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May 16, 2013
Marketplace Fairness Act … Some Good News and Some Bad News for Small Remote Sellers
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It is fair to say that remote sellers do not unanimously embrace or reject the Marketplace Fairness Act (S.743), currently pending before the United States House of Representatives.  Many support it (e.g., Amazon) and many do not (e.g., Ebay).  A bill sweetener is an exemption for the small seller that should please at least that segment of the remote seller ecosystem.  However, that exemption, by itself, may not save the remote seller who exceeds the small seller threshold in one year and then returns back to the small seller status in the next year.  This could easily happen to a start-up company.

Before we address the minimum threshold, let us first look at some key phrases and definitions.  As the bill is currently drafted, a “remote seller” --- who has no nexus with a buyer’s state but makes a “remote sale” into that state --- will be required to collect sales or use tax from the customer and remit the same to a state.[1]   

A “remote seller” is a person who makes a “remote sale” into a state.[2]   What is a “remote sale”?  A “remote sale” has two parts.  First, it is a transaction when a “seller would not legally be required to pay, collect, or remit State or local sales and use tax unless provided by this Act.”[3]  This is the case when the remote seller has no nexus in the buyer’s state.  Second, it takes place where the sourcing rules determine the sale to take place.[4]  The sourcing rules operate in a hierarchy.  Initially, the sale is sourced to where the buyer receives the product or service.  Next, when there is no delivery location specified, then the sale is sourced to the customer’s address or billing address.  Finally, if the sale location still cannot be determined, then the sale is sourced to the seller’s address from where the remote sale was made.  The member states of the Streamline Sales and Use Tax Agreement have similar but different sourcing rules.

So, if you are a remote seller covered by this Act, you must source your retail sales to the states in accordance with the sourcing rules.  This can be complicated because somebody or a system must account for the sourcing of the sales.  When customer information is lacking or unreliable, a person or a system may need to review specifically the transaction to determine which sourcing rule applies. 

Once the remote seller knows to which state to source the sale, then the remote seller must collect the proper tax and remit it to the proper state.  Keep mind that different states tax and exempt different items or services.  So, there is additional scrutiny that must be applied to determine if an exemption is properly documented according to the rules of each state.  There is no requirement that the states uniformly tax or exempt the same goods or services.

Well, the “good” news is that if you are a small business (you do not have more than $1,000,000 annually of gross remote sales in the preceding year), then you are defined as a small seller and exempt from the Marketplace Fair Act.  You don’t need to worry about (1) the sourcing rules, (2) the charge, collection and remittance of the sales tax, or (3) whether you have collected each state’s proper exemption certificates that are necessary in the event of an audit.  That seems pretty straight forward, but not so fast.  Let’s assume that in the current tax year that you broke the $1,000,000 barrier for the first time.  The good news is that you did not have to set up the compliance program to collect and remit the tax for the year in which you exceeded the small seller threshold.  However, because you exceeded the threshold in the current calendar year, then the sales or use tax must be collected and remitted in the next calendar tax year even if your sales will be less than $1,000,000, say $900,000.  Ironically, the exemption for the small seller doesn’t apply to a small seller in the year it is actually a small seller because the “look back” rule to determine whether you are a small seller applies to the following tax year.[5]

The irony may be interesting but there is a hard dollar cost problem that is not so interesting … in fact, it could be infuriating.  For what it is worth, one industry group thinks the compliance cost could be $360,000 in the first year and $242,000 in the second year based upon a product line of 40,000 items.[6]  I have no idea if the estimate is accurate, but it strikes me as too high.  So, let’s assume that it is too high and the actual cost is only 25%, or $90,000 ($360,000 times 25%).  Assuming that you have a 20% margin on your retail sales, and the first year compliance cost is $90,000, then that would mean that your first $450,000 of gross sales will pay for the first compliance year compliance cost of $90,000 ($450,000 times 20%).  Your 20% profit on the remaining $450,000 would leave you with a gross margin of $90,000 for the year.   In other words, as a small business, you are being asked to take a 50% haircut on your gross margins in the first year of compliance in the year in which you are a “small seller.” 

So, the “bad” news is that the small seller exemption may be more of a hindrance than a help because it will not apply when you may need it most.  Depending on your gross sales, your actual margins and the actual compliance costs, your entire gross margin for the year could be substantially consumed by the cost to comply with the Marketplace Fairness Act.  Some wonder if this will stifle growth as small sellers will deliberately limit sales to avoid exceeding the small seller threshold of $1,000,000.

If you have any questions, then please contact us at Eisenhower Carlson.


[1] A state can have the authority if the state is a member of the Streamline Sales and Use Tax Agreement.  S.743, Sec. 2(a).  If the state is not a member, than it can have the authority if certain minimum standards are present.  S.743, Sec. 2(b).

[2] S.743, Sec. 4(6)

[3] S.742, Sec. 4(5)

[4] Id

[5] Another problem is that the $1,000,000 small seller exemption is not state by state; rather, the threshold is aggregate of total remote sales.  This could mean that in the collection year, you could make a single $100 sale in a state and be required to comply with the collection and remittance process for that state.

[6] http://onlinestores.me/2013/05/04/the-cost-of-complying-with-the-marketplace-fairness-act/ .  This estimate includes software costs but the bill provides that the compliance software will be provided by the states at no charge.  S.743, Sec. 2(b)(2)(D)(ii).

 

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