General Practice, Solo & Small Firm DivisionMagazine


Multistate Sales and Use Taxes


© American Bar Association. All rights reserved. C. Wells Hall III, J.D., is a Charlotte, North Carolina, partner with the law firm of Moore and Van Allen, PLLC. He currently chairs the ABA General Practice, Solo and Small Firm Division’s Tax Committee. Sue A. Sprunger, J.D., C.P.A., is a Raleigh, North Carolina, associate with Moore & Van Allen, PLLC. Her practice focuses on federal and state tax planning and controversies, estate planning, and business transactions.

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As states sought new revenue sources in the 1980s and 1990s, state sales and use tax audits of businesses became more intense. In 1997, sales tax collections were the number one source of revenue for most states.

Many multistate businesses dread the sheer volume of complying with sales and use taxes as well as the complexity of observing each state’s variation in laws, administration, and collection. However, improper collection and payment of sales and use taxes can result in personal liability to officers or other employees of the business.

Thus, it is important for lawyers who assist businesses, especially companies without internal tax departments, to have an overall understanding of the potential sales and use tax issues their clients may face. Specific questions require state-by-state research because each state’s laws are unique.

States generally impose sales taxes on the sale, exchange, or lease of tangible personal property to the ultimate purchaser or consumer. Unless an exemption applies, states compel wholesalers or retailers who engage in business within the state to collect the tax from the purchaser and pay it to the state revenue or tax department. The tax rate imposed upon a taxable transaction may consist of layers collected for different governmental subdivisions, including the state, county, city, and/or a special transit or other authority.

States impose sales taxes as either a general sales tax or a gross receipts tax. In either case, states anticipate that the seller will add the amount of sales tax to the invoice and collect the sales tax from the purchaser. Failure to add the amount of sales tax to the invoice can eliminate the seller’s ability to later collect the tax from the purchaser upon a subsequent audit assessment.

Taxes and the Internet

When states implemented sales and use tax statutes in the early 1900s, the concept of an electronic business society would have been considered a fantasy or science fiction. Today, legislators and businesses struggle to apply current laws to an intangible dimension.

Some business leaders favor an Internet tax moratorium on the premise that the Internet should be "technologically neutral" or a "global, tariff-free zone." Currently, 11 states, the District of Columbia, and 13 home-rule cities in Colorado tax Internet access.

On October 21, 1998, President Clinton signed into law, as part of the appropriations bill, the Internet Tax Freedom Act.1 The act provides for a three-year moratorium on state and local taxes on the Internet; establishes a 19-member Advisory Committee on Electronic Commerce to conduct a study and submit a report within 18 months; grandfathered state and local taxes "generally imposed and actually enforced prior to October 1, 1998"; protects existing tax liabilities; and directs the president to work with multinational stakeholders to advocate establishing the Internet as a global free trade zone.

Tax on Internet access and other services in Texas derives from the 1987 data processing tax. State Comptroller letter rulings interpret the tax, which applies to services involving the storage or manipulation of data, as applying to most Internet services. Texas is still struggling with nexus aspects of the Internet.

At the other end of the scale, California recently passed its own Internet Tax Freedom Act providing a three-year moratorium on discriminatory Internet taxes.2 Discriminatory taxes include those that tax Internet access or online computer services at a rate higher than other services. The act acknowledges that taxation of the Internet is a matter of interstate and foreign commerce and should be regulated under Section 8 Article I of the U.S. Constitution. The law also addresses Internet nexus and clarifies that "engaged in business" in California does not include taking orders from customers in California through a computer telecommunications network.3

The passage of the Internet Tax Freedom Act has not silenced the debate over nexus4 and taxation on the Internet. Questions remain as to whether the federal government will design the sales and use tax system of the future, or whether state and local governments will retain the responsibility for this turf.5


1. The Internet Tax Freedom Act is identical to S. 442 passed by the Senate on October 8, 1998, by a vote of 96 to 2.

2. Cal. Rev. & Tax Code § 65001 et. seq. (approved by the Governor on August 21, 1998).

3. Cal. Rev. & Tax Code § 6203(d)(1).

4. According to IRS National Taxpayer Advocate Val Overson (a member of the National Tax Association (NTA) Communications and Electronic Commerce Tax Project), the Advisory Commission "could be the market for the results of the NTA Project." The Project is studying parallel issues, including the future impact of Quill. See Tax Analysts State Tax Notes, Vol. 15, No. 17 (October 26, 1998).

5. See Tax Analysts State Tax Notes, Vol. 15, No. 16 (October 19, 1998). See also Tax Analysts State Tax Notes, Vol. 15, No. 10 (September 7, 1998) (surveying representatives of nine of the 12 Colorado home-rule cities that currently tax the Internet). Representatives expressed concerns that governments would be forced to find new revenue sources; local businesses would be at a competitive disadvantage against Internet businesses; and large companies would find legal loopholes by starting Internet setups. Id.

States implemented use taxes to complement the sales tax. When an in-state individual or business purchases or leases tangible personal property from an out-of-state vendor with no nexus in the state, the state cannot, because of constitutional restraints, require the vendor to collect sales tax. To maintain parity between in-state and out-of-state purchases, states passed legislation imposing a tax on the storage, use, or other consumption within the state of tangible personal property (i.e., a use tax).

Generally, states allow a credit against the use tax for sales tax remitted to either the home state or another state in order to eliminate double taxation on a single purchase. Some states limit the credit allowed to state taxes and do not allow any credit for local taxes paid or incurred.

States encounter difficulties in collecting use taxes because of the small amount of annual liability per taxpayer compared with the cost to the state of auditing each taxpayer. In an attempt to generate compliance with use tax laws, some states require an attestation on the income tax return that no use tax is due for the year. Other states aggressively establish use tax nexus on the part of the out-of-state vendor, requiring the vendor to collect the tax from the consumer.


If states taxed every item sold at exactly the same tax rate, it would simplify a company’s compliance with the laws. However, for reasons of public policy, states provide exemptions from sales tax or reduced tax rates for certain types of property or transactions. Most notably, states exempt sales for resale.

For example, if a wholesaler sells an item of tangible personal property to a retailer for ultimate sale to the consumer, the transaction between the wholesaler and the retailer is exempt from sales taxes. This exemption ceases to apply if the retailer withdraws the item from inventory for use in the retailer’s own business.

Other types of exempt transactions may include sales to exempt organizations, occasional sales of tangible personal property, sales of substantially all the assets of a business, or transfers pursuant to certain types of mergers or reorganizations. Products that may fall under some type of tax reduction or exemption generally include food, agricultural products for use on a farm, medicines and drugs, or goods used in manufacturing. Not all states provide for the foregoing exemptions or rate reductions. Thus, each state’s laws must be carefully reviewed prior to claiming an exemption or reduced rate of tax.

States generally construe exemptions to sales or use taxes very narrowly. In one situation, a statute provided an exemption from sales tax for a sale of substantially all of the assets of a trade or business. The company operated two locations and sold the two locations to the same purchaser. However, the transfers of the two locations were not consummated simultaneously. The sales tax examiner contended that the transaction did not meet the letter of the statute and disallowed the exemption. On appeal, the company may be granted the exemption. However, from a planning perspective, including the two locations in one asset purchase agreement might eliminate the agony and expense of such an audit.

Other Transactions

Most states impose sales and use taxes on the sale, exchange, or use of tangible personal property. However, some states also impose these taxes on services revenues. For example, Florida has been very aggressive in imposing sales taxes on services provided and real estate leased within the state.1 Texas, which does not have a personal income tax, followed Florida’s example and taxes the provision of many services.2

Some of the taxable services include: amusement; cable television; personal; motor vehicle parking and storage; repair, remodeling, maintenance, and restoration of tangible personal property; information; and real property. Counsel for service businesses that engage in business across state lines must review tax statutes to determine whether the service such businesses provide will be a taxable transaction.

Sales and Use Tax Nexus

The Due Process3 and Commerce4 Clauses of the U.S. Constitution limit the ability of a state to impose sales and use taxes on certain transactions. According to the Supreme Court, the Due Process Clause only requires "minimum contacts" such that maintenance of a suit in the jurisdiction "does not offend traditional notions of fair play and substantial justice."5

According to the Court, states satisfy due process and can exert jurisdiction, including tax nexus, based upon activities that are purposely directed toward the forum state such that one could reasonably anticipate that her acts would subject her to the state’s jurisdiction. In 1985, the Court found that a franchisee’s breach of a contract with a Florida franchisor was sufficient to justify jurisdiction by Florida courts of law.6 Thus, due process does not require physical presence within the jurisdiction.

The Commerce Clause, however, forbids a state from placing an undue burden on interstate commerce. Under the Commerce Clause, a state’s imposition of a tax will generally pass muster if the following requirements are met:

1. The taxpayer has substantial nexus with the taxing state.

2. The tax is fairly apportioned.

3. The tax does not discriminate against interstate commerce.

4. The tax is fairly related to the benefits provided by the state to the taxpayer.7

The Court stated that Congress had the power to enact permissive legislation enabling the imposition of some type of uniform collection responsibilities on out-of-state vendors. However, to date, bills introduced into Congress to grant such powers to states have not passed.8

States disagree on the meaning of "substantial nexus." Some states, such as Rhode Island,9 hold that the slightest presence by a business in the state constitutes substantial nexus. Other states require more than occasional visits by company employees, even if accompanied by a large sales volume.10

To date, the Supreme Court has not decided this issue11 and denied certiorari in a recent Florida case.12 The Florida Supreme Court held that an annual three-day convention in Florida did not amount to "substantial nexus" sufficient to allow the state to impose use tax collection responsibilities. Employees of the out-of-state vendor sold goods at the convention and the company collected and remitted sales tax to Florida on convention sales.

Based upon the decision, the Florida Supreme Court treated the vendor as having nexus while in the state but found that the Florida nexus did not survive the company’s annual departure from the state. Some states have attempted to counteract the question of transitory nexus by passing legislation stating that nexus survives for a number of months after the company’s departure from the state.

Mail Order Retailers

The application of sales taxes to mail order transactions has been a controversial issue throughout the past 40 years. As noted above, the U.S. Constitution limits a state’s ability to impose use tax collection requirements upon an out-of-state business.

In 1967, the Supreme Court, in National Bellas Hess v. Department of Revenue,13 held that National Bellas Hess, an out-of-state mail order retailer whose only contact in Illinois was the mailing of catalogs and delivery of goods by common carrier or the United States Postal Service, did not have sufficient nexus with the State of Illinois to be required to collect use tax on shipments it made to Illinois purchasers.

The Court differentiated these facts from those in Scripto, Inc. v. Carson,14 where the Court upheld Florida’s imposition of use tax collection requirements on Scripto. Scripto used independent advertising brokers to solicit sales from Florida residents. In National Bellas Hess, the majority of the Court depicted Scripto as the "furthest constitutional reach to date of a State’s power to deputize an out-of-state retailer as its collection agent."

After numerous states enacted statutes requiring out-of-state vendors to collect use taxes on mail order sales, the test case of Quill Corp v. North Dakota15 made its way to the Supreme Court. Quill’s only presence in North Dakota was by common carrier or the U.S. mails. The Court analyzed Quill under both the Due Process Clause and the Commerce Clause and drew distinctions between the nexus required by each.

Finding that Quill Corporation had purposely availed itself of the state’s economic market, the Court nonetheless held that, absent enabling congressional legislation under the Commerce Clause, the state could not impose use tax collection responsibilities on an out-of-state vendor whose only presence within the state was delivery by common carrier or the U.S. mails. After Quill, statutes in other states imposing use tax collection responsibilities on out-of-state vendors have also been held invalid.

In 1986, Congress passed Public Law 86-27216 as a stop-gap measure to restrict states’ imposition of net income tax on taxpayers engaged solely in interstate commerce. Public Law 86-272, as interpreted by the Supreme Court, provides nexus immunity from the imposition of net income taxes on out-of-state vendors unless the vendor’s activities within the state extend beyond "mere solicitation" are more than de minimis.17

Although the standards for sales and use tax nexus under the Commerce Clause and Quill differ from those for income tax nexus under Public Law 86-272 and Wrigley, some states apply similar analyses in determining "substantial nexus" for sales and use tax purposes as they do in determining the "more than de minimis" income tax nexus standard.

One of the questions remaining after Quill, whether delivery must be made by common carrier or the U.S. mails for the company to retain sales and use tax nexus immunity, may test how analogous states view the two standards. The Multistate Tax Commission Sales and Use Tax Guidelines state that an out-of-state catalog seller of tangible personal property that delivers the property by means of a contract carrier, rather than a common carrier, will be outside the Quill parameters for retaining use tax nexus immunity.18 By comparison, Massachusetts, Virginia, New York, and Maryland, among others, provide that protection of the income tax immunity afforded by Public Law 86-272 is not lost by using private vehicles. The issue remains to be decided.

Even if the state permits use of the company’s own trucks without creating sales and use tax nexus, a company’s backhauling activities generally create nexus.

Drop Shipments

Another controversial area of sales and use tax liability involves drop shipments. A drop shipment can occur when a retailer in State A orders goods from an out-of-state wholesaler in State B. The State B wholesaler directly delivers the goods to a State A purchaser (who is a customer of the State A retailer). In this example, states generally hold that the transaction between the purchaser and the retailer is subject to sales tax; whereas the transaction between the retailer and wholesaler is exempt as a purchase for resale.

A drop shipment can also occur where a retailer in State B has the State A wholesaler directly ship goods to a State A purchaser. A state may attempt to impose use tax collection responsibilities on the State A wholesaler. Some states, including North Carolina,19 refuse to telescope the two transactions into one. These states find that the sale between the wholesaler and retailer is exempt as a sale for resale, and that the state cannot impose sales or use tax collection responsibilities on the out-of-state retailer due to lack of nexus. In such cases, the State A purchaser is liable for remitting use tax to the state.

California, however, recently held that the in-state wholesaler in the foregoing transaction was subject to sales tax collection responsibilities and liabilities.20

Voluntary Collection Agreements

Because of the complexities inherent in determining whether a company has sales or use tax nexus within a state, some states implemented legislation permitting a company to enter into an agreement with the state wherein the company would voluntarily collect from the consumer at least a portion of the tax due on a transaction.

Voluntary collection statutes may include provisions limiting the liability of the business to amounts collected in good faith—even if the ultimate tax liability exceeds the amount collected. Failure to comply with the terms of the agreement subjects the company to the normal interest and penalty provisions.

Responsible Persons

States consider sales and use taxes collected from purchasers and consumers as being held "in trust" for the state even if the seller fails to collect the tax from the purchaser. Thus, failing to pay sales or use taxes to the state is a very serious offense. Under certain circumstances, a state may impose personal liability for the tax; and penalties and/or interest on the company’s officers, owners, or another person within the business who is responsible for the signing of the returns or payment of the tax. Exercise of reasonable care by the responsible person may permit the state to eliminate the liability against that person.

Transferee liability for sales or use tax and the associated penalties and/or interest may also be imposed. Statutes may attach a lien for unpaid sales taxes against property transferred for inadequate consideration (e.g., gifts). Other statutes require purchasers of the assets of a business to withhold from the purchase price funds sufficient to pay any tax liabilities that might be owed on the transaction. Extinguishment of the transferee liability may depend on receiving proof that the taxes were paid or a certificate from the state attesting that the transaction meets a statutory exemption. CL


1. See Fla. Stat. ch. 212.05 (1998).

2. See Tex. Tax Code Ann. § 151.0101 (West 1998).

3. U.S. Const. amend. XIV, § 1, as applied to the states (prohibiting a state from depriving "any person of life, liberty or property, without due process of law").

4. U.S. Const. art. I, § 8, cl. 3 (granting to Congress the "power to regulate commerce with foreign Nations, and among the several States, and with the Indian Tribes").

5. International Shoe Co. v. Washington, 326 U.S. 310 (1945).

6. See Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985).

7. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 273, 279 (1977).

8. Congress has yet to pass the Bumpers Bill introduced in 1995. See Consumer and Main Street Protection Act, S. 545, 104th Cong. (1995).

9. See Koch Fuels, Inc. v. Clark, 676 A.2d 330 (R.I.), cert. denied 117 S.Ct. 301 (1996).

10. See, e.g., New York TSB-A-97(6)(C); TSB-A-97(7)(C) (participating in trade shows does not create taxable nexus if activities do not exceed solicitation or order taking); Cal. Rev. & Tax Code § 23104 (participating in trade shows does not create taxable nexus unless the activity exceeds seven days a year or generates more than $10,000 in gross revenue attributable to the state); Iowa HF 354 (1/1/97) (providing trading or education seminars does not create taxable nexus); S.C. Rev. Rul. 98-3 (providing attendance at trade shows for 14 or fewer days per year does not create taxable nexus); Texas Comptrollers Decision, Hearing No. 34,833 (4/18/97) (conducting seminars within the state goes beyond mere solicitation and creates nexus); Tennessee SB 2240 (participating in trade shows not exceeding 20 days in a calendar year does not create nexus).

11. See National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977) (finding nexus for the taxpayer due to its substantial activities in California, but stating that the Court was not affirming the "slightest presence" test).

12. Share International, Inc. v. Fla. Dep’t of Revenue, 676 So.2d 1362 (Fla. 1996), cert denied 117 S.Ct. 685 (1997).

13. 386 U.S. 753 (1967).

14. 362 U.S. 207 (1960).

15. 112 S. Ct. 1904 (1992).

16. 15 U.S.C. § 381.

17. See Wisconsin Dept. of Revenue v. William Wrigley Jr. Co., 505 U.S. 214 (1992).

18. MTC Reg. IV.18.(c)(4).

19. See VSA, Inc. v. Faulkner, 485 S.E.2d 349 (N.C. App. 1997); see also Steelcase, Inc. v. Crystal, 680 A.2d 289 (Conn. 1996).

20. See Lyon Metal Products, Inc. v. State Board of Equalization, 58 Cal. Rptr. 4th 906 (Cal. Ct. App. 1997), 68 Cal.Rptr. 285, cert. denied (June 8, 1998).

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