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Tax Law

Marketplace Monday – Marketplace Sales Tax Liability

The shift in tax collection responsibility to marketplace facilitators raises issues regarding which party will bear the burden of any additional sales tax liability resulting from a state audit of marketplace transactions. These issues include the extent to which marketplace facilitators can rely on information provided by marketplace sellers, and to what extent marketplace sellers remain subject to audit for transactions facilitated via a marketplace.

Audit Liability Relief for Marketplace Facilitators

Some states provide broad audit protection for marketplace facilitators where the failure to collect and remit the correct amount of tax is a result of incorrect or insufficient information provided by a marketplace seller, so long as the marketplace seller is not an affiliate of the marketplace facilitator. For example, Arkansas provides relief for marketplace facilitators who do not collect and remit the correct amount of tax “to the extent that the failure was due to incorrect or insufficient information given to the marketplace facilitator by the marketplace seller.” Ark. Code Ann. § 26-52-111(f). In Arkansas and similar states, where a marketplace facilitator seeks relief based on a marketplace seller’s provision of incorrect or insufficient information, the marketplace seller becomes subject to audit with respect to its marketplace sales. E.g., Ark. Code Ann. § 26-52-111(e)(2).

Exception – Liability for Sourcing Errors

A number of states exclude errors related to sourcing of transactions from their marketplace facilitator relief provisions. Indiana, for example, requires a marketplace facilitator to show to the department’s satisfaction that the failure to collect sales tax was not due to an error in sourcing the transaction in order to qualify for relief. Ind. Code § 6-2.5-9-3.5(b) (applicable to transactions occurring before Jan. 1, 2022). Similarly, Utah provides relief for marketplace facilitators where the failure to collect tax “was due to a good faith error other than an error in sourcing.” Utah Code Ann. § 59-12-107.6(7)(a)(iv). Massachusetts, on the other hand, expressly provides relief to marketplace facilitators from liability if the error is due to reasonable reliance on incorrect information provided by the marketplace seller or purchaser regarding the proper sourcing of an item or transaction, so long as the marketplace facilitator can show that it made a reasonable effort to obtain accurate information from the seller or purchaser. Mass. Gen. Laws ch. 64H, § 34(i).

Limitations on Relief for Marketplace Facilitators

Further, certain states provide for a cap on the amount of protection accorded to marketplace facilitators, limiting the amount of uncollected and unremitted taxes to a certain percentage of total sales or the total amount of tax that should have been collected. In Arizona for example, for calendar year 2019, relief for marketplace facilitators where the failure to pay the correct amount of tax is due to an error other than an error in sourcing, but not due to incorrect information provided by the marketplace seller, the amount of liability relief is limited to five percent of the total tax due on taxable sales facilitated by the marketplace facilitator on behalf of a marketplace seller and sourced to Arizona. Ariz. Rev. Stat. Ann. § 42-5043(A), (B). The amount of relief drops from five percent to three percent of total tax due for calendar year 2020, and for calendar years 2021 and later the relief provision is eliminated. Id. at (B).

Contractual Relief

Other states do not provide for similar broad relief for marketplace facilitators, but instead clarify that marketplace facilitators are free to contract with their marketplace sellers for the recovery of sales tax and any related interest or penalties to the extent that such tax is assessed by the state in an audit of the marketplace facilitator and where the marketplace facilitator has relied on incorrect or incomplete information provided by the marketplace seller. E.g., Utah Code Ann. § 59-12-107.6(6)(b). As a result, in states such as Utah, the contractual agreements between marketplace facilitators and their marketplace sellers will determine which party bears the risk of additional tax being assessed as a result of an audit.

Why this is important: State rules regarding audit liability and relief from liability will be significant for marketplace facilitators who have been forced to comply with state marketplace collection laws in over half of the states with limited time to implement procedures for collection, reporting and documentation. In order to take advantage of these provisions, it will be important for marketplace facilitators to carefully document: (1) information received from marketplace sellers regarding characterization of the product, and (2) sourcing determinations. Marketplace facilitators may also want to consider contractual indemnification provisions with their marketplace sellers. Marketplace facilitators may also want to consider more frequent state audits or self-audits in order to more timely understand any collection issues.

What to prepare for: Marketplace facilitators should review state marketplace collection laws to inform their potential exposure and defenses in case of an audit, to determine which aspects of accurately reporting and remitting sales tax to prioritize, and to determine the tax responsibility language to include in their contracts with marketplace sellers so as to minimize their potential exposure.

Next Monday: Sourcing of Marketplace Sales