Sales-and-use-tax nexus in the internet age: What’s a retailer to do?

By Donna Scaffidi, CPA, Milwaukee, and Dana Delsman, CPA, Appleton, Wis.

Editor: Mark Heroux, J.D.

Since the U.S. Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), physical presence has been required for states to assert nexus for sales-and-use-tax purposes. Under Quill,states cannot require sellers to collect and remit a state's sales and use tax without first having some in-state physical presence, whether from employees, independent agents, or property within the state.

In the 25 years since the Quill decision, the way consumers shop has changed significantly from brick-and-mortar stores to online marketplaces. According to a May 16, 2017, release by the U.S. Census Bureau, retail e-commerce sales (adjusted for seasonal variation) for the first quarter of 2017 were $105.7 billion, an increase of 4.1% from the fourth quarter of 2016. In recent months, large retailers such as Walmart and PetSmart have acquired e-commerce retailers in what one assumes is an attempt to capture revenue from consumers' online shopping habits.

While consumers are buying online, states continue to cry foul. They have lost their patience waiting for Quill to be overturned or for Congress to pass remote-seller legislation. Many consider Quill outdated. According to the National Conference of State Legislatures, states lost an estimated $26 billion in 2015 from the inability to collect sales taxes from online and catalog sales. As that revenue loss gets larger, states have gotten creative and taken matters into their own hands in an attempt to collect this lost tax revenue.

The U.S. Supreme Court has the final say when it comes to interpreting taxation as it applies to interstate commerce, which means Quill is still a valid decision. However, what is a retailer to do when it lacks physical presence in a state but the state has enacted laws contrary to the Supreme Court's mandate?

It all started back in 2008 when New York enacted "click-through" nexus. New York broadened the definition of a vendor to include sellers that, per an agreement, pay residents of New York for referring potential customers via a website or other means. Nexus is presumed to exist for sellers with more than $10,000 of sales to New York customers made through such referrals in the prior four quarters. The New York standard quickly became known as "Amazon" nexus. Approximately 22 states currently have click-through or Amazon nexus laws or administrative pronouncements.

In 2010, Colorado passed legislation mandating notification requirements for certain retailers without nexus. After a seven-year battle with the Direct Marketing Association (DMA), Colorado emerged as the victor (Direct Marketing Ass'n v. Brohl, No. 12-1175 (10th Cir. 2/22/16), cert. denied, No. 16-267 (U.S. 12/12/16)). Effective July 1, 2017, Colorado requires out-of-state sellers with in-state annual revenue of at least $100,000 to report information to the Department of Revenue about consumer purchases as well as notify the consumer that use tax may be owed. Alabama, Louisiana, Oklahoma, South Dakota, and Vermont are just a few other states with notification requirements.

States also added to their arsenal by passing "affiliate" nexus laws, which are aimed at the dot-com subsidiaries of large, national retailers set up to avoid state sales tax collection obligations. Nexus is deemed to exist when certain factors are present, e.g., common ownership, shared trademarks or trade names, intercompany marketing, or administrative services.

The Connecticut Department of Revenue Services recently issued demand letters to numerous remote sellers requiring them to either (1) provide electronic data for all sales to individuals with Connecticut addresses for the prior three calendar years or (2) register to collect and remit Connecticut sales and use taxes.

On June 28, 2017, the Massachusetts Department of Revenue issued Directive 17-2, which revokes the requirement for internet sellers to collect Massachusetts sales or use tax as previously outlined in Directive 17-1, which the department had issued April 3, 2017. However, the directive notes that the department anticipates proposing regulations that, if adopted, would require large internet vendors to collect Massachusetts sales and use tax on a prospective basis under standards similar to those described in Directive 17-1.

States waited anxiously for a resolution of Colorado's battle with DMA, and, after the failure of the federal government to pass the Marketplace Fairness Act of 2013 (S. 743; H.R. 684), they could wait no longer. States began to enact "economic nexus" standards. Alabama, Indiana, North Dakota, South Dakota, Tennessee, Vermont, and Wyoming are a few of the states that are outright ignoring Quill in passing legislation or regulations that require no physical presence to create nexus for sales and use tax. Instead, these states are asserting nexus when retailers make in-state sales over a predetermined dollar or transaction threshold.

These statutes are a plain invitation for legal challenges from taxpayers, with the goal of eventually overturning Quill in the U.S. Supreme Court. Both Alabama and South Dakota are hopeful their laws are fast-tracked to the Court. The South Dakota case against Wayfair Inc. and other litigants appears to be the furthest along. A South Dakota Circuit Court recently ruled the state's economic nexus law (S.D. Codified Laws §10-64) is unconstitutional (South Dakota v. Wayfair Inc., No. 32CIV16-000092 (S.D. Cir. Ct. 3/6/17)). However, the state has appealed the circuit court decision to South Dakota's Supreme Court, which must review the case "as expeditiously as possible" (S.D. Codified Laws §10-64-5). The next step would lead directly to the U.S. Supreme Court—if the justices choose to consider the case.

As sellers have been busy strategically defining what it means to be a competitive retailer in the era of e-commerce, states are redefining their "doing business" regulations and statutes to include a broader base of taxpayers that only use a distribution facility or possibly a drop shipper in a state.

Oklahoma is one such example. Effective in late 2016, the Oklahoma legislature reworded its statutory definition of "maintaining a place of business in this state" for purposes of creating nexus (Okla. Stat. tit. 68, §1352.13.a.(1)(a)). Prior to the revision, the definition included the words "having or maintaining" physical business locations, a standard that would generally be met by traditional brick-and-mortar stores.

The 2016 revision contains the language "utilizing or maintaining" physical business locations. Furthermore, the business location does not have to be owned or operated by the seller. Utilization of locations owned or operated by "any other person" could be considered a nexus-creating activity, based on this new language.

Effective October 2015, Michigan's general sales tax act includes a statement that sellers are presumed to be engaged in business in Michigan when they or their affiliates are maintaining, occupying, or using a physical place of business to facilitate sales to customers in the state (Mich. Comp. Laws §205.95a(1)(c)).

Missouri established similar criteria in determining whether an out-of-state seller is subject to use tax. A vendor is required to collect and remit tax if, within the state, it directly or by any agent or other representatives has or utilizes an office, distribution house, sales house, warehouse, service enterprise, or other place of business (Mo. Code Regs. tit. 12, §10-4.085).

The inclusion of the word "use" or "utilize" in these and other states' statutes and regulations no longer requires a seller to directly have property in a state before a state can assert nexus. A seller is not even required to have an affiliate with nexus in the state. The authors believe this revised language specifically targets online retailers with a third-party fulfillment center or drop shipper in the state.

Competition among online retailers has made the use of third-party fulfillment operations much more attractive, if not essential, from a business perspective. Hiring a third party to handle inbound purchasing, inventory control and management, order processing, and return acceptance can allow an online retailer to quickly respond to customer orders while reducing fixed costs and freeing up internal resources. This is not to mention the ability to complete delivery to customers within two days, the standard set by Amazon.

However, is the third-party fulfillment company or drop shipper a vendor or an agent? The boundaries have blurred. While the relationship between a seller and a third-party fulfiller or drop shipper may truly be arm's-length, with no characteristics of an affiliate or agency relationship, the states appear poised to assert that the use of a facility operated by another creates nexus. Third-party fulfillment contracts or drop shippers are an effective way to be competitive and limit investment in real and tangible property. At the same time, they may provide a buffer against nexus and the burden of collecting and remitting sales and use tax. This assumes no affiliate or agency relationship exists between the seller and third-party fulfiller or drop shipper.

Amazon recently indicated it is collecting sales or use tax in all jurisdictions imposing such a tax. Other large e-commerce retailers continue to fight the nexus battle even if an affiliate has retail outlets or other facilities in the state. So what are the other e-commerce retailers to do? Knowing the company's nexus footprint is imperative in managing the financial risk associated with potentially having nexus in a state and therefore creating a sales-and-use-tax liability. Examining company facts and circumstances with careful research and thorough analysis will allow executives and owners to make sound and proactive risk management decisions surrounding sales and use tax in the e-commerce world.

Many executives and owners express concerns about remaining competitive if they begin charging sales and use taxes. The financial statement implications are real. While outside the scope of this discussion, FASB Accounting Standards Codification Topic 450, Contingencies, considers sales and use taxes contingent liabilities.

The time for ignoring sales-and-use-tax nexus and the potential exposure it can bring has passed. Make no mistake—state "discovery" units are scrutinizing businesses. Be proactive. Know your nexus footprint and potential dollars at risk. This is one surprise no one wants.

For more on nexus expansion, see "States Probing Boundaries of 'Physical Presence.'"


Mark Heroux is a principal with the National Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.