By Ian McCue, senior associate content manager at NetSuite
⏰ 4-minute read

In short:

  • In the wake of new laws regarding online sales tax, many companies have discovered they’re responsible for back taxes under the old law’s standard.

  • This is especially concerning for companies that use Fulfillment By Amazon, many of whom didn’t realize their inventory was previously stored in multiple states.

  • In addition to causing companies to pay unexpected back taxes, this discrepancy could also discourage companies from registering to file taxes at all.

The Supreme Court’s ruling in South Dakota v. Wayfair last June was a major victory for states looking to recoup tax revenue from e-commerce. While most states are looking forward to a windfall of tax dollars from that decision, others are also trying to collect back taxes, causing issues for many online retailers.

The issue stems from the “physical nexus” standard that determined which companies were subject to taxes in the era before the Wayfair decision. The standard stated that a company had to charge sales tax if it had a physical presence in a state (i.e. offices, warehouses, inventory, employees, certain types of contractors, etc.). Some retailers unknowingly established a physical presence in certain states when third-party fulfillment providers moved their inventory there.

A handful of states are now pursuing back taxes based on this discrepancy, while others are simply enforcing the recent Wayfair decision, which replaced the “physical nexus” standard with a more comprehensive “economic nexus” rule and empowered states to collect sales taxes from remote sellers.

FBA sellers at risk

This problem is of particular concern to the millions of sellers who use Fulfillment by Amazon (FBA), paying Amazon to store and fulfill orders on their behalf.

Sometimes, Amazon moves a company’s inventory around within its network of more than 75 fulfillment centers in 33 states (and counting), based on the location of customers who order the product. For example, if one-third of all consumers who purchased a certain brand of wireless headphones live in Southern California, then Amazon would keep much of that seller’s inventory there to minimize logistics and delivery costs. The seller would not get an alert that its inventory was stored in California, nor that it was now subject to California sales tax.

Upon realizing this discrepancy, “Most retailers said, ‘I’m not doing anything about it, I didn’t put that inventory there, I don’t have any control over it,’” said Mike Dillon, a tax attorney who runs his own firm in Annapolis, Md. But “the state would say, ‘It’s your inventory, you own it. I get that Amazon really has 99 percent control over it, but it’s on your books, it’s your property, and it’s in our state and it gives you nexus.’”


Marketplaces like eBay, Etsy and Amazon typically have not collected and remitted sales tax on behalf of their sellers, viewing taxes as the seller’s responsibility. That is starting to change--marketplace facilitators like Amazon and eBay now must collect and remit sales tax in nine states plus Washington, D.C. that have new “marketplace nexus” laws. (Some of these laws don’t go into effect until later this year.)

Battle of the back taxes

Some states--notably California, Washington, Massachusetts and Pennsylvania--requested data from Amazon to figure out which companies may have stored inventory there. Now they’re levying back taxes, which come with interest and penalties, for the years in which retailers had a physical nexus in the state but did not remit taxes.

A company’s physical presence could pertain to business done five or six years ago, Dillon said. He has had clients owe hundreds of thousands or millions of dollars in taxes to California alone, as that state represents a significant chunk of business for many e-commerce companies. Businesses must pay these taxes out-of-pocket since they never collected the money from customers in the first place.

To register or not to register

Thousands of companies are registering with states right now in the wake of Wayfair.

For some states, this presents a golden opportunity to pursue past violations. For example, California and a few other states are using their tax registration applications to ask sellers whether they sold through marketplaces, and when. The state then contacts these businesses to figure out if they stored inventory there and therefore owe back taxes. If the organization ignores multiple notices, the state may initiate an audit.

But other states realize chasing back taxes has the potential downside of discouraging companies from registering to remit taxes at all.

“I think if the state takes a long-term view, they want people registering to collect their tax,” said Pat Riley, VP of business and corporate development at tax automation company TaxCloud. “And while there may be some who want to look backwards a little bit and try to go through this process of figuring out if someone had a physical nexus, I think the smart approach would be to focus on the future.

“Let’s be friendly, let’s not give reason for people not to register for tax for fear that they’re going to be providing information that’s going to be used against them.”

On the bright side, most states are not chasing back taxes. However, Dillon still recommends conducting a nexus study and registering in nexus states, even if it is on a “go-forward” basis.

“The companies are between a rock and a hard place in states in which they have historical nexus,” Dillon said. “At least registering stops the bleeding, so they can mitigate the exposure.”

Dillon also recommends registering and remitting returns, even if Amazon is collecting and remitting 100 percent of the sales tax on your behalf.

The bottom line

If your business runs into issues with online sales tax, it’s a good idea to talk to a tax attorney or another tax expert. The first step to becoming compliant with the new laws is to understand where you owe money in the first place.

Then, we can all get back to the fun part of e-commerce.

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