Archives for July 2018

In many cases, shopping online comes with a major perk—online purchases are not subject to sales tax.  While online purchases are not subject to sales tax, they are generally subject to use tax.  Use tax is not charged by the online seller, but shoppers in many states are required to report purchases subject to use tax on their personal tax returns and pay the use tax liability along with filing their state tax returns.  As you can guess, compliance with this requirement is very low.

States are obviously not happy because they are not able to collect sales tax from online retailers and because online buyers are not reporting their purchases that are subject to use tax.  It’s estimated that online sales surpassed $409 billion last year and according to the U.S. Government Accountability Office, states lose between $8 billion and $33 billion every year.

The reason states are not able to collect sales tax from many online retailers is because a retailer must have a physical presence in the state before the retailer is subject to the sales tax collection requirement.  The Supreme Court in two older cases held that the Constitution requires a physical presence before a business can be subject to a state’s sales tax jurisdiction.  Physical presence could include a retail location, warehouse, employees, or delivery vans in a state.

In-state retailers are also not happy because online retailers are effectively able to sell their products at a discount because no sales tax is imposed.

The Times Are a Changin’

In 2016, South Dakota declared a fiscal emergency based on its inability to collect sales tax from remote sellers.  To combat this, South Dakota passed a law that requires out-of-state sellers to collect and remit sales tax as if they had a physical presence in the state.  The statute applies to retailers that (1) deliver more than $100,000 of goods or services (yes, South Dakota imposes a sales tax on services) into the state or (2) engage in 200 or more transactions for delivery of goods or services into the state.

South Dakota was challenging the physical presence requirement for sales tax.  The case was recently decided in the Supreme Court of the U.S.  In South Dakota vs. Wayfair, Inc. the Supreme Court sided with South Dakota, ruling that the physical presence requirement is outdated.  Given advances in technology, a business may be present in a state in a meaningful way without being physically present in that state.

Example:  Before Amazon.com opened a warehouse in Michigan it was not subject to sales tax in Michigan because it had no physical presence.  Regardless of how powerful a presence it had in Michigan through its website it was not subject to sales tax liability in Michigan.  However, a small retail shop located in Michigan would be subject to sales tax liability.  Should a small retail shop be subject to sales tax even though Amazon.com has a much stronger presence in the state (albeit not a physical presence).

 In the wake of Wayfair, the following items have to be kept in mind:

• States will likely change their sales tax laws to remove the physical presence requirement. Business owners selling into states where they do not have a physical presence should determine what the sales tax requirements are in those states to determine if they have a filing requirement.  As states will update their laws in the coming months and years, regular reviews of state filing requirements should be conducted.
• States still are not free to do whatever they want. The Court in Wayfair pointed out that South Dakota’s statute has several features that pass muster under the Constitution.  First, the law does not apply to businesses that do not meet the $100,000 sales threshold or the 200 transaction threshold.  Also, South Dakota is a member of the Streamlined Sales and Use Tax Agreement, which reduces administrative costs by providing state-funded sales tax software.  States that impose laws that do not have similar safeguards may find their laws invalid.

 

It isn’t easy deciding whether a worker should be treated as an employee or an independent contractor. But the IRS looks at the distinction closely.

Tax Obligations

For an employee, a business generally must withhold income and FICA (Social Security and Medicare) taxes from the employee’s pay and remit those taxes to the government. Additionally, the employer must pay FICA taxes for the employee (currently 7.65% of earnings up to $128,400 and 1.45% of earnings exceeding that amount).¹

The business must also pay unemployment taxes for the worker. In contrast, for an independent contractor, a business is not required to withhold income or FICA taxes. The contractor is fully liable for his or her own self-employment taxes, and FICA and federal unemployment taxes do not apply.

Employees Versus Independent Contractors

To determine whether a worker is an independent contractor or employee, the IRS examines factors in three categories:

• Behavioral control — the extent to which the business controls how the work is done, whether through instructions, training, or otherwise.
• Financial control — the extent to which the worker has the ability to control the economic aspects of the job. Factors considered include the worker’s investment and whether he or she may realize a profit or loss.
• Type of relationship — whether the worker’s services are essential to the business, the expected length of the relationship, and whether the business provides the worker with employee-type benefits, such as insurance, vacation pay, or sick pay, etc.

In certain cases where a taxpayer has a reasonable basis for treating an individual as a non-employee (such as a prior IRS ruling), non-employee treatment may be allowed regardless of the three-prong test.

If the proper classification is unclear, the business or the worker may obtain an official IRS determination by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Year-End Statements

Generally, if a business has made payments of $600 or more to an independent contractor, it must file an information return (Form 1099-MISC) with the IRS and send a corresponding statement to the independent contractor.

Consequences of Misclassification

Where the employer misclassifies the employee as an independent contractor, the IRS may impose penalties for failure to deduct and withhold the employee’s income and/or FICA taxes. Penalties may be doubled if the employer also failed to file a Form 1099-MISC, though the lower penalty will apply if the failure was due to reasonable cause and not willful neglect.

Correcting Mistakes

Employers with misclassified workers may be able to correct their mistakes through the IRS’s Voluntary Classification Settlement Program (VCSP). For employers that meet the program’s eligibility requirements, the VCSP provides the following benefits:

• Workers improperly classified as independent contractors are treated as employees going forward.
• The employer pays 10% of the most recent tax year’s employment tax liability for the identified workers, determined under reduced rates (but no interest or penalties).
• The government agrees not to raise the issue of the workers’ classification for prior years in an employment-tax audit.

Your tax advisor can help you sort through the IRS rules and fulfill your tax reporting obligations.

Source/Disclaimer:

¹Internal Revenue Service. For 2018, the Social Security tax rate is 6.2% and is applied to earnings up to $128,400. The Medicare tax rate of 1.45% is applied to all earnings.