California Now Pursuing FBA Sellers for Franchise Tax

Sales Tax and More has been predicting that the next big battle for Amazon sellers who utilize the FBA program is income tax

FBA stands for fulfillment by Amazon. We thought that it would begin about 12-18 months from now after the states got their arms around the sales tax revenues being remitted by Amazon and the other marketplaces on behalf of third-party sellers. However, it looks like California is not wasting any time and has begun pursuing Amazon FBA sellers starting with the tax year 2018. 

Many Amazon FBA sellers have received letters from the California Franchise Tax Board (FTB) and have reached out to us

The California FTB administers the California income tax which is called the California Franchise Tax. California, unlike most states, has two different agencies that administer their taxes. The other agency is called the California Department of Tax and Fee Administration or CDTFA. The CDTFA administers most other taxes, including sales tax, permits, and licensing.

The letter from the FTB is a demand for a tax return. It says the FTB has checked its records and they have no record of a 2018 return being filed. The letter indicates that the FTB believes the seller has a responsibility based on what appears to be information from the CDTFA. In most instances, the letter is accompanied by a Business Entity Questionnaire. This questionnaire can be completed if the seller does not believe that they are subject to the franchise tax. However, since California believes that inventory in the state, consigned or otherwise, creates nexus we do not believe the use of this form to be merely a delaying tactic.

In fact, we believe that the information provided to the FTB is the list of third-party sellers who had inventory in an Amazon warehouse during 2017. This list was provided to the CDTFA by Amazon. This is also why we believe the state is asking for the 2018 return. 

Historically the FTB has not communicated very well with either the CDTFA or its predecessor the Board of Equalization (BOE). As mentioned earlier we believed this would be an issue in the near future. We thought that once the states got settled with the sales tax being remitted by marketplaces they would request additional information from the marketplaces, especially Amazon in order to enforce income tax compliance on larger sellers. 

So why now instead of 12-18 months from now? It may be because of the COVID-19 pandemic and its related revenue shortfalls. The states need to refill their coffers and this may be one way of doing it. Or it could be a direct response to the Online Merchant’s Guild’s lawsuit regarding sales tax. Or it could literally be due to almost anything else. We just don’t know at this point. Regardless of the timing, it is upon sellers now. 

And it is likely that not just the 2018 franchise tax return that is due. In general, if you are required to file a franchise tax return you are typically required to register with the California Secretary of State (SOS). This typically requires a registered agent and annual reports. It is also likely all years going forward will require a return to be filed. Even though a marketplace is collecting and remitting the sales tax, income is still being earned on those transactions. And heaven forbid they decide to go back further than 2018.

State income tax is not based on your entire income

Instead, it is generally based on the apportioned income to a state. A very simplified explanation is that you take your sales into a state and divide them by your sales everywhere. You then take this percentage and multiply it by your net income. We call this process apportionment and the resulting number is the tax base upon which a tax rate is applied. Sellers generally receive credits in their home state for tax legally paid to another state so in general the amount of tax paid will remain the same unless you're from a state without an income tax or the company is losing money. California has a minimum tax of $800. 

The franchise tax is primarily imposed on corporations; however, there is also a tax on LLCs. Returns for both taxes need to be filed regardless of whether a profit was made during the corresponding tax year. Each tax has a minimum of $800 which is due regardless of whether a profit is made.

We have been asked why FBA sellers are being singled out over other eCommerce sellers and why this is just becoming an issue now. A big part of the answer to both questions is a federal law called the Interstate Income Tax Act of 1959 or Public Law 86-272. This federal law was passed by Congress in response to the U.S. Supreme Court Case Northwestern Cement Co. v. Minnesota, 358 U.S. 450 (1959). The Supreme Court sided with the states and it looked like interstate income would be open game. So congress quickly stepped in passing P.L. 86-272 which nullified the Supreme Court’s decision. What the law basically says is that a state can not impose a net income tax if a company's only activities in the state are the solicitation of tangible personal property, the orders are approved from a point outside the state, and the orders are then fulfilled from a point outside the state. 

So for an eCommerce seller, who has nexus based solely on economic nexus, they will generally be protected by PL 86-272 under current interpretations, although the Multistate Tax Commission (MTC) is looking to modernize the interpretation in light of Wayfair, which may change this in the near future. However, FBA sellers and anyone else with inventory in a state will generally not meet that last criterion. If you have inventory inside a state at least some of your sales will be filled from a point inside the state and the protections of PL 86-272 are all or nothing. So most Amazon sellers will not be protected from PL 86-272 in most states where they have inventory according to the plain language of the law.

The second reason that we see this being a big issue for larger FBA sellers is that information about large sellers is just a question away from the states

Many states say that they can request any information they deem relevant to ensure tax compliance. While we have not seen this yet, we believe it is coming. California got the jump because Amazon had previously provided this information.

We should point out that since the first $800 in California is a minimum tax and not a net income tax, that this $800 is not protected by PL-86-272. For sellers who do not have inventory in California or any other physical nexus, California has an economic nexus that began with the tax year 2011. The threshold in 2011 was $500,000 and it has been adjusted every year since then. The threshold for 2019 is $601,967. So while FBA sellers will have the biggest exposure as they are not protected by PL 86-272, any eCommerce seller who is over the economic threshold may have the requirement to pay the minimum $800.

While California is the first state to pursue Amazon FBA sellers we do not think it will be the last. We will keep you updated as we learn of future changes. In the meantime, if you need help getting through this let us know.

Sales Tax and More is a consulting and solutions firm that provides state and local tax services in all U.S. states, Canadian provinces, and Puerto Rico. In addition to providing sales tax returns services, sales tax registrations, sales tax audit defense, sales tax research, nexus, and taxability reviews, they also provide state income tax consulting and registered agent services. 

By: Michael J Fleming

This blog is intended for educational purposes and not as tax advice. Tax policies and procedures change frequently, so specific information, such as thresholds, rates, etc. included in this blog may have changed since it was originally published. Please request a consultation for more in-depth information.