California has rightly developed a reputation for aggressively pursuing whatever taxes it can legally get away with assessing. From taxes on out of state businesses with only a tangential connection to the Golden State to a proposal to keep taxing Californians even after they leave the state, California has repeatedly demonstrated that it puts maximum revenue extraction above good tax policy and the interests of taxpayers. Yet in attempting to claim up to eight years in retroactive taxes from small businesses, the state has managed to reach a new low.
According to a lawsuit filed by a group of small businesses under the name of the Online Merchants Guild, California’s Department of Tax and Fee Administration (CDTFA) is enforcing tax remittance obligations on small businesses using Amazon’s platform and its “Fulfilled By Amazon” (FBA) program going back to 2012. The legal claim behind this enforcement is so specious that even the state’s own Treasurer has urged the CDTFA to drop its claims.
Prior to the 2018 Supreme Court decision in South Dakota v. Wayfair, states could only require businesses to collect and remit sales taxes to a state if that business had some form of physical presence in that state. States were still collecting plenty of revenue from online retail giants, however, through agreements between the states and businesses. One such agreement, between Amazon and California in 2011, allowed for the company to begin collecting sales taxes on purchases in 2012.
At the time, it was clear that this agreement applied only to Amazon, and not to third-party sellers using its platform. These third-party sellers, usually small businesses, did not have a legal obligation to collect and remit sales tax, and so they did not.
But California is now using this agreement to justify claiming back taxes from these third-party retailers if they took part in Amazon’s FBA services. This program allowed third-party sellers to ship their inventory to Amazon’s warehouses, where Amazon would then take care of fulfilling orders, allowing smaller retailers to take advantage of Amazon’s much faster delivery network.
These retailers had no idea that participating in this program would subject them to tax obligations in the state of California. After all, once their inventory was sent to Amazon, their oversight ended — receiving orders, processing payment, and managing delivery were all performed without their involvement. Despite this, California has determined that these small sellers owe the state years’ worth of sales taxes.
Should these out-of-state businesses be held liable for these back taxes, it could prove financially ruinous. Though sales taxes are sent to a government by businesses, they are collected from customers as part of a purchase. In this case, however, no such levy was collected at the time of sale, meaning that any assessment would come straight out of the pockets of the sellers in question.
Few small businesses have the kind of profit margin where they can absorb paying a 7.25 percent tax (the California rate) on sales going back eight years, and multiple small businesses testified before Congress that California’s action would put them out of business if they were forced to pay.
Should the justice system fail to rein in California in this case, it will doubtless continue its uninterrupted pattern of aggressively enforcing tax obligations well beyond its legal authority to do so. Taxpayers outside of the Golden State may think that they are beyond California’s grasping tax apparatus, but without legal enforcement of the boundaries on the state’s tax enforcement actions, they are not.
Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government.