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. Collection of sales tax on Internet sales has been a matter of ongoing debate both within individual states and at the federal level.
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 a1992 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:
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.
Examples of Physical Presence
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.
While the physical presence rule may seem clear, that is not necessarily the case. In Quill, the Supreme Court discusses not only physical presence, but also several types of potential nexus (connection) between a business and a state. Many states, including Kentucky, have used the term nexus rather than physical presence in their sales tax laws or other official documents, and have defined nexus in ways that could go beyond physical presence.
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.)
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 documentbriefly 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.
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.
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. An online document from the Kentucky DOR suggests that Kentucky customers who make “purchases through the Internet . . . may owe use tax in Kentucky.” Moreover, another DOR online document indicates that the Kentucky DOR considers use tax as a “back stop” for sales tax. Finally, a third DOR online document states as an example of when use tax may be due the purchase of items “through the Internet” where the buyer did not pay the state’s sales tax.
At the federal level Congress has repeatedly considered legislation that would affect large Internet retailers and how online sales taxes are collected in all states. The most recent form of a proposed federal law is the Marketplace Fairness Act of 2015. As in previous versions, the 2015 Act 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.
For most small online businesses, it is the long established physical presence rule that will apply in Kentucky. However, because Internet sales tax is a subject of ongoing debate, you should consider checking in periodically with the Kentucky Department of Revenue to see if the rules have changed.
Updated: April 27, 2016