If you are selling goods or products online and some of your customers are located in Texas, 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 Texas. 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 Texas, as well as quite a few other states, 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. The type of “nexus” the Supreme Court ultimately 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 Texas, have used the term “nexus” rather than “physical presence” in their sales tax laws, and, in the process, have sometimes defined nexus in ways that some people may think goes beyond physical presence.
For basic guidance on how physical presence is defined specifically under Texas law, consult Section 151.107 of the Texas Tax Code (Tax Law), which provides a variety of definitions for “RETAILER ENGAGED IN BUSINESS IN THIS STATE.” (The entirety of Texas’s sales tax law is available online as a single PDF file.) The first of the statutory definitions refers to maintaining a place of business in the state directly, or indirectly or through a subsidiary or agent; the fifth definition acts as something of a catch-all, by stating that, if permitted by federal law, a retailer who solicits orders by mail or other media can be required to collect and pay sales tax.
For additional guidance, check Rule 3.286 under Title 34 of the Texas Administrative Code, which provides definitions of when “A person is engaged in business in Texas.” Some of these definitions overlap with the foregoing statute. The Rule begins with the general statement that a person is engaged in business in the Texas “if the person has nexus with the state.”
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. An online publication from the Texas Comptroller of Public Accounts (TCPA) on Internet sales states that businesses with “physical representation” in Texas must collect sales tax, but “An out-of-state seller is not required to collect Texas tax if the seller only conducts business in Texas from out-of-state by mail, telephone, or via the Internet . . . .”
Example 1: You are operating solely out of a warehouse in Bangor, Maine and make a sale to a customer in El Paso, Texas—a state where your business has no physical presence: You are not required to collect sales tax from the El Paso customer.
Example 2: You are operating solely out of an office in Austin, Texas and make a sale to a customer in San Antonio, Texas: You are required to collect sales tax from the San Antonio customer.
Example 3: After several years of operating solely out of a warehouse in Bangor, Maine, you open a one-room satellite office just outside of Houston, Texas—a state where previously you had no physical presence. A day later, you make a sale to a customer in Dallas, Texas: You are required to collect sales tax from the Dallas customer.
Under Texas law, certain items are exempt from sales tax, and certain purchasers may not be required to pay sales tax. For example, most food and food ingredients are exempt from sales tax. You can find information on various exemptions in Rules 3.286 through 3.344 of the subchapter on sales and use tax in the Texas Administrative Code. Also, the TCPA continues to make available online a guide to exemptions, dated September 2007, that focuses on exempt organizations.
Texas also has an annual sales tax holiday from the third Friday in August through to the following Sunday; it covers certain clothing, footwear, backpacks, and school supplies costing less than $100 per item. The TCPA publishes a webpage on the holiday, and more detailed information is available in Rule 3.365 of the Texas Administrative Code.
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 TCPA states on a use tax FAQ page; it states that one of the most common reasons for a purchaser being subject to use tax is purchasing a taxable item “from an out-of-state retailer without paying Texas tax and us[ing] the property in Texas.” The FAQ page goes on to state that if a purchaser “purchase[s] merchandise through a catalog or the Internet from a seller located outside of Texas and use[s] the taxable item in Texas, then [the purchaser] owe[s] Texas use tax on the purchase.” You can find more formal guidance about the use tax in Rule 3.346 if the Texas Administrative Code.
While you might not know it from looking solely at Texas’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 Texas has not enacted any law that would require out-of-state retailers to collect sales tax from Texas customers.
In Texas, the physical-presence rule applies for Internet retailers. However, because the issue has been contentious in many places around the country, you should consider checking in periodically with the Texas Comptroller of Public Accounts 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.