SALT Considerations of Purchasing (or Selling) an E-Retail Business

This article was originally published in the Journal of State Taxation
Ilya A. Lipin and Corey A. McMonagle walk us through the issues that arise in the purchase or sale of an online retail business.
The online retail business sector, or e-retail, which enables consumers to access products without having to visit a physical store, thrives in the modern marketplace. In 2019, per the U.S. census, consumers spent approximately $601.75 billion on online retail, up nearly 15% from the prior year. Although many businesses saw a drop in sales due to the coronavirus pandemic, it is safe to say that the past year fueled an even greater demand for e-retail.

Given its low barriers to entry, e-commerce is an attractive business opportunity for many. Some entrepreneurs that can identify in-demand products, establish a large online presence through effective branding, marketing and search engine optimization, and effectively leverage existing marketplace platforms and distribution channels may potentially see their small e-business blossom into a multimillion dollar enterprise within a couple of years.
After experiencing success, some business owners may decide to sell their company and use the proceeds to fund a new venture, while others may choose to scale up operations by raising capital from outside investors. In either scenario, the company’s historical operations and tax compliance will be thoroughly reviewed by independent professionals.

This article examines unexpected state and local tax liabilities that are typically uncovered during the due diligence process associated with an acquisition (or sale) of an e-retail business or raising of new capital from outside investors. While these considerations are discussed in the context of businesses that sell tangible goods, similar concepts and conclusions also apply to service providers.


Income, Franchise and Gross Receipts Taxes

An e-retail business can operate from a single domestic or foreign location, employ a handful of workers and take up limited office space. With the existence of third-party logistics (3PL) companies, third-party marketing, including both a more traditional model of hiring agents to market on the company’s behalf or collaborating with social media influencers, and fulfillment and distribution programs offered by marketplace facilitators (e.g., Fulfillment by Amazon (FBA)), even e-retailers that do not own warehouse facilities or distribution vehicles can make their inventory available for immediate shipment across the country. Because a third party is employed to perform these services, an e-retail business operator may believe that it only needs to file a tax return in the state where it has an office and where its employees reside.

A business is required to report and pay state income, franchise and gross receipts taxes to all jurisdictions in which it has sufficient minimum contact to establish nexus. Business activity thresholds vary by state, but one way that nexus is generally created is through physical presence, such as owning or leasing in-state property (office space, warehouse, inventory) or employing human capital (employees, agents, affiliates, or independent contractors).
Nexus also can be created where the company’s sales exceed factor-based or bright-line economic nexus standards. In 2018, the U.S. Supreme Court in South Dakota v. Wayfair rejected the principle that physical presence in a state is required for a remote seller to have sales tax compliance obligations in that state and held that economic presence could create a sales tax obligation. This ruling has empowered numerous states and local jurisdictions to join Alabama, California, Colorado, Connecticut, Michigan, New York and Tennessee in adopting bright-line economic nexus laws for direct taxes (e.g., Chicago and Philadelphia and Hawaii, Indiana, Massachusetts, Pennsylvania and Texas). In addition, some states assert corporate income tax nexus when a corporation has a “substantial economic presence” or “significant economic presence,” and others assert nexus to the “fullest extent of the U.S. Constitution” (e.g., Indiana and New Jersey).  For example, New Jersey asserts that a company deriving any receipts from the state establishes nexus and a filing requirement for corporate income tax, regardless of the amount.

E-retailers utilizing marketplace facilitators and social media influencers often fail to recognize the company’s nexus footprint. For example, under FBA, a company sends its inventory to one Amazon warehouse and from there the inventory can be moved to other fulfillment centers around the country, as required by customer demand. The sellers generally are not notified when and to which location their inventory is moved, but they can request a report summarizing where inventory has been held in the past. Throughout this process, the company holds title to its inventory, which expands the company’s income and sales tax nexus in each state where Amazon holds the company’s inventory in a fulfillment center.
The relocation of inventory according to demand is unavoidable unless the business withdraws from FBA and performs its own fulfillment services. States generally take the position that because the seller can request a report at any time, the seller cannot claim ignorance of the fact that their inventory was in the state. Protections afforded under the federal law P.L. 86-272,1 which prohibit a state from imposing a net income tax on a business that limits its in-state activity to the solicitation of sales of tangible personal property that are filled or shipped from outside the state, likely do not apply to e-retailers using FBA, because shipments from fulfillment centers often occur intrastate. Certain states are actively pursuing remote sellers for this “inventory nexus”; for instance, California’s Franchise Tax Board sent an average of 11,000 notices a year from 2014 to 2016 demanding income tax returns from merchants. Therefore, when performing due diligence for a company that uses marketplace facilitator arrangements, potential buyers and lenders should review historical inventory locations to determine where and when the company may have established nexus.
A similar nexus issue may arise even before the final product is manufactured. Many e-retail businesses rely on domestic contract manufacturing whereby the product is produced in one state and then delivered to a warehouse or fulfillment center for distribution. Physical nexus is created when a business stores its raw materials or inventory at its manufacturer’s facility or warehouse. Nexus also could be established in a “flash title” transaction when the product is shipped or drop shipped from the manufacturer to the e-retailer’s customer or another third party’s warehouse.
Additionally, nexus can be created in each state in which marketplace facilitators or social media influencers are deemed to be agents acting on behalf of the company by allowing it to create and maintain a marketplace in a state. P.L. 86-272 would not apply if these deemed agents solicit sales of any services associated with the product or engage in any other unprotected activity.
The Multistate Tax Commission (MTC), an intergovernmental state tax agency consisting of 47 states seeking to create uniformity in the application of state tax laws, is in the process of updating its guidance on P.L. 86-272. The proposed revisions would make out-of-state retailers exceed the threshold for P.L. 86-272 protections when they engage in business in a state via the internet (e.g., interactive websites, chatbots or placing cookies on customer computers to collect information not ancillary to solicitation of sales of tangible personal property).3 These types of online features, in MTC’s view, are not part of solicitation activities and thus should not be protected under federal law.
Finally, an e-retailer’s entity legal classification may give rise to another concern. While for state and local tax reporting purposes, many taxing jurisdictions conform to the federal income tax flow-through treatment of partnerships and S corporations (passthrough entities, or PTEs), some state and local jurisdictions impose an entity-level tax based on net income or gross receipts. In addition, most states impose withholding obligations at the entity level for income taxes owed by nonresident owners or require that PTEs file composite returns in place of withholding. PTEs need to pay close attention to nexus standards, which, when it comes to bright-line economic nexus standards, sometimes differ from state rules for corporate income tax. That is the case in Michigan, New York and Pennsylvania, for example. In states where taxpayers have established nexus, e-retail businesses formed as PTEs may face exposure for failure to pay entity-based taxes, failure to withhold nonresident income taxes or failure to file composite returns when required.

As a result of the aforementioned issues, e-retail businesses may learn during the due diligence process that they have had nexus and a filing requirement in numerous jurisdictions. If a company had nexus with a state, but never filed a tax return, the statute of limitations remains open, allowing states to go back up to 10 years or more to collect any tax owed and associated interest and penalties.

Sales and Use Tax

Sales and use taxation regimes are operated independently by each of the 45 states and the District of Columbia that have sales and use tax. Some states also have local sales and use taxes that are administered by local municipalities and counties; these local-level taxes are governed by their own ordinances, they use their own tax forms and audits can be conducted by third-party contingency-fee firms.

Companies with sales in the United States are subject to sales tax regimes if they have nexus with a given state, which can be established through a physical presence in that state (payroll, property, agents and inventory held under a marketplace facilitator or 3PL arrangements) or by eliciting sales that exceed economic thresholds (for example, $100,000 of gross sales or 200 separate transactions within the past or current year). Currently 44 out of the 45 states that impose sales tax have economic nexus standards, with the last remaining state without one, Missouri, in the process of enacting one effective beginning in 2023. Even when the cost of products is low, e-retailers can reach the transaction threshold without exceeding the volume of sales threshold. Unlike income taxes, which may be covered by P.L. 86-272 protections, sales taxes are not afforded such protection.

Some e-retailers incorrectly believe that their nexus in a state was established only post-Wayfair. However, as noted above, when an e-retailer used a 3PL, FBA or a similar distribution network, physical nexus was likely present prior to the company’s economic nexus with the state due to the company’s physical presence in the state. Similarly, click-through nexus laws, whereby a remote retailer without physical presence in the state is deemed to have nexus if the retailer has an in-state affiliate making referrals through online banner advertisements (for example, an ad with a link on the referrer’s website), remain in effect in numerous states, including Illinois and New York. When inventory-based, click-through or other type of physical nexus existed and the statute of limitations remains open, the state will look beyond the effective date of economic nexus to collect the tax due.

The seller is responsible for the collection and remittance of sales tax, unless an exemption applies (e.g., sale for resale and a valid exemption certificate is collected). E-retailers selling through a marketplace (commonly referred to as “marketplace sellers” in state legislation) often incorrectly assume that marketplace facilitators always collect sales tax on their behalf. With the intent to simplify sales tax compliance obligations for many small businesses and to collect tax closer to the source of the transaction, marketplace facilitators laws enacted post-Wayfair now require facilitators to collect and remit sales tax on behalf of retailers selling through their platforms in approximately 40 states. However, in about 27 of those states, these marketplace facilitator laws have later effective dates than economic nexus laws. As a result, there may be a gap between the timing of when a marketplace seller first established nexus with a state and when the marketplace facilitator collection requirements took effect.

For example, the economic nexus enforcement date for remote sellers in Tennessee is July 1, 2019, whereas the enforcement date for marketplace facilitators is October 1, 2020. This 15-month gap can create unanticipated and significant exposures for e-retailers if they failed to collect and remit tax when it was due. Other states with a gap of a year or more include Georgia, Hawaii, Illinois, Louisiana, Maryland, Maine, Michigan, Mississippi, North Carolina, North Dakota, Ohio and Wisconsin. Thus, during the due diligence process, potential buyers and lenders should confirm that all sales tax due was collected and remitted by reviewing the e-retailer’s sales tax returns and marketplace sales tax reports.
Marketplace sellers should also be aware that marketplace facilitators are required to collect tax only on sales made through their platform. Therefore, to the extent that e-retailers make sales both through a marketplace facilitator and through their own online storefront in a state where they have established nexus, they are required to withhold and remit sales tax on the storefront sales.
When it comes to taxability, marketplace facilitators may not have detailed knowledge of every good being sold through their platform or whether the retailer provided complete and accurate information about the product. This disconnect may lead to improper characterization of a product for sales tax purposes, which may in turn lead to sales tax either not being collected at all or the wrong tax rate being applied. Thus, potential buyers and lenders should review marketplace reports to confirm the accuracy of sales tax collected and remitted.
To address these difficulties in accurately capturing sales tax, many e-retailers automate their sales tax compliance through software solutions. Automated software solutions offer several benefits, including tracking tens of thousands of tax rates in real time and providing access to taxability information to determine how products and services are taxed in various jurisdictions. During the software’s implementation process, a specific code must be selected that represents the description of the product, which the tax engine uses to make rate and taxability determinations. Haste or do-it-yourself implementation by a non-expert can result in an inaccurate product code selection, which impacts state-by-state taxability decisions. These mistakes can compound quickly when a business has a high volume of transactions, resulting in quickly growing exposures for which the e-retailer and owners may be personally responsible. During due diligence, it is imperative to check if the proper tax code was selected and applied.

Purchases made over the internet, through toll-free numbers, from mail-order catalogs and from out-of-state locations may be subject to use tax when sales tax was not paid. Use tax is also due when a property is purchased for resale but is subsequently consumed or used in the business. For e-retailers, use tax liabilities generally arise when the company provides free samples and giveaways from the company’s inventory. Businesses without a dedicated tax professional generally do not have strong review procedures to monitor whether sales tax was not paid and use tax may be due, thus resulting in growing exposure.


Employment Tax

States that impose a personal income tax require employers to withhold tax on wages paid to employees working in the state. E-retailers that do not track travel by their sales force or other employees outside of the state of residence may have payroll tax and unemployment insurance exposure. In some instances, state payroll withholding rules could require an employer to withhold tax in every state in which its employees work, even for periods of time as short as one day (e.g., Michigan) or where a certain threshold of in-state compensation is reached (South Carolina, at $800). During due diligence, potential buyers and lenders should verify if any independent contractor or employee misclassification issues exist.


Property Tax

States impose taxes on a company’s real or personal property that is owned or leased. E-retailers generally do not own real property and may lease an office or a warehouse; however, these leases are often triple net leases that require the lessee to pay any real property taxes. Several jurisdictions, including Florida, New York City and Philadelphia impose commercial occupancy or rent taxes on leased property. Of the states that impose personal property tax, most exempt business inventory from personal property tax (with the exception of approximately 13 states). However, most states imposing tax on inventory provide for a freeport exemption from imposition of personal property tax if business inventory is shipped to an out-of-state destination within a certain amount of time. During a due diligence review of e-retailers with inventory located in numerous states, potential buyers and lenders should perform analysis to confirm if material exposure may exist.


Unclaimed Property

All 50 states and the District of Columbia have unclaimed property laws that require companies to report and remit various unclaimed property types that have been unclaimed or dormant for a statutorily defined period of time. The purpose of this reporting is to ensure that the property is returned to its rightful owner. Jurisdiction over unclaimed property is in the state of the rightful owner’s address, and if the owner’s address is unknown, the state where the holder is incorporated or formed.

Unclaimed property may include various types of intangible property, as well as some tangible personal property, depending on state law. Common types of unclaimed property include uncashed payroll or commission checks; uncashed vendor checks; unresolved voids, unredeemed gift certificates and gift cards; customer credits, layaways, deposits, refunds and rebates; overpayments and unidentified remittances; and accounts receivable credits, including credits that have been written off and recorded as income or expense (for example, bad debt or miscellaneous income).
For e-retailers, vendor-issued unused gift cards, vendor payments and customer credit card balances can result in exposure. Many start-ups, including e-retailer businesses, do not have procedures to review whether enough time has lapsed to trigger escheat requirements. Audits are now prevalent for all industries and businesses of all sizes and can go back 15 years or more. Most of these audits are multistate in nature, and are conducted by third-party, contingency fee-based firms. Failure to timely escheat the property to the state may transfer exposure to an acquiror.



The purchase of an e-retail business can be a valuable addition to an investor. Prior to the transaction, it is imperative that a due diligence team examine the business’s operations and taxes. Inadequate pre-launch tax planning, coupled with quick growth, often leads to state and local tax exposures (among many others) for e-retailers. For the seller, thorough preparation for due diligence can uncover previously overlooked applicable state and local taxes and opportunities may be available to mitigate exposures prior to the transaction, such as through voluntary disclosure agreements, amnesty programs or taxpayer-initiated disclosures. These preparations can help sellers avoid unpleasant requests for purchase price adjustments, proceeds to be withheld in escrow or other unfavorable indemnity provisions. Conversely, conducting sell-side due diligence can protect the acquiror from buying into potential material tax liabilities that carry over with the business under successor liability laws.
The due diligence process will arm the buyer with insight on how to revise an offer to reflect any exposures found during the process. After the buy-side or sell-side diligence is completed, it is important to have a concrete plan of action to address any issues and exposures found during the process so that in the future the findings do not come back to haunt the parties involved. To the extent any exposures are found, they can be timely mitigated, ensuring a smooth transaction for buyers and sellers.

[1] 15 USC §381, et seq.
[2] California to Marketplace  Sellers: You May Owe Income Tax Too (2),  available at bloombergtaxnews/daily-tax-report-state/ X7RCMA9K000000?bna_news_filter=daily-tax- report-state#jcite.
[3] Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272, proposed revision approved by Executive Committee (nov. 20, 2020), available at Statement-of-Information-proposed-revision-(as-app-by-Exec-Committeel).pdf.

This article is reprinted with the publisher’s permission from JOURNAL OF STATE TAXATION, a quarterly journal published by CCH Incorporated. Copying or distribution without the publisher’s permission is prohibited. To subscribe to JOURNAL OF STATE TAXATION or other journals, please call 1-800-344-3734 or visit All views expressed in this publication are those of the author and not necessarily those of the publisher or any other person.