Some Fulfillment by Amazon (FBA) sellers are getting notices from the California Franchise Tax Board ordering them to determine whether they owe business income taxes and fees.
In the notices, some of which were sent out in late October, the board says that its records show sellers “may be deriving income from California Sources and may have a California filing requirement,” in one case for tax year 2018.
According to the FTB, a seller is “required by law to respond to this demand notice” and, if doing business in the state, “must file a tax return and pay the appropriate tax and applicable fees.”
The board said in a statement that its actions aren’t the result of a new policy, and that such notices go out because the California Department of Tax and Fee Administration (CDTFA) passes on information to the FTB about taxpayers’ California sales tax obligations.
“We have been pursuing cases based on sales tax returns for years,” according to the FTB’s statement. “The demand for tax returns is sent because we have information that leads us to believe an entity may have a filing requirement.”
If a taxpayer believes it doesn't have a filing requirement, “they can fill out the attached questionnaire and substantiate why they don’t have a filing requirement,” the board said.
According to Paul Rafelson with the Online Merchants Guild, at least some of the messages appear to be going to FBA sellers that registered with the CDTFA after it pursued them in recent years for unpaid tax on sales they made into the state. Before the Supreme Court issued its decision in South Dakota v. Wayfair, a state still had to prove that a seller had some form of physical presence to require the seller to collect and remit the sales tax.
California, like other states, has asserted that FBA sellers — many of whom hadn’t been collecting or remitting sales tax on their sales — have a physical presence in the state because Amazon stores their goods in its California warehouses prior to sale. According to the CDTFA, those sellers therefore owe the state the unpaid sales tax on their pre-Wayfair sales.
Rafelson said he's been contacted by FBA sellers who are now “getting letters saying they need to file income tax returns.” Rafelson, along with the guild, represents many FBA sellers that have been pursued by the CDTFA. When the CDTFA began seeking taxes from FBA sellers, some “got scared, and registered, and those registrations are getting turned over to FTB, and they’re sending out these [business income tax notices] automatically,” he said.
Scott Peterson, director of government affairs with Avalara, said he believes the FTB’s actions are normal and that a seller registering to comply with sales tax in a state would typically put the business on a tax agency's radar for potential income tax filing obligations.
“This is normal tax administration,” Peterson said.
But the development is a double blow for the FBA sellers being pursued for prior sales taxes, according to Rafelson, who argues that the state has no right to go after the sellers for sales tax payments on past sales in the first place. He and the guild have argued against the idea that the FBA program’s storage of sellers’ goods in-state created physical nexus with California and recently initiated a new lawsuit against the state over the CDTFA’s efforts to get unpaid sales taxes from FBA sellers.
The suit, Online Merchants Guild v. Maduros, which was filed in federal court in September, argues that the CDTFA’s assertion of nexus by sellers violates the due process clause and other provisions of the U.S. Constitution.
Rafelson said the unpaid sales tax obligations the CDTFA has imposed on some FBA sellers is a hardship for many of the business owners and that the possibility of those sellers also having to pay state income taxes would make their situation worse.
Notably, after the Wayfair decision, California’s lawmakers in 2019 approved legislation that requires marketplaces like Amazon to collect and remit the sales tax due on its third-party sellers’ sales into the state. They also approved that same year a limited amnesty for FBA sellers that allows sales tax forgiveness for sales conducted before 2016 for sellers that meet specific conditions, but Rafelson argued the amnesty was insufficient.
Whether California considers an FBA seller to owe franchise fees and income tax depends on whether it believes the sellers have been doing business in California. Under the state’s rules, an entity is doing business in the state if it engages in any transaction for the purpose of financial gain within California; is organized or commercially domiciled in California; or makes a specified percentage or amount of sales or has a specified percentage or amount of property or payroll in the state — the thresholds are either 25 percent of total annual sales or 25 percent of property or payroll; or, for 2019, $601,967 in total sales, $60,197 in property, or $60,197 in payroll. An entity doing business in California must file an income tax return and pay the state’s franchise fee, even if it owes no income tax.
Remote sellers are generally protected from a state’s income taxes by Public Law 86-272, which asserts that states can’t assess income tax on sales of tangible goods by sellers whose only activity in the state is to solicit sales. But P.L. 86-272 may not apply to FBA sellers. Notably, storing inventory in a state prior to sale, which is what California and other states view FBA sellers as doing, could exempt a seller from P.L. 86-272’s protection.
A Multistate Tax Commission work group focused on P.L. 86-272 has said in a draft update to the MTC's guidance that storage of a seller’s inventory in an in-state warehouse by an online marketplace like Amazon “defeats the business’s P.L. 86-272 immunity in those states where the fulfillment centers are located.” Peterson told Tax Notes that he believes P.L. 86-272 requires that a seller's in-state property “be de minimis and directly related to selling” for the law’s protection to apply.
Requiring FBA sellers to comply with income tax laws in California would be extremely burdensome, Rafelson said.
“It’s a real mess for these people. And this is just one state,” Rafelson said.
Rafelson said he hopes that the federal court will rule against California’s position that FBA sellers have nexus by virtue of their use of Amazon’s service, which he said would not only help sellers avoid sales tax payments the state is seeking but potentially also hinder the state’s ability to obtain income tax payments from FBA sellers.
A win in federal court “would be helpful in this issue as well,” Rafelson said.