Your inventory may be giving your business a sales tax obligation
Because marketplace facilitators like Amazon and Etsy are required to collect and remit sales tax on behalf of third-party sellers, marketplace sellers may assume they’re off the hook for sales tax. But that’s not necessarily so. All else aside, marketplace sellers and other remote sellers often have inventory stored in various third-party or marketplace warehouses or fulfillment centers — and having inventory in a state can give you an obligation to register for sales tax in that state.
Determining if you need to register for sales tax in a state comes down to nexus, which is a connection between a taxing authority and a business that’s significant enough to trigger a sales tax obligation. It’s a simple concept with devilish details because sales tax nexus laws vary from state to state; while all states with a sales tax require businesses with a physical presence in the state to register for sales tax, each state defines “physical presence” differently.
Read on to learn whether having inventory in a marketplace facility or other type of distribution or fulfillment center can establish physical presence nexus for your business.
Having inventory in a state can give you a sales tax obligation in most states
More than 20 states specify that holding inventory in the state — including inventory stored in a marketplace facilitator’s facility and managed by the marketplace — creates physical presence nexus for the third-party seller. These include California, Georgia, Indiana, Kentucky, Michigan, Minnesota, New Jersey, North Carolina, North Dakota, Ohio, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.
For example, the California Department of Tax and Fee Administration (CDTFA) is clear that if you have inventory stored in a third-party’s fulfillment center in California, “you are engaged in business in California” and responsible for the tax due on sales not made through a registered marketplace facilitator.
The Pennsylvania Department of Revenue is equally straightforward. It explains, “Under Pennsylvania law, a business with property or inventory in Pennsylvania is subject to Pennsylvania taxes. This requirement applies to online retailers with inventory stored at a distribution or fulfillment center located in Pennsylvania.” Though a registered marketplace is responsible for collecting and remitting sales tax on behalf of third-party sellers, a marketplace seller with inventory in the state is responsible for the tax due on direct sales and sales made through an unregistered marketplace.
Similarly, even a few products stored briefly in the state can create nexus with Washington. According to one Washington State Department of Revenue ruling, “The fact that goods owned by the Taxpayer were physically stored in Washington until sale, even briefly via digital reassignment of ownership, is sufficient to establish substantial nexus.” Read more about digitally reassigning inventory and how it can affect nexus here.
Keep in mind that sales tax laws are subject to change. Virginia changed its law in 2017 to specify that inventory held in a facility owned by a third party establishes a physical presence for an out-of-state seller.
It’s always helpful when state departments of revenue provide clear guidance on sales and use tax matters. Unfortunately, they sometimes don’t. If the following states have specific guidance on this issue, the tax departments don’t make it easy to find: Alabama, Alaska, Colorado, Connecticut, Florida, Hawaii, Idaho, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Mexico, South Carolina, and the District of Columbia.
When in doubt, it’s generally best practice to err on the side of caution and assume marketplace inventory could establish physical presence nexus for remote sellers. Discussing your situation with a professional tax advisor is also a good idea. See Avalara’s state tax expert directory if you need a recommendation.
Marketplace inventory may not give you a sales tax obligation in these states
Having inventory in a marketplace or third-party warehouse generally does not establish physical presence nexus for remote sellers in the following 10 states:
- New York
That said, it’s important to note that states may make a distinction between inventory used to fulfill direct sales and inventory used to fulfill marketplace sales. Who controls the inventory, the seller or the marketplace/distributor, can come into play as well.
Whether the seller controls the inventory or not, Iowa, Kansas, and Nebraska generally treat a business as a remote seller so long as their only physical presence in the state is inventory stored in a third-party’s warehouse. But in Arkansas and Oklahoma, while inventory stored in a third-party warehouse usually doesn’t give a remote seller physical presence in the state if it's controlled by the third party, inventory held in a third-party warehouse does give a remote seller a physical presence in Arkansas if the seller controls the inventory’s movement.
The Arizona Department of Revenue says that “temporarily storing property with a third-party fulfillment center over which you have no control likely does not rise to the level of physical nexus” (emphasis mine). However, the department also explains, “If the assets or property are in Arizona and you have control over where and how it is stored, you likely have physical nexus.”
The Illinois Department of Revenue specifies that if inventory is used strictly to fulfill orders made over the marketplace, the inventory does not create physical presence nexus for an out-of-state retailer. But if the inventory is used to fulfill marketplace orders and direct sales (or direct sales only), it does create physical presence nexus.
According to the Nevada Department of Taxation, “If you are a remote seller that ONLY makes sales through a Facilitator(s) registered to collect Nevada sales tax, you do not need to register with the Department for a Sales Tax Permit if your only presence in Nevada is inventory stored in a third-party’s fulfillment center located in Nevada.” The department’s emphasis on “only” suggests that if you also make direct sales in the state or sell through an unregistered marketplace, having inventory in the state could give you nexus.
New York law holds that “a person who is not otherwise a vendor who owns tangible personal property located on the premises of an unaffiliated person performing fulfillment services for such person” is not a vendor liable for sales tax.
Finally, the Texas comptroller explains that “a remote seller who is below the $500,000 safe harbor threshold and has tangible personal property temporarily stored in Texas at a marketplace provider’s facility does not have to obtain a permit or have a collection obligation if the marketplace has certified it will assume the duties of a seller.” However, a remote seller with more than $500,000 in annual sales in the state that has inventory temporarily stored in Texas at a marketplace provider’s facility “must obtain a tax permit and collect tax” on their sales. This is because of economic nexus, discussed below.
States that have offered amnesty for remote sellers with marketplace inventory
States are sometimes sympathetic to the plight of retailers who develop a sales tax obligation through inventory stored in a third-party or marketplace warehouse.
In 2017, the Multistate Tax Commission ran a tax amnesty program for marketplace sellers whose marketplace inventory had created physical presence nexus in one or more states. About 25 states participated, and most waived past taxes without limitations. The remaining states provided more limited amnesty.
In 2019, California provided temporary relief for marketplace sellers who were “engaged in business” in the state solely because they used a marketplace facilitator to facilitate sales of their merchandise for delivery in this state and the marketplace facilitator stored their inventory in California.
In 2021, Pennsylvania offered limited tax amnesty to unregistered remote sellers that held inventory in the commonwealth.
Additional states could offer amnesty to remote sellers with inventory in the state in the future, but the trend seems to be moving in the opposite direction. A number of states are aggressively pursuing remote sellers for back sales tax based on inventory and inventory alone.
States pursuing remote sellers for back sales tax based on inventory
California, Pennsylvania, and Washington are among the states keen to collect back sales tax liability from out-of-state retailers that had or have inventory stored in a marketplace facility in the state.
In 2019, the California Department of Tax and Fee Administration (CDTFA) informed an Amazon seller based in Pennsylvania that he could owe $1.6 million in delinquent California sales tax, interest, and penalties because he held inventory in a marketplace facility in the state and also made direct sales in California. Though the CDTFA later said that astonishing figure was “higher than it should have been,” it didn’t retract its assertion that the seller was liable for past sales tax.
The Pennsylvania Department of Revenue is also moving forward with efforts to collect back taxes from thousands of Amazon’s Fulfillment by Amazon (FBA) sellers based on their inventory in the state. Affected remote sellers are fighting back; the case is Online Merchants Guild v. C. Daniel Hassell. And as noted above, Washington has determined some remote sellers owe back sales tax (plus penalties and interest) because they had inventory stored in the state through a facilitator’s inventory management system.
California, Pennsylvania, and Washington don’t give much credence to sellers’ claims of ignorance (i.e., that they didn’t know a marketplace facilitator had put their products in the state). And to be fair, though a marketplace facilitator may not make it easy for a third-party seller to discover where its inventory is held, there’s usually a way to do so. In theory, at least, retailers participating in the FBA program can access inventory reports via their Amazon Central account.
Can states do this?
This is a question many businesses ask, particularly in light of the U.S. Supreme Court’s ruling in South Dakota v. Wayfair, Inc. (June 2018).
Prior to the Wayfair decision and subsequent state action, states were limited to taxing businesses with a physical presence in the state. Because of this, states often interpreted “physical presence” rather broadly. For example, Massachusetts and a few other states decided that putting web cookies on computers in the state was enough to trigger a sales tax obligation. In light of that, basing sales tax on inventory — even inventory stored temporarily in the state — seems rather reasonable.
Wayfair overturned the physical presence rule, allowing states to tax businesses with no physical tie to the state. Every state with a sales tax has since adopted an economic nexus law requiring remote sellers with a certain degree of economic activity in the state (e.g., $100,000 in sales or 200 transactions in the current or previous calendar year) to register for sales tax and comply with all applicable sales tax laws. All economic nexus laws specify that the state will not enforce economic nexus retroactively.
Every state with a sales tax has also adopted a marketplace facilitator law making marketplace facilitators responsible for collecting and remitting tax on behalf of their third-party sellers.
It can be easy to forget old-fashioned physical presence nexus with economic nexus and marketplace facilitator laws grabbing headlines, but it would be a mistake. Wayfair enabled states to expand their taxing authority; it didn’t curb their existing taxing authority.
"The Wayfair decision changed many things for out-of-state retailers, but it didn't change what constitutes an in-state retailer,” explains Scott Peterson, vice president of Government Relations at Avalara. “Placing inventory in a state remains one of several ways a business can create physical presence."
So yes, states can do this.
If you have inventory scattered throughout the country, either in a marketplace facility or another third-party distribution or storage facility, you may have established an obligation to register for sales tax in one or more states.
To learn more about nexus and the various ways you can establish a sales tax obligation in different states, see our state guide to nexus laws.
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