If you are an Internet seller of goods or products and have customers located in North Carolina, you should know about North Carolina’s Internet sales tax rules. These rules have been a matter of some debate in North Carolina, as well as in other states and at the federal level. More particularly, in 2009, North Carolina enacted special legislation that effectively forces larger, ostensibly out-of-state Internet retailers to collect and pay sales tax.
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 North Carolina. 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.
While the physical-presence rule may seem clear, in the case of North Carolina, as well as a fair number of other states, this is not necessarily the case. The type of “nexus” the Supreme Court found relevant for mail-order businesses was based on the Commerce Clause of the Constitution, which—as described by the Supreme Court—means physical presence. However, many states, including North Carolina, have used the term “nexus” rather than “physical presence” in their sales tax laws in ways that arguably may go beyond physical presence.
The definition of physical presence—or nexus—specifically under North Carolina law has become more complicated since new state legislation was passed in 2009. However, you can find initial guidance by referring to North Carolina General Statutes, which defines the term “engaged in business.” The definition includes not only what is in the list above (including places of business in the state controlled directly or indirectly), but also retailers that make a “remote sale” if certain additional conditions are met. As further discussed below, the combination of remote sales and certain conditions is part of the new, 2009 legislation.
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.
The following simplified examples would apply in the absence of special state rules; keep in mind that, as of 2009, North Carolina does have such special rules for larger Internet retailers.
Example 1: You are operating solely out of a warehouse in Sioux Falls, South Dakota and make a sale to a customer in Winston-Salem, North Carolina—a state where your business has no physical presence: You are not required to collect sales tax from the Winston-Salem customer.
Example 2: You are operating solely out of an office in Greensboro, North Carolina and make a sale to a customer in Raleigh, North Carolina: You are required to collect sales tax from the Raleigh customer.
Example 3: After several years of operating solely out of a warehouse in Sioux Falls, South Dakota, you open a one-room satellite office just outside of Charlotte, North Carolina—a state where previously you had no physical presence. A day later, you make a sale to a customer in Durham, North Carolina: You are required to collect sales tax from the Durham customer.
Some items sold via the Internet to North Carolina customers may be exempt from sales tax under North Carolina law. For example, computer software “designed to run on an enterprise server operating system” is exempt from sales tax. For a complete description of all tax-exempt items and transactions, review all sections of N.C. Gen. Stat. 105-164.13.
North Carolina also has an annual sales tax holiday from the first Friday in August through to the following Sunday. The tax holiday covers such things as clothing and shoes costing less than $100, school supplies costing less than $100, and computers costing $3,500 or less. For additional information, check the August sales tax holiday website, as well as Section 34-24 of Tax Technical Bulletin 34, both published by the North Carolina Department of Revenue (DOR).
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.” The DOR has a webpage providing basic guidance on the use tax, as well as a FAQ page on the use tax. The DOR’s basic guidance states that “Out-of-state retailers that are not ‘engaged in business’ in this State cannot be required to collect North Carolina's tax,” and that such retailers include out-of-state businesses selling over the Internet. Similarly, the FAQ page mentions that items purchased on the Internet may be subject to use tax.
For additional information, you can check the use tax statute, N.C. Gen. Stat. 105-164.6.
North Carolina’s “Amazon Law”
In 2009, the North Carolina legislature amended the definition of “retailer” and updated its rules regarding “remote sales.” These changes have the effect of requiring larger Internet retailers with no physical presence in North Carolina, but meeting certain other conditions, to collect and pay North Carolina’s sales tax. Similar laws have been at least considered, and sometimes enacted, in various states around the country; they are commonly known as “Amazon Laws.” As you might guess, the name refers to Amazon.com, which is a large, Internet-based retailer that does not have a physical presence in many states, and therefore, under the default sales tax rule, need not collect sales tax from customers in those states. As customers in those states often do not pay the corresponding use tax, Amazon’s sales, and those of other large online retailers, such as Overstock.com, are frequently understood to constitute significant lost tax revenue for those states.
Under the new law, if an out-of-state Internet retailer has what is commonly known as a “click-through” arrangement with one or more persons located in North Carolina, and meets a few other conditions, the retailer must collect sales tax. More specifically, an out-of-state retailer needs to collect sales tax from North Carolina customers if that retailer:
- has an agreement with one or more North Carolina resident to refer potential customers to the retailer via a website link or otherwise
- compensates the resident or residents in North Carolina for directing potential buyers to the retailer, and
- the retailer’s “cumulative gross receipts” from such directed sales to North Carolina customers exceeds $10,000 during the preceding 12 months.
The North Carolina DOR has published a bulletin that covers the main changes that the state legislature made to North Carolina’s tax laws in 2009. The bulletin has brief but useful sections on the change in the definition of “retailer” and on the new law on click-through arrangements.
It is worth noting that North Carolina law states that “A nonresident retailer who purchases advertising to be delivered by television, by radio, in print, on the Internet, or by any other medium is not considered to be engaged in business in this State [i.e., is not required to collect and pay sales tax] based solely on the purchase of the advertising,” thereby distinguishing Amazon-style click-through arrangements from some other types of Internet-based presence in North Carolina.
In 2009, in advance of North Carolina’s passage of the law, Amazon.com shut down all click-through arrangements with North Carolina residents.
For most small online businesses, it is the long-established “physical presence” rule that provides primary guidance on collecting tax on sales to customers in North Carolina. However, the issue is contentious, as demonstrated by the Amazon law enacted in North Carolina in 2009. Therefore, consider checking in periodically with the North Carolina 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.