Direct selling companies and multi-level marketing (MLM) businesses have numerous complexities to consider when it comes to sales tax calculation and reporting requirements. Along with an expansive physical nexus footprint, direct sellers must know how their products and services are taxed around the country. It’s a daunting task when facing it alone.
Where are you selling?
Knowing whether or not physical presence nexus has been established is a critical first step for direct sellers. It’s important to consider nexus first because once nexus is established, the responsibility to collect tax begins immediately.
Physical nexus is established through people or property. For example, if a business has employees or contractors, such as distributors or brand ambassadors, then the physical nexus has likely been met. However, even in the absence of a direct salesforce, attending trade shows, conferences or seminars can sometimes be enough. The rules vary from state to state.
Even if you happen to avoid establishing physical presence nexus in a state or two, you also need to be concerned about economic nexus. Economic nexus is established simply through sales activity, and in many states, $100,000 in sales or 200 individual transactions is enough to trigger a sales tax compliance obligation.
Understanding how to tax
Many direct selling companies offer goods that are subject to complex and nuanced sales tax requirements. With every state having a sales tax administer their tax independently, the complexities multiply. For example, 38 states have special tax rules for food. However, each of those states may define “food” a little differently. Several states exclude candy and soft drinks from their food exemption, and within those states the terms “candy” and “soft drinks” can also be defined differently. Does a beverage need to be carbonated to be considered a soft drink? Well, it depends.
Likewise, eight or so states exempt clothing intended for everyday wear from sales tax. Some, like the Commonwealth of Massachusetts, exempt clothing but only on a portion of the sales price. If that were not complex enough, every state with a clothing exemption defines “everyday wear” a little differently. A fishing vest may not seem like something you would wear unless you were actually fishing (usually not an everyday activity) but in some states, fishing vests would qualify.
Layered on top of that are the many temporary sales tax holidays that happen every year, many of which include an exemption for clothing.
When considering your sales tax responsibility, don’t just think about the products your distributors/brand ambassadors market to the public. Consider the services you provide to them. Do you charge your ambassadors a membership fee? If so, what does that membership fee entitle them to? Depending on what they get, the membership fee could be taxed.
Similarly, most direct sellers offer their salesforce a “replicated website.” This is often accomplished through hosted software, or software-as-a-service (SaaS). While not taxable everywhere, access to SaaS software is taxable in many jurisdictions.
When direct selling companies have a thorough understanding of what it takes to be sales tax compliant, they can better ensure their companies meet their legal obligations and avoid audit exposure. Partnering with sales tax experts is always helpful (and sometimes necessary) in achieving a simplified sales tax compliance experience.
Learn more about the sales tax complexities related to direct selling by checking out our webinar with Squire.