If you are selling goods or products online and some of your customers are located in California, you need to be aware of California’s Internet sales tax rules. Keep in mind that collection of sales tax on Internet sales has been a matter of ongoing debate both within individual states and at the federal level. California is one of a number of states that has enacted special legislation (known as Amazon laws) that effectively forces larger, out-of-state Internet retailers to collect and pay sales tax.
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, physical presence means having:
The corollary to the physical presence rule is that, if you do not have a physical presence in the state, you are not required to collect sales tax for an Internet-based sale to someone in that state. However, California has special rules that apply to certain larger Internet sellers that make them subject to sales tax laws even without a physical presence in the state (see California’s Amazon law, below).
Examples of Physical Presence
Example 1: You are an online retailer located in Memphis, Tennessee and make a sale through your website to a customer in Santa Monica, California—a state where your business has no physical presence: You are not required to collect sales tax from the Santa Monica customer (with the exception of sellers who fall under California’s Amazon law).
Example 2: You are an online retailer located in San Francisco, California and make a sale through your website to a customer in Santa Monica, California: You are required to collect sales tax from the Santa Monica customer.
Example 3: After several years of operating solely out of a warehouse in Memphis, Tennessee, you open a one-room satellite office just outside Los Angeles, California—a state where previously you had no physical presence. A day later, you make a sale through your website to a customer in San Diego: You are required to collect sales tax from the San Diego customer.
Under a law that went into effect in 2012, larger Internet retailers with no physical presence in California are required to collect and pay California’s sales tax under certain conditions. More specifically, an out-of-state retailer must collect sales tax from California customers if that retailer:
Similar laws have been enacted in other states; they are commonly referred to 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 where it sells merchandise. Under the default physical presence rule, this type of seller would not have to collect sales tax from customers in states where it has no physical presence. Since most customers don’t pay the corresponding use tax, online sales by large online retailers like Amazon and Overstock.com constitute a significant lost tax revenue for many states. Amazon laws are enacted to try to reduce this loss.
California’s Amazon law is distinctive mainly because of the final condition listed above. Unlike analogous laws in other states, the law in California only applies if an out-of-state retailer not only has more than ten thousand dollars in click-through sales, but also has overall California sales exceeding one million dollars.
While the physical presence rule may seem clear, this is not necessarily the case. InQuill, the Supreme Court discusses not only physical presence, but also several types of potential nexus (connections) between a business and a state. Many states, including California, have used the term nexus rather than physical presence in their sales tax laws, regulations, or other official documents, and have sometimes defined nexus in ways that could go beyond physical presence.
For a more specific statement of what counts as physical presence under California law, consult Section 6203 of California’s Revenue and Taxation Code. With the exception of the state’s Amazon law, California law generally adheres to the Quill decision.
Certain items sold via the Internet to California customers may be exempt from sales tax under California law. Possible non-taxable items include:
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. Under California law, if an item would otherwise be subject to sales tax, it is generally subject to use tax. For more information, see this online publication from the Board of Equalization.
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 California. However, because Internet sales tax is a subject of ongoing debate, you should consider checking in periodically with the California Board of Equalization to see if the rules have changed.
Updated: April 14, 2016