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SPECIAL CONSIDERATIONS FOR ONLINE BUSINESSES

Internet Riches Made Easy! How I made $30,000 in 42 days.

—SPAM E-MAIL

WWW = Who, What, Where?

In 1996, when talking to radio and television talk show hosts about an Internet site I had created, I had to devote most of that precious on-air time to explaining what the Internet was, how to get on it, and how to use the site’s address to find the site.

We’ve come a long way, baby! We’ve learned the jargon. We can find websites, with or without their www’s. We can tweet, post on Facebook, IM our friends, or text all day.

Today, no business is complete without a website. Even if you sell nothing, it’s vitally important to establish a web presence. You certainly want to secure ownership of the uniform resource locator (URL) that is your business’s name.

Your website provides information about your business for your clients or customers to access when you’re not available. We are all faced with questions our customers ask over and over again. You can easily provide the information online. With the right software and security, even a small company can arrange for clients, vendors, and customers to look up their own accounts, make corrections, and find information.

The web offers many time-saving tools. It’s easy to set up an online database with your clients’ contact information. In fact, many accounting programs integrate with MS Word or Symantec’s ACT!, Outlook, or your iPhone, BlackBerry, or favorite portable communications device. You can e-mail all your clients instantly when something important happens. Or you can target just a few—just those with children, for example. You simply write the message and click—and they have it. They can respond instantly.

Compare that to the time and cost of writing to a hundred people. You print out all the letters, stuff the envelopes, add postage, and get everything to the post office before the last pickup. The Internet offers so many time-saving applications that you can kill a lot of time, saving time. In fact, you can get lost for hours, can’t you?

All kidding aside, once you stick your toe into the Internet’s web, you’re stuck forever. And all kinds of new tax issues and questions surface.

What? I Thought There Was No Internet Tax

You’re so right. For now, no one may assess you taxes for your use of the Internet.¹ In fact, the Internet tax moratorium bill (HR 3678) passed in October 2007, extending the moratorium on Internet taxes for another seven years. And so on, and so on, and so on. Finally, in February 2016, President Obama signed the Permanent Internet Tax Freedom Act into law. (It was hidden in part of another bill.)²

SEC. 922. PERMANENT MORATORIUM ON INTERNET ACCESS TAXES AND ON MULTIPLE AND DISCRIMINATORY TAXES ON ELECTRONIC COMMERCE.

(a) PERMANENT MORATORIUM.—Section 1101(a) of the Internet Tax Freedom Act (47 U.S.C. 151 note) is amended by striking “during the period beginning November 1, 2003, and ending October 1, 2015”. (b) TEMPORARY EXTENSION.—Section 1104(a)(2)(A) of the Internet Tax Freedom Act (47 U.S.C. 151 note) is amended by striking “October 1, 2015” and inserting “June 30, 2020”.

Subsection (b) means that those states that do tax the Internet have until June 30, 2020, to repeal their laws and come into line with the federal government. So it’s all good, right?

Unfortunately, though, that doesn’t mean you don’t have to pay taxes on the Internet. The legislation only refers to communications activities—being connected to the Internet—access, online services, and hosting services. You can’t pay a separate Internet tax for that. But you are paying taxes, nonetheless.

Have you looked at your phone bill lately? You know, the bill for the phone line you use to be connected—even if it’s a DSL line or cable.

One of my recent phone bills shows:

Holy baloney! That adds 17 percent to each of my phone bills. Are you telling me there are no Internet taxes?

Also, nowhere does any federal law say anything about not taxing income earned online or prevent charging taxes on sales of products and services. Of course you’re going to be taxed.

The real question is, of course, where will you be taxed? To answer that, you must know your nexus.

Nexus

What an odd word—nexus. What is it? A car? A telephone company? A quickie photo shop? No! Nexus means a place where you have a business presence. It sounds pretty simple, doesn’t it?

Not according to Diana DiBello, of Taxnologi Solutions, LLC. DiBello is one of the top people in the country who have seen the broad picture. She once used nearly 80 PowerPoint slides to explain the complexity of this question to an audience of tax professionals. While the average small business owner doesn’t need to know that much information, he or she does need to understand the information that typically affects small businesses.

Start by answering this question correctly: Where is your business located?

•  Is it in your home?

•  Is it at your office?

•  Is it where your website’s server is located?

•  Is it where your webmaster is located?

•  Is it where your post office box is located?

•  Is it where you’ve incorporated?

•  Is it where you’re drop-shipping your products?

•  Is it where your salespeople are?

•  Is it where your affiliates (commissioned sales force) are?

•  Is it where your related companies are?

•  Is it where your merchant account receives your money?

•  Is it where your virtual assistant is located?

•  Is it where your online shopping cart is hosted?

•  Is it where your mailing list is hosted?

•  Is it where your advertising agency or public relations agency is?

•  Is it where you’re running your ads?

•  Is it where your shoppers or customers are located?

Are you starting to get the picture? A business’s nexus can be widespread. But the good news is that with the advent of the Internet, home-based businesses can have customers all over the globe. Literally.

Why Do We Care About Nexus?

Nexus costs money. Even when you don’t think you have a physical presence in a state, that state might believe it has the right to your money. State governments are hungry. With the slump in the economy after the wild ride in the 1990s and again in the early 2000s, state revenues have dropped dramatically. With more people shopping over the Internet, states are also losing the sales taxes they used to count on.

Having to make up the money somewhere, states have tapped into anyone they feel is operating within their reach. And they’ve won. There are solid legal precedents for states to assess income and sales taxes from people and companies that lightly brush the boundaries of their domain.

Perhaps you remember that infamous day in 1991 when Michael Jordan, playing for the Chicago Bulls, was hit by the state of California for a share of his earnings. David Hoffman, Tax Foundation economist and author of the “jock tax” report, explains: “The jock tax began with California trying to get back at Michael Jordan for beating the Lakers in 1991 and Illinois fought back with a retaliatory tax the next year. Ironically, if Jordan rejoined the Bulls in any capacity, he would find himself paying double taxes.”³

Once other states learned that California had succeeded in taxing a transient, they too started to see this as a lucrative new means to replenish their depleted treasuries. The “jock tax” now affects all performers traveling across state lines, traveling sales folks, even Internet businesses. Many of my clients are affected. These days, their employers routinely provide W-2s with all the states’ incomes and withholdings. Some of my film industry clients get three or four W-2s from the same employer for the same show.

As I predicted in the first edition of this book, this has become a major issue for online retailers. In particular, this is affecting the affiliate marketing community—companies that sell their products online with the help of people like you, who put links on your website to promote companies. You do this with Amazon.com, Vista- print, the Wall Street Journal, and more. New York was the first state to get really aggressive about forcing online retailers based out of state to start charging sales tax if they had affiliates in New York. Now you have Colorado and California, too. Commission Junction is keeping tabs on the situation, since it is one of the major players in the affiliate marketplace. You can find the Commission Junction Internet nexus tax map at http://www.cj.com/about-cj/click-through-nexus-tax.

Once you start making a lot of money online, if you’re not aware of how the nexus rules and definitions affect your business, you might find yourself paying taxes to a state you’ve never visited.

For now, most likely, state income taxes on your earnings won’t be your big problem. But sales taxes will be. You’ll also face a problem with those 1099s we discussed in Chapter 9. We’ll talk about both these issues now.

Where Is My Nexus?

I sit here in my living room; it is my principal office. I have several websites. One of the servers is in Colorado. I don’t even know where the other one is. One of my mailing list servers is in Minnesota, or at least the company I pay is. The company may be hosting its server in China, for all I know. My web designer is in Colorado. My corporation is in California. My partners for various ventures are in India, New York, and Portugal. I have a mailing address in California, but my sites’ shopping carts might be in England and Missouri. In fact, I don’t even know where many of my cloud-based services are sourced. Do you? My tax returns are electronically transmitted to the IRS from a company headquartered in California—but with locations all over the country. I don’t know which one transmits my tax returns. My tax clients have been in Africa, Asia, South America, North America, Europe, Australia, New Zealand . . . My affiliates, those people who get a commission for selling my products or referring clients to me, are all over the world.

With all this information, where is my nexus? And what part of it is affected by tax laws?

You’re beginning to see how unclear this can be, even for a small home-based business, once you take it online.

Internet Sales Tax Issues

Many people believe that because the Internet is relatively new—and the topic of online taxes is so new—new ground will have to be broken to establish guidelines for when and how taxes are paid.

Actually, that’s not really true. It’s only new to you, because, suddenly, your local business is selling nationwide or even internationally.

The sales tax issues involved with online transactions are the same ones the mail-order industry has been facing for decades. Currently, domestic sales tax issues are governed by your state’s sales tax department. But what will happen in the long run? The states are getting together to create a system and software that collects sales tax from shoppers, remits it to the correct state automatically, and doesn’t require the vendor to file forms in those other states. For more information on how states are working together, take a look at the Streamlined Sales Tax Project (http://streamlinedsalestax.org). It’s still a long way from being implemented. This project is still just a cooperative committee with certain states taking part of their own volition. Actually, what the states really want is for the federal government to mandate that companies, nationwide, charge sales taxes based on the destination state. DiBello suggests that even if a law like this passes, it’s only practical for the large national companies. There will be thresholds designed to exclude small businesses.

I have no faith in that threshold level. These are the same legislators who think that a luxury auto is any car that costs more than $15,800 and that $100,000 is high income for an entire urban household.

What do you do now? DiBello recommends that you stay tuned in to the status of the legislation so that when it does affect you, you’re prepared.

In the meantime, should you simply ignore sales taxes for out-of-state shoppers?

Sales Tax Case Law

DiBello recently cited interesting situations where states went after companies that have no business presence in a state. Connecticut, for instance, sued Dell Computer for unpaid sales taxes because Dell contracted with a company to provide local service on customers’ computers. The Connecticut Superior Court ruled against the state only because of the low volume of service calls. If the volume of repairs were higher, Dell would be paying sales tax in Connecticut.

Dell got hit because it simply had a contract with a local company.

What about your business?

Perhaps you’re using an affiliate program or agents to sell your products on their own websites or in their own locales. You might just have created an “agency nexus” in their states. An agency nexus occurs when you have a representative in a state. Exactly what constitutes an agent depends on how aggressive the state is.

In another instance, the Scholastic Corporation was hit by California. You’re familiar with Scholastic products. The Junior Scholastic magazines are in every dentist’s office. We all got Scholastic books and publications in school, even preschool. That’s how the publisher got into trouble. Scholastic sold books to students by having their teachers give them order forms and collecting the money. The California Supreme Court held that because the teachers in California schools sell Scholastic’s products, Scholastic does have nexus.

Think about how your business and sales avenues are structured. Will agency nexus affect you?

Sales Tax Nexus and Your Business

Because online sales tax is such a hot issue, I want to make sure you receive the best information possible. Until speaking with DiBello, I took a conservative approach to sales tax collections. I had been advising clients and readers that if they started shipping a high volume of sales to a state, it would be wise to register with that state’s sales tax authority.

After all, you don’t really pay the sales taxes. You collect them from your customers and pass them along to the state. The money only comes out of your pocket if you don’t collect but should.

DiBello clarifies a common misconception about your nexus. Just because you ship a lot of merchandise into any state does not mean you have to collect the sales tax. Under the current status of U.S. sales tax laws, to be required to collect sales tax, you must have “physical nexus” in that state. What do the physical nexus rules mean?

1.  You must have a physical presence in the state.

2.  There must be sufficient benefit to the merchant from the taxes.

3.  The taxes can’t interfere with interstate commerce or give the merchant unfair advantage.

This basically means that unless you have an office or store in that state, you don’t need to worry about collecting sales taxes on your out-of-state sales.

But hiring a contractor or agent in another state to represent you, along with the agent’s other companies, falls under the rules of agency nexus. Of course, if you place your own agent in a state and that person represents you exclusively, you’ve just established a physical presence in that state. For instance, the state of California has a tax collections office in Florida, where many former Californians have retired. California has nexus in Florida. Do you think the state of Florida should be taxing California on the taxes it collects?

You do have to comply with your own state’s rules, but you already know that. You registered with your state’s sales tax department for in-state sales when you went through your checklist in Chapter 1.

Recently, I spoke to a manager in an educational business based in California. Its employees work remotely—one in a distant city in California, another in Montana, and a project manager in South Africa. These first two people are not being treated as freelancers. They are full-fledged employees. So the company had to register its business in Montana in order to set up the payroll there, which means it also has to file business tax returns in Montana. It contracts with the South African company, so it doesn’t have to file tax returns there. Or . . . does it?

Rents and Services—Domestic and Abroad

Since I started operating on the Internet in early 1995, it became clear to me that federal tax issues were going to emerge. As early as 1998, IRS spokesman Ed Mieszerski ruefully admitted, “Some of these questions [dealing with online taxes] will only be dealt with when they come before us as a result of an examination or court case.”⁴

To date, I haven’t seen an IRS case addressing these issues head-on. But we will, and you need to make sure you have protection in place when these issues start to arise. To avoid problems, you need to be aware of the issues. Following are some real- life scenarios and some points to ponder.

Incorporated in Nevada (no state income tax), Starry-Eyed, Inc., is based at home in California and receives money from sales of products. The company’s inventory is stored and shipped from a fulfillment house located in Pennsylvania. The website is hosted on a server in New York. Starry-Eyed encountered the following questions—the answers should help you stay legal, too.

Q: As a corporation, can it deduct office-in-home costs? (As a proprietor it can, so . . . )

A: Treat your office at home the way you would if you weren’t doing business online. Chapter 7 explains the rules for office in home.

Q: In which state is it conducting business? All work, including design, artwork, search engine placement, etc., is often done by people working from their homes, often across the country. Under what circumstances would those workers be employees? Will the company have to file income, sales, or property tax forms in each (or any) state?

A: Consider your business nexus to be only those states where you have a physical presence. Comply with all local rules.

Q: Should the company be sending a 1099-MISC to the web hosts (those hosting the actual site) for rent?

A: The web server rent is unclear. If you want to be safe, send the 1099-MISC for rent.

Q: Some work is being done by foreign nationals in their own country. Since payment is being made for services rendered, how does the company “1099” a foreigner? Must it issue a 1099? Must the company take any backup withholding?

A: Don’t send 1099s to foreign individuals or companies outside the country that do work for you. If you knowingly hire a U.S. citizen or someone who holds a green card who works overseas, issue the 1099-MISC. Don’t withhold taxes unless the IRS sends you a withholding order on that person. Review the 1099 instructions in Chapter 9 for guidance. But do have the foreign national fill out and sign a Form W-8BEN for your records—https://www.irs.gov/pub/irs-pdf/fw8ben.pdf. This certifies that the individual is a foreign national, and will allow you to pay the foreign individual without having to deduct any withholding.

Roger B. Adams, an enrolled agent in Portugal, answered a similar question in TaxMama’s TaxQuips Forum:

Ingrid’s question: What do I do with the affiliates that are in Canada, Australia, or any other foreign country? Is there a set form like the W-9 that they need to fill out?

Roger’s answer: Essentially this is a treaty issue. The income you are paying these people is characterized as commission, and they are performing “independent personal services”; thus the treaty article covering that type of payment is the one that applies. That kind of income can only be taxed in the country of residence of the person you are paying. Rita is absolutely correct; they need to send you a W8-BEN (see the previous answer) claiming the appropriate treaty article.

On the other hand, if they are U.S. citizens or green card holders, they submit a W-9 to you, and you send them the 1099-MISC.

However, if no treaty exists between the United States and your affiliate in another country, you as “payor” must withhold 30 percent of the payment and send that off to the Treasury and the balance to the “payee.”

To make things just a little more complicated, they might have to get an ITIN to claim the treaty benefit. That is where the real problem will present itself, as this is no easy task for those abroad.

Let’s look at another company with some different issues.

I Can Sell Anything to Anyone (ICSATA) is based in the United States, and its website also is hosted here. The company operates an associate or affiliate program. Other websites link to ICSATA’s site—and ICSATA pays the linked companies a commission on whatever sales arise from those links (this is similar to how Amazon.com operates). Many of the companies that are linked are overseas businesses. The questions to consider here include:

Q: Is this a commission, referral fee, royalty . . . what?

A: When someone is a contributor to the design, content, or substance of your product or services, and he or she is contractually entitled to a share of the sales, it’s royalty. Otherwise, you’re paying commissions. Chapter 5 explains why we care about the distinction.

Q: Is any of this subject to self-employment tax?

A: When regular salespeople receive commissions, it’s self-employment income. Why shouldn’t this be? Chapter 11 explains self-employment taxes.

Frequently, when you ask the IRS these types of questions, you’ll receive a vague answer. The above answers provide the most sensible approach for you to use until the IRS issues formal guidelines.

Legal Issues on the Internet

Once your business touches the Internet, you’re going to be hit with some powerful legal issues, and you won’t realize it until you get into trouble. Even though the book was written back in 2000, several Internet generations ago, the best guide to this topic is still attorney Jonathan I. Ezor’s book Clicking Through: A Survival Guide for Bringing Your Company Online.

So many things can affect you, even if you’re just minding your own business:

•  You face copyright issues. For instance, did your web or logo designer give you a written release for all the graphics and design? Or does he or she own your site?

•  You face liability issues. You have affiliates marketing your product or service. They say something that isn’t true, without your permission. You’re the one getting sued.

•  You face spam issues. You think you’re sending out a simple newsletter. But one recipient becomes violently upset and decides he or she never subscribed. What do you do?

•  You have liability issues. You are running someone’s ads on your site. Perhaps you have banners through an affiliate program. You might be using Google’s AdSense service. Someone clicks on an ad and is unhappy with the product. Are you liable?

•  You face privacy issues. Issues with privacy can become very nasty. Suppose someone hacks your site or telephone book and steals client information. Or suppose you do something with a sponsor that results in the sponsor gaining access to your clients’ e-mail. Your members can get really unpleasant if they feel invaded.

Overall, we’re just scratching the surface of Internet issues. But don’t let the worries get to you. Resources like Ezor’s book will keep you safe.

The World Wide Web is an exciting environment. It can make your dreams come true. It did for me and for many of the people I know. The streets are virtually paved with gold. As I’ve said before, the Internet has the pioneering spirit and excitement of the Old West—law just hasn’t been established yet. Getting there is lots of fun.

In the End

Most issues related to Internet taxation are unclear and apt to change. You now know you don’t have to worry about sales taxes across borders. For all the other areas, when questions arise, treat them the way you would if you were not doing business online. If you’re not sure, check with your advisory team for guidance. And if your advisory team can’t give you reliable guidance, you can always try TaxMama’s TaxQuips Forum, http://iTaxMama.com/AskQuestion. One of our tax professional members will either have an answer or be able to point you to a resource that can help you.

Online Business Resources

•  Vertex Inc. http://vertexinc.com. This authority on all sales tax issues—and other business tax issues—publishes software and reference materials for companies engaged in interstate commerce. Sign up for a free newsletter.

•  Avalara Inc. https://www.avalara.com/. Another terrific resource for various compliance software (sales taxes, excise taxes, hotel taxes, etc.), articles, white papers, and information.

•  The Tax Foundation. http://www.taxfoundation.org. Find tax facts, statistics, and in-depth analyses of federal and state governments.

•  Streamlined Sales Tax Project. http://streamlinedsalestax.org. This is a cooperative effort by most U.S. states to create a universal sales tax system to allow them to collect sales taxes on Internet sales.

•  Senate Finance Committee. http://finance.senate.gov. See it before it becomes law.

•  Performance Marketing Association. http://www.thepma.org/. This is a not-for-profit trade association founded in 2008 by the leaders of the performance marketing industry to connect, inform, and advocate on behalf of this rapidly growing field. It is an excellent source of information about the sales tax issues related to nexus.

•  Commission Junction Internet tax map. http://www.cj.com/about-cj/click-through-nexus-tax.

•  TaxMama.com. www.TaxMama.com. The Ask TaxMama feature is free. Pose your question. If it hasn’t been asked dozens of times before, you’ll get an answer. Simply click on “Ask a Free Question.”

•  Google’s AdSense. http://adsense.google.com. If your website provides useful information, Google can provide advertising revenues for your site. Once accepted, you simply paste Google’s code on your site, and Google sells the advertising. The software reads the content on your page and serves advertisements related to the content. People are excited, saying it adds value to their articles or information. The income is terrific—and you never have to sell an ad or give out information about your demographics.

•  Google’s AdWords. https://www.google.com/adwords/. Use this to advertise and to test your advertising campaigns.

•  The National Association of Tax Professionals. http://www.natptax.com, (800) 558-3402. They offer an inexpensive tax research service. NATP tax professionals will provide written responses to your tax questions, with citations supporting their answers. Like the site above, the advice on this site is also offered for a low fee, and satisfaction is also guaranteed.

•  Jest for Pun. http://www.workinghumor.com/jfp/index.htm. The source of some humorous quotations used in this book.

•  TaxMama’s Quick Look-Ups. http://iTaxMama.com/TM_QuickLookUp. You will find all kinds of useful reference materials, webinars you can replay, e-books, and more.

•  Your Business Bible. http://www.yourbusinessbible.com. Look for worksheets, printable checklists, and other goodies and resources.

1  The Internet Tax Freedom Act, available at http://en.wikipedia.org/wiki/Internet_Tax_Freedom_Act.

2  Kelly Phillips Erb in Forbes—http://www.forbes.com/sites/kellyphillipserb/2016/02/11/congress-makes-internet-access-tax-ban-permanent/#2201598c380a quotes from—Trade Facilitation and Trade Enforcement Act http://www.finance.senate.gov/imo/media/doc/CONFERENCE%20REPORT%20TRADE%20FACILITATION%20AND%20TRADE%20ENFORCEMENT%20ACT%20OF%2020152.pdf.

3  Tax Foundation report—Washington, D.C., July 14, 2003: “‘Jock Taxes’ Spread as State and City Governments Try to Maximize Revenue from Nonresidents,” available at http://taxfoundation.org/tax-topics/jock-taxes.

4  In a memo to the author, in response to Internet-related tax questions, for use in the 1998 Insiders Series Workshops for tax professionals in Burbank, California.