Supply chain management is a major pain point for ecommerce and DTC merchants who just want to get back to growing their brands. In fact, it's safe to say, it's second only to ecommerce accounting as the least sexy part of operating an online brand.
Third-party logistics providers, or 3PLs, provide brand operators with a way to offload and unpack the stress of supply chain so they can focus on other things. 3PLs generally provide services that include warehouse and inventory management, packing and order fulfillment, shipping, distribution, exchanges, and returns.
Using Amazon FBA, or another 3PL can provide HUGE benefits on the operational side of running a business, but it's important to be aware that it could complicate things on the tax side. Using 3PLs can trigger income tax obligations in states in which you didn't even know you had nexus (or a taxable connection).
State income tax obligations can arise whether you are selling on a Marketplace like Amazon or Walmart or on a branded site like Shopify. Here are some things that every ecommerce seller should know.
For the sake of brevity, we won't dive into the basics of nexus and state tax rules but you can learn more about it here.
What are the state income tax filing implications of using a 3PL?
Generally, if there is a physical connection, or physical nexus, with a state, including if you have employees, property, an office, or inventory in that state, it can trigger income tax filing requirements.
As a general rule, using a 3PL can create physical income tax nexus in many states. Here's how:
Let's say you ship your inventory to the warehouse closest to you which is operated by your 3PL. Your 3PL, wanting to provide faster order fulfillment, may distribute that inventory to their other warehouses across the country. Now you have inventory you own in multiple states (many of which you don't even realize you are warehousing inventory).
With this rule of thumb in mind, let’s explore some additional considerations.
Meet de minimis, your new best friend
Nexus is generally determined by facts and circumstances. But it's not all bad news. The concept of de minimis or minimal activity within a state is important here.
This means that many state tax authorities hold that if you have only insignificant activity or presence in a state, they won't treat you as having nexus in their state. Determining this threshold of 'de minimis' activity is often based on understanding the specific considerations of your business and the nature & volume of the activity.
Factor Presence Nexus
Since the 'de minimis' standard is a bit vague, some states apply a factor presence nexus test which provides a standardized concept of what creates nexus.
Factor-based nexus is met if any of the following thresholds are exceeded in that state:
- $50,000 of property;
- $50,000 of payroll;
- $500,000 of sales; or
- 25% of total property, total payroll, or total sales.
Some states adjust these amounts annually to take inflation into account.
Important note: Some states that have adopted factor-based nexus may consider it an alternative method to determine nexus and not a replacement of the physical nexus test. This means that, for example, a state may consider a warehouse to create nexus even if inventory in that state is less than $50,000 if the business is actively engaged in any transaction for the purpose of financial gain or profit.
FBA as a 3PL
Using Amazon FBA has the same considerations as using a 3PL. Please check out our blog post on FBA state income tax implications here. Below are some most recent relevant updates:
Pennsylvania - Recently a Pennsylvania court ruled that an Amazon FBA warehouse in PA, does not create income tax nexus.
Does this also apply to ecommerce sellers who use 3PLs? It's complicated.
The Pennsylvania court based the ruling on the amount of control that the ecomm seller had over the FBA warehouse as well as their connection to the end customer. Since the seller had limited (or no) control over the location of the inventory after it was shipped to Amazon, and since the seller did not have direct contact with the end customer, the court ruled that sufficient nexus was not created.
Could an argument be made to extend this to a 3PL where the seller has more control? Will other states follow PA? All good questions.
California - In contrast to PA, California has been particularly aggressive in pursuing FBA sellers for income tax on the basis of physical nexus.
Businesses with a limited amount of property in the state, may fall under the $50,000 property threshold ($63,726 in 2021 adjusted for inflation), with the considerations mentioned above. Here is our general blog post on income tax requirements in CA.
In order to come to a balanced decision regarding how to approach 3PL and income tax nexus, a company should explore and weigh the considerations mentioned above; de minimis, factor presence, and the potential application of the PA FBA nexus ruling, as they apply to the business.
While there is no clear guidance, the most conservative approach is to file an income tax return in all states where a company uses a 3PL. If, considering the facts and circumstances, a company comes to the conclusion that they are not required to file an income tax return in a state where they have a 3PL, and later the state determines that there was in fact nexus, there may be penalties assessed for not filing (even if there was no tax payment due).
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*The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.*