Preparing for E-Commerce Taxation: The Nexus Issue

Any tax professional whose clients do business over the Internet needs to be aware of the new or different tax obligations those clients may face. Because doing business online has become easier and more accessible to everyone, even small, general tax practitioners may find themselves advising individuals and small business clients on the tax impact of engaging in e-commerce.

While there currently is a moratorium on sales and use taxes on Internet transactions, the companies themselves are still subject to federal, and possibly state, income taxes on their profits. To determine a client’s potential exposure to e-commerce taxation, a CPA first should establish that nexus exists. The practical issue companies face is “creeping nexus” as they continue to grow and their business activities increase across state lines. CPAs, more than anyone else, know the importance of accurate business records, but some—at their peril—might rely on old information about the company’s business activities rather than update their records.

Following is a list of questions that will help a CPA determine whether a client’s Internet business is exposed, through nexus, to possible state or local taxation.

Is the company’s Internet service provider physically present in the state? Does the company have a server located in the state? What telecommunication services does the company use, and where are the providers located? What intangible property does the company have, and where is it located? Does the company have customers in the state? How important are they in relation to the rest of the business? Advertisement Does the company have a brick-and-mortar affiliate in the state? Does the company advertise itself as a business in the state? Does the company have a business telephone number in the state? What provision, if any, is made for product repair services within the state? (For example, the company may sell cars, television sets or appliances.) What are the state tax ramifications for transactions involving barter—for example, with an Internet provider—and for contractual obligations? Barter transactions are likely to be taxable, as they often are an exchange of goods and services.

Source: Adapted from Avoiding Tax Malpractice by Robert Feinschreiber and Margaret Kent. Copyright 2000, CCH Inc. Reprinted with permission.