If you are selling goods or products online and some of your customers are located in Kentucky, you need to be aware of the state’s Internet sales tax rules. As you read, keep in mind that collection of sales tax on Internet sales has been a matter of ongoing debate both at the state and federal level.
The federal government is currently considering legislation that would affect large Internet retailers and how online sales taxes are collected in all states. The proposed federal law, called the Marketplace Fairness Act of 2013, would allow states to require sellers not physically located in their state to collect taxes on online and catalog sales made to people in their state. Sellers that make $1 million or less in annual sales and have no physical presence in the state would be exempt from this requirement. States would have to meet certain criteria to simplify their sales tax laws and make sales tax collection easier before they could require sellers to collect the tax.
Below is an article on the current rules on Internet sales tax in Kentucky. The new federal law scheduled to be voted on in May 2013 would affect all state Internet sales tax laws so be sure to check for updates in this area. (We will continue to keep you updated as well.)
The General Rule: Physical Presence in the State
The current default rule throughout the United States is that you must collect sales tax on Internet sales to customers in those states where your business has a “physical presence.” The physical-presence rule is based on a 1992 United States Supreme Court decision, Quill Corp. v. North Dakota, that addressed the obligations of mail-order businesses to collect sales tax on out-of-state sales. The decision has been extended to include online retailers. Generally speaking, a physical presence means such things as:
- having a warehouse in the state
- having a store in the state
- having an office in the state, or
- having a sales representative in the state.
For basic guidance on how physical presence is determined specifically under Kentucky law, consult Section 139.340(2) of the Kentucky Revised Statutes (KRS), which defines “Retailer engaged in business in this state.” Note that the definition includes not only the bulleted items mentioned just above, but also those same types of items when maintained or controlled by “a subsidiary or any other related entity.” (More generally, KRS Chapter 139 is Kentucky’s sales and use tax statute; a main index to all the sections of the statute is available online.)
As you might expect, the corollary to the physical-presence rule is that, if you do not have a physical presence in the state, you generally are not required to collect sales tax for an Internet-based sale to someone in that state.
Note on “Nexus” in Kentucky Sales Tax Law
In its Quill decision, the United States Supreme Court discusses not only physical presence, but also several types of potential “nexus” between a business and a state, including one type based on the Due Process Clause of the Constitution and another type based on the Commerce Clause of the Constitution. The type of “nexus” (or connection) the Supreme Court ultimately found relevant for mail-order businesses was the Commerce Clause version, which, for all practical purposes, is physical presence.
The Kentucky sales tax statute itself does not use the term “nexus,” but various publications from Kentucky’s Department of Revenue (DOR) that interpret that statute do use the term. For example, one DOR online document briefly explains that the state’s “nexus standard” includes “remote sellers” who use “affiliated stores” to receive or exchange merchandise at any location in Kentucky. According to the DOR, such sellers must register to collect Kentucky sales tax. Also, the DOR publishes a questionnaire to help out-of-state business entities that limit personal liability, such as corporations and limited liability companies, determine if they have nexus with Kentucky. The key difference between “physical presence” and “nexus” is that nexus is generally understood to include the physical presence in a state not just of the out-of-state business itself, but also of any subsidiary or affiliated entity. Where an in-state subsidiary entity exists, Kentucky DOR documents suggest the primary entity has an obligation to collect and pay state sales tax.
Example 1: You are operating solely out of a warehouse in Burlington, Vermont and make a sale to a customer in Covington, Kentucky—a state where your business has no physical presence: You are not required to collect sales tax from the Covington customer.
Example 2: You are operating solely out of a store in Louisville, Kentucky and make a sale to a customer in Ironville, Kentucky: You are required to collect sales tax from the Ironville customer.
Example 3: After several years of operating solely out of a warehouse in Burlington, Vermont, you open a one-room satellite office just outside of Lexington, Kentucky—a state where previously you had no physical presence. A day later, you make a sale to a customer in Meads, Kentucky: You are required to collect sales tax from the Meads customer.
Some items sold via the Internet to Kentucky customers may be exempt from sales tax under Kentucky law. For example, KRS 139.480(11) states that various items classified as “farm machinery” are exempt from sales tax. For further information on many exemptions, check Title 103, Chapter 30 of the Kentucky Administrative Regulations, accessible online, which covers general exemptions to the sales and use tax, as well as sections 139.470 through 139.537 of the Kentucky Revised Statutes, which are also available online.
The Customer’s Responsibility
In cases where the online retailer does not have to collect sales tax, it is the customer’s responsibility to pay the tax—in which case it is known not as a sales tax but, rather, a “use tax.” As an online document from the Kentucky DOR suggests that Kentucky customers who make “purchases through the Internet . . . may owe use tax in Kentucky.” Moreover, as another DOR online document indicates, the Kentucky DOR considers use tax as a “back stop” for sales tax. The same document goes on to emphasize that, “As the popularity of web-based and mobile e-commerce continues to increase, the liability of purchasers for payment of the . . . Kentucky use tax also increases” and “When a web-based retailer or any out-of-state retailer does not collect the . . . Kentucky sales and use tax, the consumer is responsible for” paying it.
While you might not know it from looking solely at Kentucky’s sales tax statute, the issue of whether to require online retailers to collect sales tax in states where they have no physical presence has been a matter of significant debate in many states and at the federal level. However, at this time, Kentucky has not enacted any law that would require out-of-state retailers to collect sales tax from Kentucky customers.
In Kentucky, the physical-presence rule continues to apply for Internet retailers. However, because the issue is hotly debated in various quarters, you should consider checking in periodically with the Kentucky Department of Revenue to see if the rules have changed. For more general information on taxes on Internet sales, see Nolo's article Sales Tax on the Internet. And, for information on the rules about collecting sales tax for Internet sales in any other state, see Nolo’s article, 50-State Guide to Internet Sales Tax Laws.