Act only if the remote seller has gross annual receipts in total remote sales in the United States in the preceding calendar year exceeding $1,000,000. For purposes of determining whether the threshold in this section is met, the gross annual receipts from remote sales of 2 or more persons shall be aggregated if--

(1) such persons are related to the remote seller within the meaning of subsections (b) and (c) of section 267 or section 707(b)(1) of the Internal Revenue Code of 1986; or

(2) such persons have 1 or more ownership relationships and such relationships were designed with a principal purpose of avoiding the application of these rules.

This language is similar to that of S. 1832 (112th Congress), except that the threshold in S. 1832 was $500,000 rather than $1,000,000.

In contrast, the language of H.R. 3179 (112th Congress) is slightly different in that it had two thresholds. As described in H.R. 3179:

(1) SMALL SELLER EXCEPTION- An exception for remote sellers with gross annual receipts in the preceding calendar year from remote sales of items, services, and other products in the United States not exceeding $1,000,000 (or such greater amount as determined by the State involved) or in the State not exceeding $100,000 (or such greater amount as determined by the State).

What is the right size and description for a small seller exception?

That is a question that will likely delay any possible enactment of this legislation until it is resolved. I think the H.R. 3179 definition is better than that of S. 743 in terms of truly helping small businesses avoid numerous compliance challenges.  Let me go through some examples to illustrate the problem and help point out a solution to alleviate compliance complexities for small businesses (and to prevent them from shutting down some sales to avoid compliance difficulties and costs).

Example 1: Fashion Galore (FG) is located in San Jose, California. It is a retail store with physical property and employees only in California. A few years ago, it started selling online and has sold to people in all 50 states. Sales in the store are about $1,200,000 per year. Sales online are about $800,000. Because its remote sales (in states where it does not have nexus) do not exceed $1 million, under both S. 743 and H.R. 3179, FG only has to collect sales tax in California.

Example 2: Same as Example 1, but last year, FG's remote/online sales totaled $1,200,000 and it had sales in all states. Other than Hawaii, the total online sales in all states did not exceed $100,000. Under S. 743, FG must now collect sales tax in all 50 states. Under S. 3179, FG must collect sales tax in California and Hawaii.

Now, here is an oddity of S. 743: Assume FG's sales in Hawaii were $250,000. If FG creates nexus in Hawaii, those sales are no longer "remote" and FG continues to use the small business exception and only has to collect in California and Hawaii. Of course, other states may challenge FG's nexus in Hawaii.

Example 3: Super Furniture, Inc. (SFI) has several retails stores in Arizona. Sales at its retail stores usually total over $50 million.  SFI has online sales in about 3 states that total $900,000. SFI does not have nexus in those states. As long as SFI's sales in states in which it does not have sales tax nexus do not exceed $1 million, it only has to collect sales tax from Arizona customers. Thus, even though SFI is a large company and likely quite capable of collecting sales tax in the three states where it has online sales, it does not have to (until those sales exceed $1 million). Contrast this to FG in the earlier example, where its total sales of under $3 million could subject it to sales tax collection in all states (unless it plans around the rule to limit its exposure).

These outcomes seem odd to me. I think a vendor's total size has to be factored in because that size has a bearing on how much compliance costs it can reasonably handle. For example, the small business exception should provide that if a vendor has total sales everywhere of less than $X, it does not have to collect in states where it has remote sales. Perhaps X should be $2 million.  What do you think?

Think of all the online vendors with sales under $1 million and under my modified small seller exception of $2 million. Certainly, states will need to continue to educate their citizens and in-state companies of their use tax obligations and find ways to increase use tax compliance. [For some ideas on that, please see my paper presented to California legislative and tax agency staff in February 2013, which is similar to testimony I presented (by phone) in October 2012 to the Vermont legislature's Sales and Use Tax Study Committee.]

The small seller exception is just one of several issues to be resolved before there is any likelihood of Marketplace Fairness legislation reaching President Obama's desk. Sylvia Dion covers a few more in her May 10, 2013 post. Also, Congressman Goodlatte, Chair of the House Judiciary Committee, has expressed concerns that S. 743 was not properly vetted in the Senate because it skipped the committee with subject matter expertise (apparently he means the Senate Finance Committee as the Senate doesn't have a Judiciary Committee). He also believes the proposal is not simple enough yet (statement of 5/6/13). The House Judiciary Committee has jurisdiction over this legislation in the House and has held a few hearings in the past.

What do you think? How should the small seller exception be worded? What should the definition and dollar amounts be? Why?

Other recent “Sales Tax Policy - Tales & Trends” posts by Annette Nellen, CPA, ESQ:

NOTE: All blog content, comments, and participation subject to disclaimer at bottom of page.


1 Responses to Marketplace Fairness: Small Seller Exception Definitional Flaws

  • Posted by Todd on June 28, 2013 2:03pm:

    Creating an enormous frankenstein that will be used as a vehicle to destroy nexus rules and laws regarding income and franchise tax is great for taxing jusridictions, especially those that are spending hungry and cash strapped. It is destructive to states where businesses are located that will suddenly have their taxpayers' incomes impacted, which will affect hiring, pay and tax revenues in those states. MFA will also accelerate the departure of internet sellers from these shores. If the aim is really to capture sales and use taxes, it would be simpler to require internet sellers to report to states in the same manner they report Form 1099's: name, address, amounts, with copies to both jurisdiction and buyer. The buyer would then be required to respond in his/her state tax return, either paying at that time or providing proof that taxes had already been remitted. No complicated structure, no perversion of nexus.

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