Amazon FBA (fulfilled by Amazon) is really stirring the pot in the area of taxes. For a while now I have heard about the potential multi state tax concerns of using Amazon FBA, but I was never asked by any of my clients to really research the issue until recently. The main question is: “If I use Amazon FBA, will me and my business need to file sales tax and income tax filings for EVERY state Amazon has a fulfillment center? After digging down this very interesting rabbit hole, I figured I would share the step by step results with everyone (or at least the 10 or 12 people who read my blog posts).
Let me start this conversation with the word Nexus. Nexus is a fancy word for connection….how strong is your connection to a particular state? If your connection to a particular state is “strong” enough then you have “nexus” within that particular state and if you have nexus within that state, that state can lawfully tax you. By using Amazon FBA your “connection” to any particular state will be the following:
- You will own property (inventory) in every State Amazon decides to store your inventory; and
- You will be using an independent third party agent to fulfill orders for you in that State
To make this a little more murky, nexus for sales tax purposes does not always align with nexus for income tax purposes. As a general rule nexus for income tax purposes requires a greater connection than for sales tax purposes.
I started my search with sales tax. This one was easy and after a quick google search I found that all tax practitioners with a blog seem to agree that sales tax must be filed in every state that Amazon holds your inventory, period end of story. Fortunately service providers and software has stepped up and provided solutions to the FBA users making sales tax compliance manageable (I should say more manageable, it is still a pain)….. but sales tax is only half the story….
What about income tax? As an Amazon FBA seller do I now have to file income tax returns in multiple states? Given that I found my answer so quickly for sales tax I figured there would be plenty of professionals writing all over the internet on this topic. To my surprise I found NOTHING AT ALL… I had to turn to my overpriced and less user friendly tax research tools.
Through one of my tools, I was able to dig out a report where state tax departments were asked to respond to whether the following activity would create nexus:
“Unrelated third parties in the state providing fulfillment services (i.e., fill product orders from corporate-owned inventory)”
The short answer is that all state’s say yes, that activity will create income tax nexus (well, close to all State’s, there are a few exceptions).
To make my findings even more interesting, the fine print of the report has the following disclaimer:
Disclaimer: This report is based on information from Bloomberg BNA’s annual Survey of State Tax Departments, in which Bloomberg BNA asks an official from each state whether a particular activity performed within a state’s borders would, by itself, be sufficient to trigger income tax nexus and reporting and payment obligations. While the responses are generally indicative of each state’s policy, they should not be relied upon as legally binding policy statements.
So, to me at least, this statement means that this is the position the tax authorities will take, but this position may or may not actually be law. Since it is still the position of the tax department expect to be assessed tax by that tax department and be ready to litigate if you take the opposite position.
Not completely satisfied with this outcome, I wanted to dig further. Reaching out to contacts in the FBA space I learned that sellers agree and are aware that sales tax in multiple states is what “should” be done but sellers were more or less confused when I brought up the topic of multi state income tax filings and I learned that very few have even considered it, let alone are filing income taxes in multiple states. But I did manage to get contact information of three accounting / tax advisers in the FBA arena. So being the nudge that I am, I decided to cold e-mail them with the following email:
Good afternoon ZZZ
ZZZ gave me your contact information and I was hoping you can lead me in the right direction. Long story short, I have a client that is pretty active with an Amazon FBA business. He is all set up with his sales tax compliance, but my question is around income tax compliance.
The way I see it is that so long as inventory is held throughout the year within one of the FBA centers, and orders are being fulfilled by Amazon from that state, my client will also have income tax nexus within that State. I also know for a fact that not too many FBA sellers are filing income tax in all those states, so it makes me think I am missing something.
Attached is the nexus report I ran with my BNA nexus tool. As you can see from this report it says most states that have unrelated third parties fulfilling inventory for them within the state would give them nexus within that state. I would love any guidance or experience you may have in this area to point me in the right direction.
Thank you in advance for your assistance
I wasn’t sure that I would even get a response to my solicitation for free advice, but to my surprise I received responses from all three professionals pretty quickly. Here are all 3 responses:
The conservative approach is to file income tax returns in these states, however, the threshold for many FBA sellers is rarely met to do so.
Part of the issue that leads me to believe that there is no requirement is that the sale proceeds the storage of inventory, and is therefore subject to Public Law 86-272. However, this is purely a constitutional approach, and one that may or may not be completely rooted in the laws of the state. This concept states that the sale occurs in interstate commerce and the storage of inventory is ancillary to the sale, and, most importantly, is done at the convenience of Amazon and not the seller. Also, there is doubt that the inventory is owned by the Seller once it is under Amazon’s control. I believe a “de facto” title transfer happens when it enters the FBA system.
At any rate, this is where I would concentrate focus when determining whether or not an FBA seller has nexus for income tax.
Thank you for reaching out to me. Would it be OK with you if I kept a copy of the Nexus Report you sent?
I am including a copy of a letter ruling I got from VA saying that FBA does not have Nexus in VA.
Now, to the point of you question. Yes, they have an income tax liability in each of the Nexus states. They may not reach the level of income tax filing requirements if they are a sole prop (they need the Non-Resident individual in each Nexus state.) like in AZ I believe it is $5500. I believe however if they file an 1120 or 1120S they are obligated in every state regardless of volume. No Texas for example has a Franchise Tax that can be filed very easy online via the online sales tax filing portal. It has to be filed, but until they sell $1 Million nation wide, they have no tax due in Texas (prorated).
I would like to open up a relationship with you regarding Sales and Income Tax for clients. I am getting rather busy with the Sales Tax applications, and have been starting to work with international sellers using FBA. No, I do not do international income taxes. Do you? maybe we can help eachother out.
Thank you again for reaching out to me. I appreciate you doing so and look forward to a great collaboration.
I do focus on all areas of State and Local Tax (sales, income/franchise, employment) and will say that yes, the inventory is going to likely create income and franchise tax nexus in many states. And I agree – many FBA sellers don’t even think about the income/franchise nexus. I do think you’re making the correct conclusion.
So what is the conclusion?
How I like to advise my clients in any uncertain area of the tax law is to compare your options and what risks are associated with each option. Option 1 is to not file income tax returns in the multiple states where your inventory is located. What are the risks associated with option 1? Let me first explain the concept of the statute of limitations. Generally speaking, as long as you file a tax return, the taxing authority has 3 years to audit that return. After the three year time period runs out, the “statute of limitations” runs out and that tax authority cannot audit that year any longer. However, if no return is ever filed, the statute of limitations never begins and the taxing jurisdiction can audit you as far back as they would like. So back to the risk of option 1…since you never filed a tax return the risk is that you are audited for every year a return was not filed which can be 5, 10, 15+ years. You can run into problems of not having adequate records to prove where your sales were shipped to or shipped from and that taxing authority may assert that a 100% allocation should be done within their state if you cannot prove otherwise. Since this is not a one year problem your problem the problem is compounded for 10+ years of backed taxes, interest and penalties. While this is the worst case scenario, in my opinion this is a big risk and not that far out of the ballpark of state tax authorities / auditors who love to tax “out of staters” rather than their own constituents.
Option 2 is to file income tax returns in all states where you held inventory during the year. Since you are filing tax returns in each state your only potential tax risk is accuracy of the tax returns. But that is also minimized to three years of returns by the statute of limitations and since sales tax returns are being filed (or should be filed), you should have an accurate state allocation with minimal effort. Further, if an audit results in a change in allocation you can likely claim a credit in your home state for the additional tax owed. But of course there is a cost. First is the tax cost. If you are located in a no tax state and not previously paying state income tax, you will have an added state income tax cost to the states that do have an income tax where you have nexus. However, if you are in a state where you were already paying an average rate of income tax it is likely your state tax burden will remain the same, you will just be paying that same dollar amount to multiple different states. Your second cost will be professional fees. Depending on how many state’s and what type of returns you are filing, your professional fees will easily double from what you are already paying for tax preparation.
Given that all signs are pointing toward yes income taxes should be filed, and option 1 is too risky for me to sleep well at night, my recommendation to my FBA clients is that both sales tax and income tax in multiple states should be filed if you plan for Amazon FBA being an integral part of a long term business model.
UPDATE: Only a day or so after I posted this I received a very insightful email from a fellow FBA seller. I liked his response so much I asked his permission to share his insights, and he agreed. Below is his exact email to me in response to my initial post (btw, other ideas and experiences are welcome, PLEASE email me any ideas you have on the topic):
Dear Mr. Lucibello,
Thank you for your blog post:
I am not a tax professional or involved in tax law. I am only a (small) online merchant… and i am a wholesale supplier to Amazon.
In your blog post:
> By using Amazon FBA your “connection” to any particular state will be the following:
> • You will be using an independent third party agent to fulfill orders for you in that State
Not exactly… What is missing from some of the discussion is that FBA is technically (and probably legally) a “consignment” service. I have not seen any tax professional “go there” … As you know:
1. The ownership of the product is never transferred to FBA;
2. The “seller” has no choice where or how the product is warehoused or shipped;
3. FBA takes a “commission” on the sale of the item.
This is clearly a consignment relationship and this does not force nexus, as much as a state may want it.
In my (non-tax-lawyer) opinion, the states are grasping at straws here.
The big misconception here is that Amazon still calls sellers, “sellers” — and the government agencies accept Amazon’s description of the relationship by name, without considering what exactly an Amazon “seller” is:
The suppliers to FBA are not the “seller”, Amazon is the seller:
a) an FBA “seller” has no relationship with the customer – “FBA sellers” are prohibited from just about all types of communication with the customer — the customer relationship is owned and controlled by Amazon.
b) an FBA “seller” doesn’t collect the money – the transaction is entirely handled and controlled by Amazon. The “seller” has zero participation in the transaction;
c) an FBA “seller” doesn’t have the right to refuse a sale or shipment without consequences;
d) an FBA “seller” must adhere to Amazon’s policies;
e) Amazon advertises the products they sell, including those supplied by FBA “sellers”. A “seller” does not control the advertising message that Amazon pushes to their customers;
Amazon has built a superb consignment store. It should be treated as such.
Amazon is the seller. The supplier is only the wholesale source of the item.
Amazon should be collecting sales tax and doing all tax filing on every transaction where Amazon has nexus (not the “seller”).
A wholesale supplier without nexus does not force income tax filing.
Isn’t this obvious to everyone?
My business is too small for anyone to notice, so I am not a good “poster-child” for this. I am truly surprised larger Amazon suppliers have not tried to argue this case in public?
I recognize that you’re the expert here — so I hope this piece of information is helpful to the discussion.
I love his point here, especially regarding FBA sellers access to their “customers”. This is not the first time I have heard this complaint from FBA sellers that AMAZON CONTROLS ALL CONTACT WITH THE CUSTOMER! Usually the complaint is around cross selling and marketing, but now tax can play a key role in this as well. Without your own customers are you truly a “seller”? While I certainly have not read the FBA seller “agreement” the arrangement certainly does smell like a pretty typical consignment arrangement. So what is the basic definition of consignment?
- : shipped to a dealer who pays only for what is sold and who may return what is unsold<goods shipped on consignment>
So what is the income tax and sales tax ramifications if you are a consignor? Well that would be great for the FBA “consignors”, they are making sales for re-sale (not subject to sales tax), and likely will not have an issue with income tax nexus as well. Conversely, amazon will now be considered the seller and will have to charge and remit the sales tax for all the FBA sales. So why isn’t Amazon already doing this? Why not make their sellers lives easier? I have no idea…the only thing I can think of is the administrative cost of compliance. If Amazon were to have to handle all of the FBA sales tax compliance there must be a cost to do this and that cost would have to be passed on to FBA sellers. If that cost is too great, perhaps sellers will not see FBA as a viable business model.
The problem is, until all of this gets litigated we are still in a grey area. Being the conservative accountant that I am, my advice to my clients is still to err on the side of caution. Definitely deal with the sales tax and start thinking about your risk exposure for income tax.