Is my business a marketplace? What does that mean for sales tax?

The line between direct retailers and marketplaces has become blurred as more and more businesses operate in both channels. Unobservant consumers may not even recognize when they’re buying directly from a retailer or from a marketplace facilitator, and they’re probably no worse for it (I’m speaking from experience here). But the back-end requirements for direct sellers and marketplace facilitators can be quite distinct — especially when it comes to sales and use tax compliance.

There are buckets of online marketplaces today. Many sell tangible personal property, but there are digital goods marketplaces and marketplaces for on-demand services as well. Each may encounter a particular set of sales tax issues.

Whatever you sell, to understand and meet your sales tax obligations, you need to know what you are and what’s expected of you. And to do that, you need to know:

• What is a marketplace?
• Is your website an online marketplace?
• Are marketplaces required to collect and remit sales tax?
• Do marketplaces have other tax obligations?
• How can compliance software simplify complex marketplace tax obligations?

An online marketplace is an ecommerce platform where multiple businesses congregate to sell their products and/or services.

To be an online marketplace rather than simply a direct seller, a facilitator must:

• Contract with multiple individual sellers (marketplace sellers) to aggregate, showcase, and facilitate sales of their products or services
• Directly or indirectly collect payments from purchasers and transmit all or part of the payment to the independent sellers

Additionally, the marketplace facilitator (aka, marketplace provider) must own, operate, or otherwise control the look, feel, and function of the website. The marketplace sellers (aka, third-party sellers) typically cannot customize their product pages or process their own payments.

Craigslist may look a lot like a marketplace, but it doesn’t process payments for third-party sellers so it isn’t. Facebook operates both a marketplace and a platform more like Craigslist, where people list items for sale, arrange for local pickup, and take payments directly from the buyer. Amazon is an online marketplace for thousands of third-party sellers and also makes direct sales.

Some marketplaces offer end-to-end fulfillment services, meaning the marketplace stores, picks, packs, and ships goods for third-party sellers, for a fee. That’s how the Fulfillment by Amazon (FBA) and Walmart Fulfillment Services programs work, to name just two.

Other marketplaces provide no fulfillment services, relying instead on drop shipping. In a drop shipping transaction, the marketplace displays the items for sale, takes the order, collects the payment, and then has the third-party seller ship the goods directly to the consumer. This may be the easiest path for a direct seller transitioning into a marketplace.

Finally, a marketplace may offer both options, allowing individual sellers to fulfill orders themselves or pay for fulfillment services. For the sellers, as well as the marketplace providers, there can be advantages and disadvantages to each.

Direct retailers looking to grow have a couple of different options. They can broaden their reach by selling through one or more marketplaces in addition to making direct sales. Alternatively, they can expand their offerings and client base by becoming a marketplace facilitator.

A variety of different platforms in the wild today enable established businesses and retailers to create and operate their own ecommerce marketplaces. So, if you 1) control the look and function of your website, 2) contract with individual businesses to sell their products or services through your website, and 3) collect payments from customers and transmit them to the sellers, then you’re probably operating an online marketplace.

Emerging online marketplaces need to keep sales tax compliance top of mind.

Generally speaking, businesses have an obligation to register with the tax authority then collect and remit sales tax in states where they have sales tax nexus. This is true for online marketplaces as well as other online sellers.

There are several ways for a business to establish sales tax nexus with a state:

• Physical presence in a state (physical presence nexus)
• Economic activity in a state (economic nexus)
• Ties to affiliates in the state (affiliate nexus)
• Online referrals originating in the state (click-through nexus)

Businesses usually have physical presence nexus with their home states but may create nexus from one of the ways listed above and need to collect sales tax on out-of-state sales as well.

Storing inventory in a state or making deliveries in a state can give a business physical presence nexus, as can having employees in the state even temporarily. Making as little as $100,000 in sales or 200 separate transactions in a state in a year can give an out-of-state seller economic nexus. With thresholds that low, it doesn’t take long for even an emerging marketplace to establish sales tax nexus with one or more states.

Sales tax nexus is something all businesses need to be aware of. Marketplace facilitators need to keep marketplace facilitator laws top of mind as well. Marketplace facilitators are obligated to collect and remit sales tax in all 45 states with a general sales tax, plus Puerto Rico, Washington D.C., and some jurisdictions in Alaska.

The specifics of each state’s marketplace facilitator law are unique: Some states consider food delivery platforms to be marketplaces for sales tax purposes, for example, while others don’t. Yet all marketplace facilitator laws require businesses meeting the definition of a marketplace facilitator to collect and remit sales tax for all transactions made through the platform — so long as the marketplace has sales tax nexus with the state.

So.

If you have an online store, you need to understand who’s responsible for sales tax. Ecommerce platforms are not required to collect and remit sales tax for businesses that use the platform, so if you operate your own online store, you’re on the hook for sales tax in states where you have nexus. If you sell through a marketplace, you need to know if your online marketplace handles sales tax for you, and whether you’re required to register and file returns as well.

And if you’re operating a marketplace yourself, you need to know where you’re subject to marketplace facilitator laws and required to take care of sales tax for your third-party sellers. This is true whether you use drop shipping in your marketplace transactions or pick, pack, and ship orders yourself.

Most marketplace facilitator laws don’t reference drop shipping, so if you’re operating a marketplace and relying on drop shipping to get goods into consumers’ hands, you may need to do some research. (Kudos to California for explaining how drop shipping fits into marketplace transactions and sales tax obligations.)

Sales tax is a key consideration for online marketplaces, but it’s not the only tax or compliance issue marketplace providers need to consider.

For instance, certain marketplace providers are required to report and remit franchise tax in Texas. And marketplace facilitators registered with California must collect, report, and pay the California Battery Fee or other applicable fees on certain retail sales.

The INFORM Consumers Act, which took effect in June 2023, requires online marketplaces to protect consumers from counterfeit, unsafe, and stolen goods. To that end, marketplaces must collect and verify certain information from high-volume sellers, provide “clear and conspicuous” reporting options for customers, and comply with data privacy and security requirements. For more details, read INFORM Consumers Act creates new compliance requirements for online marketplaces.

Marketplace facilitators also need to brace themselves for the new 1099 reporting thresholds.

The 1099 is a tax form documenting payments to a business, individual, or entity that isn’t an employee. The payer (in our case, the marketplace facilitator) fills out the appropriate 1099 form and sends copies to the payee (in our case, the marketplace seller), the IRS, and the state taxing authority, where required.

There are more than 20 different 1099 forms in circulation today, but the 1099-K may be one of the most important for marketplace facilitators. Form 1099-K reports non-W-2 income received during the year from payment card transactions or third-party network transactions, like payment apps or online marketplaces.

The 1099-K reporting threshold is currently $20,000 in aggregate payments and 200 transactions, but that’s on track to change. Marketplaces and payment apps only need to complete 1099-K forms for individuals or businesses that reach that threshold, which rules out a lot of small businesses.

The American Rescue Plan slashed the 1099-K reporting threshold to $600, period. For online marketplaces and the folks who sell through them, it will be a whole new ball game once the $600 threshold takes effect.

The lower threshold for the 1099-K was supposed to take effect for the 2022 tax year, but it was delayed, then delayed again. There’s been talk of easing into the lower threshold, moving from $20,000 and 200 transactions to $5,000, but nothing’s final yet. Read our blog, House approves new thresholds for 1099 forms, to learn more.

New and emerging marketplaces may find themselves overwhelmed by these and other compliance obligations, but there’s no need to panic. Automated solutions can help.

Avalara can help your emerging marketplace with sales and use tax compliance. Our marketplace solution helps marketplaces classify physical products, research tax rates, and calculate taxes with greater efficiency and accuracy than manual processes. We can also help you collect and manage exemption documents and file returns across multiple jurisdictions. To find out if Avalara is the right tax solution for your emerging marketplace, schedule a call with one of our experts.

Avalara can also help you manage 1099 forms. To learn more, check out our on-demand webinar, Everything you need to know about managing 1099 and W-9 forms.