When California says you owe it $1.6 million in back sales tax – Wacky Tax Wednesday

Imagine that you’ve been selling through an online marketplace for years but haven’t collected or remitted sales tax outside of your home state because you thought you didn’t have to.

Have you put yourself in a pickle?

Maybe, if your merchandise is stored in warehouses located in other states. Storing products intended for sale in a warehouse or fulfillment center can give you a physical presence in a state, even if you don’t own or operate the facility. And if you have a physical presence in a state, you generally have an obligation to register with the tax authority, collect and remit sales tax, and file sales tax returns in that state.

If a state discovers you made sales but didn’t collect sales tax to customers in its borders, it will probably send you a notice. That’s what happened with California and Brian Freifelder.

Freifelder lives in Pennsylvania and sells through the Amazon marketplace in multiple states, including California. Earlier this month, he was informed by the California Department of Tax and Fee Administration (CDTFA) that he could owe the state up to $1.6 million in delinquent sales tax, interest, and penalties from the first half of 2019. It’s a wonder he didn’t drop from shock on the spot.  

His predicament made national news, and before too long, the CDTFA admitted the $1.6 million estimate was “higher than it should have been.” However, the CDTFA didn’t say Freifelder was completely off the hook for California sales tax. 

It’s important to note that this is not because of Wayfair.

In June 21, 2018, the Supreme Court of the United States overruled a physical presence rule in its decision on South Dakota v. Wayfair, Inc. Before the Wayfair ruling, states could only impose a tax collection obligation on businesses with a physical presence in the state. Wayfair authorized states to tax businesses with no physical presence in the state, or remote sellers.

Most states that have a general sales tax now require remote sellers doing a certain amount of business in the state to collect and remit sales tax under economic nexus laws. Economic nexus has dominated sales tax news (including the Avalara blog) for a year and a half, so it’s easy to see how people could assume California came after Freifelder because of Wayfair and economic nexus.

But that’s not what the California notice is about. I repeat: The California/Freifelder situation wasn’t caused by Wayfair. 

For some time now, the CDTFA has been reaching out to people like Freifelder who sell into the state through the Amazon marketplace. It knows who to contact because Amazon was required to share third-party seller information with the department last fall, as it’s had to do with several states.  

California knows these marketplace sellers have or had inventory stored for sale in the state, which gives them physical nexus and an obligation to collect and remit sales tax. Presumably, the CDTFA is only contacting businesses that aren’t registered or collecting tax as the state thinks they should.

When this first came to the attention of Fiona Ma, Treasurer of the State of California, she urged Governor Gavin Newsom to “direct CDTFA to cease this activity”; Ma takes the position that marketplace facilitators, not marketplace sellers, should be responsible for sales tax.

The governor must not have done as Ma asked, because out-of-state marketplace sellers with inventory in the state are still receiving letters from the CDTFA. However, Gov. Newsom did sign a bill into law that holds marketplace facilitators liable for the tax due on all sales made through the marketplace. It took effect October 1, 2019.

Because of California’s new law, Amazon is now required to collect the tax due on Brian Freifelder’s Amazon marketplace sales in California. But it wasn’t responsible for that tax prior to October 1.

According to the CDTFA’s Tax Guide for Marketplace Facilitator Act, if you have a physical presence in the state (“inventory”), “you are engaged in business in California.” For out-of-state businesses, physical presence includes having inventory "stored in a third-party fulfillment center in California.” 

There’s no free pass for businesses with physical presence nexus. In most states (all but one), remote sellers only need to collect and remit sales tax if they surpass the state’s economic nexus threshold. That said, the small seller exception that’s baked into most state’s economic nexus laws doesn’t come into play in this case, no matter how much or little Freifelder sells in California. Safe harbor for small sellers only pertains to remote sellers with no physical presence in the taxing state.

Tax authorities in California don’t consider Brian Freifelder a remote seller. He has physical nexus with California through the inventory he’s stored for years in California in Amazon warehouses.

The good news, for Freifelder, is that it appears he doesn’t owe California $1.6 million in back sales tax, penalties, and interest charges. The bad news is that he may owe California some amount of back sales tax, penalties, and interest.

There’s no reason to believe the California Department of Tax and Fee Administration won’t continue with its policy of going after marketplace sellers for their untaxed past sales. Yet it can only reach back so far. Due to the enactment of Senate Bill 92 last June, the department can only seek unpaid sales tax revenue for periods on and after April 1, 2016. This limitation applies to sales by sellers who are engaged in business in California soley because they used a marketplace facilitator to facilitate sales, and the facilitator stored their inventory in California. This notice provides more details.

All eyes will be on California in the coming months to see what happens with its actions toward marketplace sellers. Among the watchers will be people, like Freifelder, who believe marketplace sellers based in other states shouldn’t be held liable for California sales tax.

Also watching will be California-based businesses who have sued the state for giving Amazon what they say is “an unfair advantage over California businesses by failing to collect adequate taxes” from its marketplace sellers “for the last three to eight years.”

Wacky times.