California is Sending Out Franchise Tax Letters
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
For most eCommerce sellers, online marketplaces like Amazon provide great opportunities for growth and increased sales volume. However, just like brick-and-mortar store owners, it is important that these eCommerce sellers stay abreast with all issues related to taxation in the states they operate.
At the end of October 2020, the California Franchise Tax Board started sending out letters to Amazon FBA sellers. This is because the California Department of Tax and Fee Administration (CDTFA) got information from Amazon about its sellers who had inventory in the state in 2017, and now the board is pursuing these sellers starting with the tax year 2018. So, what options do FBA sellers have in regard to these recent tax demands?
In this week's episode of the Sales Tax and More Podcast, Michael J. Fleming is interviewed by his co-host Ellie Moffat about the recent franchise tax letters being sent to Amazon sellers from the California Franchise Tax Board. Michael explains why the letter was sent out, what it says, and what options sellers have in regard to its contents. Stay tuned.
Here’s a glimpse of what you’ll learn:
Michael J. Fleming explains why income tax will be the next problem for large Amazon sellers
Why is California currently pursuing sellers?
Michael discusses the letters being sent out by California’s Franchise Tax Board
What options do sellers have in regards to the franchise tax letters?
Michael's recommendations to Amazon FBA sellers
What complying with the California franchise tax involves
Resources Mentioned in This Episode
Ellie Moffat's email: emoffat@salestaxandmore.com
Michael's Blog Post about the California Franchise Tax Letter
Connect with Michael
Sponsor for This Episode
Sales Tax and More assists companies and their trusted advisors like CPAs with sales tax needs. They offer consulting and research, registrations, returns, and so much more. Over the years they have assisted thousands of sellers both foreign and domestic with their tax issues in the United States and in Canada.
To learn more about their services, visit https://www.salestaxandmore.com/.
Make sure to register and join the Sales Tax and More Webinar to get access to complex materials on tax in an easy-to-understand format.
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More, your go-to resource for all things sales tax-related. Now here is your host, Michael Fleming.
[0:26] Mike: Hi, I'm Mike Fleming, Founder of Sales Tax and More and today's co-host of the Sales Tax and More Podcast, where we talk about everybody's favorite topic, which is, of course sales tax. Today, my co-host, Ellie Moffat will be interviewing me about the California franchise tax and this letter that the California Franchise Tax Board sent out. But before we get started, I'd like to introduce you Ellie.
[0:51] Ellie: Hey, everyone, Mike, it's great to be here. I love talking sales tax with you on these podcasts, definitely my favorite topic. But before we get started, before we get going here, I want to do a quick introduction for Sales Tax and More. Sales Tax and More is a full service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling any of your state tax and related needs. So we do a lot of sales tax returns, sales tax registration, sales tax audits, consulting, research, and like our name states more. If you have questions about our services, please do not hesitate to reach out, we are more than happy to answer those questions for you. So, Mike, I've heard you say that income tax would be the next problem for Amazon sellers. Why is that?
[1:41] Mike: Well, it's for large Amazon sellers. I think we may need to make the distinction there. But for a couple of reasons. Number one, let's break it down to the very basics, nexus. We've got all of this economic nexus and some states actually have an economic nexus for income tax. So we've got to start worrying about this. Plus physical presence nexus has not gone away. Many states believe that having inventory in a state, consigned or otherwise, is nexus creating for income tax. So, we've got these two types of nexus out there. If you only have an economic nexus, well, there's a federal law, it's called the interstate income act of 1959, or public law 86-272. And federal law overrides state law. So what this federal law says if your only activity in a state is the sale of tangible personal property, and all the orders are sent outside the state for approval, and then they're fulfilled from a point outside this state, this state cannot impose a net income tax on you. So as the interpretation of this stands right now, if your only connection with the state is an economic connection, you're protected by this public law. However, for FBA sellers, if you're selling through the FBA, you probably have inventory in a bunch of different states. This is all or nothing protection. So you meet the first two protections. It's that third, excuse me, the first two provisions of this public law, but you can't meet the third one, the one that says that the orders have to be fulfilled from a point outside the state. It's all or nothing. And if you have inventory in a California warehouse, at least some of your orders are going to fail from a point within the state.
[3:55] Ellie: So, okay, Mike, so we've expected this. But I've also heard you say time frames ranging from six months to a couple of years. What happened? What happened, that California is pursuing sellers right now?
[4:11] Mike: You know, we don't really know why that they've sped this up. I have a couple of theories. Number one is the economy. I mean, the states are hurting for cash right now, because of the pandemic and all the closures. They've got to try to fill their coffers quickly. I think that may be one of the reasons why we're seeing a speed up in the enforcement of income tax. Another one maybe, the online merchants guild. They've got a lawsuit going against California. This may be a direct response to that. But we've really just don't know. At this point, it really doesn't matter why they sped up the timeline. We knew that this was going to be a big issue. It's just here a lot sooner than I had expected.
[5:11] Ellie: Okay, well, you know, Mike, it is the spooky season, right? And this is eerily reminiscent of when California sent out the sales tax letters. So it’s deja vu a little bit here.
[5:26] Mike: Yeah, it really is. You know, historically, the Franchise Tax Board had not communicated well with the Board of Equalization (BOE), that was the predecessor to the California Department of Tax and Fee Administration. Up until this point, they really haven't communicated very well with the CDTFA. But this has changed. Why this feels the same, is because it looks like the California Department of Tax and Fee Administration got information from Amazon. Amazon told on all of their sellers. They provided California with a list of everyone who had inventory in this state in 2017. It looks like at this point, the CDTFA just turned that list over to the Franchise Tax Board. The Franchise Tax Board has started sending out letters, just like the CDTFA did with sales tax. I think this is a lot scarier, though, and it is eerily familiar.
[6:41] Ellie: So Mike, what exactly does this letter from the California Franchise Tax Board say.
[6:48] Mike: Number one, it's a demand for a 2018 franchise tax return. So that's their push, that's what they really want you to be doing. They want you to be paying their franchise tax. They say that if you don't believe that you have a responsibility to file, then you can fill out the attached business entity questionnaire. So that came in this letter also. On the demand, they get pretty threatening. I take them as threats. I don't know what else to call them. But they say that you have to respond by 11/25/2020. If you don't, they're going to impose these threats.
[7:41] Ellie: Okay, let's back up just a smidge here, Mike. Threats. What do you mean by threats?
[7:48] Mike: This is really not a laughing matter. But here we are just right before Halloween, and this is scary stuff. First, they say they're going to estimate the amount of tax if you don't respond. They're just going to make up a number. That's always scary to me. Because if you're making up a number, why not make it up as high as you want? I mean, it's a made-up number, it's designed to get your attention. So they're going to make up a number, and then they're going to add a delinquency penalty, then they're going to add a demand penalty, then they're going to add a cost recovery fee, then they're going to add interest, and then they talk about an additional $2,000 fee. These fees, you know, they're not saying we might do this, they're saying, here's what we're gonna do. And, you've got until 11/25 to act. I don't think when the letters came out from the department about sales tax, people dragged their feet and the state didn't do anything. I don't think that we're going to see that same scenario here. I think you got to do something, you got to do one of these options that the state is giving you because I do think they're going to follow through on these threats if you don't.
[9:18] Ellie: Oh, ouch, Mike. Okay, let's… tell me what options the seller has?
[9:26] Mike: Well, the first thing they can do is complete the business entity form. But, this is a delaying action at best for most sellers. I mean, if you didn't have any inventory in California, then I think that you should fill out this form. But if you have inventory there, there could be other reasons why you want to fill out this form also, but that's the biggest reason. They're going to ask in two separate places on the form about inventory. They don't care, it can be consigned inventory, which they specifically talked about, or it can just be general inventory. But if you've got inventory there, which they already know, because they've got this information directly, not directly from Amazon, but Amazon provided the information to the CDTFA, and then they've gotten it from the CDTFA. So, the state already knows you have inventory there. They're giving you an out just in case you have some other reason. But once you tell them, and by the way, there's a penalty of perjury language on this form. Once you, start filling it out if you don't answer it completely, now, they got more threads, they can come after you for. So if you're going to fill out the form, you gotta fill it out, correctly. If you fill it out, and you tell them, you didn't have inventory there, they're gonna come after you. They're not gonna say, oh, we're gonna leave you alone. So you know, at best, I think that this is a delaying action. And it could open up a whole other can of worms. I mean, if you're saying you don't know it, and you fill out this form and provide them all this information, they may come back and say, Oh, you should have been filing for the last six years, seven years, eight years. So, for a couple of reasons. that may not be your best solution. It could be depending on your specific facts. But for most people, it’s a delaying solution at best. The second thing you can do is just comply. I mean, we have a number of people who have contacted us. And they've said, can you just file the 2018 return for us? And yes, we can. It's not just the 2018 return, though, you've got to worry about filing with the Secretary of State, most people who have a responsibility to file the income tax return. Also, by the way, the franchise tax is an income tax. So you'll hear me switch back and forth between franchise tax and income tax. But those people who have a responsibility to file usually also have a responsibility to get registered with the Secretary of State. And then you have to get your registered agent. So there are additional costs associated with this. You can't generally just file the franchise tax form. You can fight the state, that's always an option. Now the state is pretty sure of their position, so they're not going to roll over and play dead. We can try to defend you. But I don't recommend that. I think that if you're going to try to fight this, you're going to need an actual attorney because you're not going to win by talking to the state, you're actually going to have to sue the state. Lots of money is involved in suing a state. So for the majority of sellers out there, it's going to be a cheaper route to go with compliance rather than fighting them. So it's just a very costly proposition to fight a state especially when they're making a stand like this. They can't waver for you because then they have to waver for everyone. And it's just not in the cards as they stand today. The last thing you can do is ignore this. We saw people ignore the letter about sales tax. There's now a lawsuit out there from the Online Merchants Guild for those who didn't comply, plenty of people complied. Once they complied, they didn't have a lot to worry about. Here, if you do nothing, I think that the state is going to act sooner, I don't think they're going to go down the same route, that the CDTFA was, which was, allowing this to stretch out over a period of time. I think that they're giving you a deadline. And I think that there will be ramifications past that deadline. Weren’t very many with the sales tax issue. There still might be. California is still pursuing sellers for sales tax. looking backward, even though California is now collecting Amazon now collecting that tax on a going-forward basis. California is still pursuing people looking backward. So I just don't think doing nothing is the way to go this time.
[14:44] Ellie: So Mike, these four options and what do you recommend for our listeners out there?
[14:50] Mike: All right, here's my favorite answer. It depends. And the reason why it depends is because each scenario has its own set of facts. And depending on those facts, I may choose, option number one, filling out the business entity questionnaire. I may suggest doing nothing. It's going to be very fact-specific. But for the most part, for the majority of FBA sellers, my recommendation would be to comply unless you've got an attorney on staff or you're an attorney and you've got a big legal budget to fight this. I just think that complying is the path of least resistance at this point, and will actually cost you the least amount of money over time.
[15:48] Ellie: So, Mike, if someone complies, then what does that involve?
[15:53] Mike: Alright, so in general, just subject to the California franchise tax, we have already said, you usually have to get registered with the Secretary of State, the Secretary state general has a $100 fee. You can hire someone like us to get your registered, you can register yourself, then there's Registered Agent fees. So you've got to worry about all of that. Also, some people are saying, well, Mike, I didn't make any money, I actually lost money, doesn't matter. California has a minimum tax due or minimum fee due of $800. So even if you lost money, you got to file a return and you're still going to owe this minimum of $800. Corporations are treated differently than LLCs. The corporations, the way that you generally figure this out, is you take your sales in California, divided by your sales everywhere, and you come up with a percentage, you take that percentage, apply it to your net income from your federal return. And that becomes your tax basis for California. That's how you apportion a portion of your income to California. And then you pay the rates, based upon that number, that's a portion to California. With an LLC, it's, it's different, they're going to look at your revenues or your income in California, and it's going to fall inside of a bracket, and then for each bracket, it's going to have a $1 amount assigned to it. With an LLC, you're going to pay a minimum of $800, even if you're losing money. You're going to pay a maximum of $12,590. So, it's going to be somewhere in between the two. So that's what compliance generally involves here, something else, you're going to have to continue filing. So most people, if your company's closed down, and we have talked to some people whose companies have closed after that tax year. These companies obviously don't have to worry about filing going forward. Even if you pull your inventory out of the state, though, you still may have a responsibility to file. because of, the economic nexus, California has an economic nexus of $500. So, depending on how this goes, right now, the multi-state tax commission is looking at updating their protected activities. And because of Wayfair, so that what they're proposing is that even offering customer service through your website, in email, or chat, that's enough to nullify the protections of this public law 86-272. So that's another reason why I think that income tax for all eCommerce sellers is going to be getting a lot tougher. The states are going to be pursuing, sellers a lot more. Most of that is going to come a little bit down the road. It's just that we have to deal with California right now. And it's not going to stop with 2018. They're going to want 2019 2020 going forward, so long as you have inventory in California at this point. This is going to continue to be an issue for large Amazon sellers, and even some smaller ones that may have gotten caught up with this letter going out.
[19:53] Ellie: Thank you so much, Mike, for all of this information. I think it was incredibly helpful. So everyone knows the letters were mailed from California on October 20th. So just last week from when we are recording this podcast, they began arriving about October 23, 2020. As we learn additional information, we will be updating everyone. So make sure you're following along with us on social media that you're subscribed to our newsletter so you don't miss those updates. Mike has also already written a blog post about this, which can be found on our website on our blog, I'll be linking that in the show notes so that that's easily accessible. If you'd like one-on-one consultation with Mike as well to discuss your specific facts, you can sign up in the show notes as well. Or you can go to salestaxandmore.com/consultations. And additionally, as always, we have a lot of resources on our website that are free, and incredibly helpful. We get great feedback about them, we get even better feedback about the paid portion of our website as well. And, yeah, we have services that fill most of, if not all, of your state and local tax needs. So thank you everyone for attending and listening in. We thank you.
[21:15] Mike: Thank you, everyone, and as we said, this is very serious, we feel for those sellers who have gotten these letters and it is something that needs to be taken care of the timing of it, With it being scary and Halloween, that's if we don't smile, we might end up crying. But we appreciate you for listening to this episode, the Sales Tax and More Podcast and we hope to see you on the next one also.
[21:56] Outro: Thanks for listening. Be sure to click subscribe and check out all the resources we have out on the web.