Your inventory may be giving your business a sales tax obligation

Because marketplace facilitators like Amazon and Etsy are required to collect and remit sales tax on behalf of third-party sellers, marketplace sellers may assume they’re free from sales tax obligations. But that’s not necessarily so.

All else aside, marketplace sellers and other remote sellers often have inventory stored in various third-party or marketplace warehouses or fulfillment centers — and having inventory in a state can establish physical presence for your business along with an obligation to register for sales tax in that state.

Determining if you need to register for sales tax in a state comes down to nexus, which is a connection between a taxing authority and a business that’s significant enough to trigger a sales tax obligation. It’s a simple concept with devilish details because sales tax nexus laws vary from state to state.

For instance, while all states with a sales tax require businesses with a physical presence in the state to register for sales tax, each state defines “physical presence” differently.

Read on to learn where having inventory in a marketplace facility or other type of distribution or fulfillment center can establish physical presence nexus and a sales tax obligation for your business.

More than 20 states specify that holding inventory in the state — including inventory stored in a marketplace facilitator’s facility and managed by the marketplace — creates physical presence nexus for the third-party seller. These states include California, Georgia, Indiana, Kentucky, Michigan, Minnesota, New Jersey, North Carolina, North Dakota, Ohio, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.

Inventory in California

As an example, the California Department of Tax and Fee Administration (CDTFA) is clear that if you have inventory stored in a third-party’s fulfillment center in California, “you are engaged in business in California because you have a physical presence in this state (inventory).” 

You may not need to obtain a California sales tax permit if you have no other nexus-creating activities in California and only sell through a marketplace that collects and remits sales tax on your behalf. But if you also sell directly to California consumers, you’d be required to register with the CDTFA, collect sales tax as applicable, and file sales and use tax returns.  

Inventory in Pennsylvania

The Pennsylvania Department of Revenue is equally straightforward. It explains, “Under Pennsylvania law, a business with property or inventory in Pennsylvania is subject to Pennsylvania taxes. This requirement applies to online retailers with inventory stored at a distribution or fulfillment center located in Pennsylvania.” 

Registered marketplaces are responsible for collecting and remitting Pennsylvania sales tax on behalf of third-party sellers. However, a marketplace seller with inventory in Pennsylvania is responsible for the tax due on any direct sales and sales made through an unregistered marketplace.

Inventory in Washington

Similarly, even a few products stored briefly in the state can create sales tax nexus with Washington. Per the Washington State Department of Revenue: “Physical presence is a nexus standard that requires only more than the slightest presence,” and physical presence nexus-creating activities include “having a stock of goods in Washington, including inventory held by a marketplace facilitator or another third party representative.”

According to one departmental ruling, “The fact that goods owned by the Taxpayer were physically stored in Washington until sale, even briefly via digital reassignment of ownership, is sufficient to establish substantial nexus.” Read more about digitally reassigning inventory and how it can affect nexus here.

Having inventory in a marketplace or third-party warehouse generally does not establish physical presence nexus for remote sellers in the following 10 states:

• Arizona
• Arkansas
• Illinois
• Iowa
• Kansas
• Nebraska
• Nevada
• New York
• Oklahoma
• Texas

That said, it’s important to note that states may make a distinction between inventory used to fulfill direct sales and inventory used to fulfill marketplace sales. Who controls the inventory, the seller or the marketplace/distributor, can come into play as well.

Inventory in Iowa, Kansas, and Nebraska

Iowa, Kansas, and Nebraska generally treat a business as a remote seller so long as their only physical presence in the state is inventory stored in a third-party’s warehouse. This is true whether the seller or the marketplace facilitator controls the inventory. So, if a remote seller has no other nexus-creating activities in those states, they likely don’t need to register for sales tax.

Inventory in Arkansas or Oklahoma

Inventory stored in a third-party warehouse usually doesn’t give a remote seller physical presence nexus in Arkansas or Oklahoma, so long as the inventory is controlled by the third party. 

However, inventory held in a third-party warehouse does give a remote seller a physical presence in Arkansas and Oklahoma if the seller controls the inventory’s movement.

Inventory in Arizona, Illinois, and Nevada

The Arizona Department of Revenue says that “temporarily storing property with a third-party fulfillment center over which you have no control likely does not rise to the level of physical nexus” (emphasis mine). However, the department also explains, “If the assets or property are in Arizona and you have control over where and how it is stored, you likely have physical nexus.”

If inventory located in Illinois is used strictly to fulfill orders made over the marketplace, the inventory does not create physical presence nexus for an out-of-state retailer, according to the Illinois Department of Revenue. But if the inventory is used to fulfill marketplace orders and direct sales, or direct sales only, then the Illinois inventory does create physical presence nexus for the retailer, and the retailer would need to register for sales tax.

Having inventory in Nevada generally establishes physical presence nexus for a business and an obligation to register, collect, remit, and report Nevada sales tax. Yet according to the Nevada Department of Taxation, “If you are a remote seller that ONLY makes sales through a Facilitator(s) registered to collect Nevada sales tax, you do not need to register with the Department for a Sales Tax Permit if your only presence in Nevada is inventory stored in a third-party’s fulfillment center located in Nevada.” 

The department’s emphasis on “only” suggests that if you also make direct sales in the state or sell through an unregistered marketplace, having inventory in the state could give you sales tax nexus.

Inventory in New York and Texas

New York law holds that “a person who is not otherwise a vendor who owns tangible personal property located on the premises of an unaffiliated person performing fulfillment services for such person” is not a vendor liable for sales tax. You have to hunt for this information; the New York Department of Taxation and Finance doesn’t provide clear guidance on this matter like the Texas Comptroller does.

In the Lone Star State, “a remote seller who is below the $500,000 safe harbor threshold and has tangible personal property temporarily stored in Texas at a marketplace provider’s facility does not need to obtain a permit and does not have a collection obligation if the marketplace provider has certified it will assume the duties of a seller.”

A remote seller with more than $500,000 in annual sales in Texas that has inventory temporarily stored in Texas at a marketplace provider’s facility “must obtain a tax permit and collect tax” on their sales. This is because of economic nexus, discussed below.

Finally, a remote seller that’s a taxable entity and has inventory in a marketplace provider’s facility in Texas would have a Texas franchise tax obligation.

States are sometimes sympathetic to the plight of retailers who develop a sales tax obligation through inventory stored in a third-party or marketplace warehouse.

In 2017, the Multistate Tax Commission ran a tax amnesty program for marketplace sellers whose marketplace inventory had created physical presence nexus in one or more states. About 25 states participated, and most waived past taxes without limitations for businesses whose only connection to the state was marketplace inventory. The remaining states provided more limited amnesty.

In 2019, California provided temporary relief for marketplace sellers who were “engaged in business” in the state solely because they used a marketplace facilitator to facilitate sales of their merchandise for delivery in this state and the marketplace facilitator stored their inventory in California. To qualify for the tax relief, businesses needed to voluntarily register with the CDTFA, file completed tax returns for all applicable tax reporting periods by September 25, 2019, and meet certain other criteria.

In 2021, Pennsylvania offered limited tax amnesty to unregistered remote sellers that held inventory in the commonwealth. The program limited the lookback period and penalty relief for eligible, participating businesses that took the required steps to become sales tax compliant.

Additional states could offer amnesty to remote sellers with inventory in the state in the future, but the trend seems to be moving in the opposite direction. A number of states are aggressively pursuing remote sellers for back sales tax based on inventory and inventory alone — with mixed results.

California, Pennsylvania, and Washington are among the states keen to collect back sales tax liability from out-of-state retailers that had or have inventory stored in a marketplace facility in the state. Overall, California and Washington have been more successful than Pennsylvania.

Courts side with California

California started requiring marketplace facilitators to collect and remit sales tax on behalf of third-party sellers in October 2019, but the CDTFA has continued to seek sales tax from third-party Fulfillment by Amazon (FBA) sellers for periods prior to that date. The state’s efforts were challenged by the Online Merchants Guild, an ecommerce trade group, but the courts repeatedly sided with California — in 2021, 2022, and again in 2023. 

The Supreme Court of the United States has refused to hear the case, so unless a different type of challenge proves effective, California can hold marketplace sellers that had inventory in the state liable for back sales tax and applicable penalties. Fortunately, for affected marketplace sellers, the CDTFA will only hold them liable for periods between April 1, 2016, and March 31, 2019.

Court sides with Washington

Washington has also been taken to court for holding marketplace sellers liable for sales tax based on their marketplace inventory. And as in California, taxpayer arguments generally haven’t been successful.

On January 23, 2024, an appellate court found two out-of-state sellers liable for both sales tax and business and occupation (B&O) tax for sales made through the FBA program prior to January 1, 2020, when Washington’s marketplace facilitator law took effect. 

The court made a few interesting observations in its opinion, including:

The Amazon Services Business Solutions Agreement (BSA) reads, “You understand and acknowledge that storing Units at fulfillment centers may create tax nexus for you in any country, state, province, or other localities in which your units are stored, and you will be solely responsible for any taxes owed as a result of such storage.” 

Amazon’s BSA reads that it will not collect and remit sales tax on behalf of a merchant unless the merchant elects for Amazon to do so.

“Ignorance of the law excuses no one.”

Additionally, the court determined that marketplace sellers may be liable for B&O tax obligations even if the marketplace facilitator collects and remits sales tax on the sellers’ behalf. Businesses are required to report B&O tax if they have a physical presence in Washington or economic nexus with the state (i.e., if they have more than $100,000 in Washington sales annually).

Pennsylvania loses in court

Like their counterparts in California and Washington, the Pennsylvania Department of Revenue  holds that marketplace inventory establishes physical presence for marketplace sellers. Pennsylvania tried to collect back taxes from thousands of Amazon’s Fulfillment by Amazon (FBA) sellers based on their inventory in the state, but affected remote sellers fought back (Online Merchants Guild v. C. Daniel Hassell).

In September 2022, the Pennsylvania Commonwealth Court sided with the taxpayers. Finding in part that FBA merchants have no control over their merchandise once Amazon receives it, the court ruled that FBA inventory is not sufficient to establish sales tax nexus for nonresident FBA sellers. 

This is a question many businesses ask, particularly in light of the U.S. Supreme Court’s ruling in South Dakota v. Wayfair, Inc. (June 2018).

Prior to the Wayfair decision and subsequent state action, states were limited to taxing businesses with a physical presence in the state. Because of this, states often interpreted “physical presence” rather broadly. For example, Massachusetts and a few other states decided that putting web cookies on computers in the state was enough to trigger a sales tax obligation. In light of that, basing sales tax on inventory — even inventory stored temporarily in the state — seems rather reasonable.

Wayfair overturned the physical presence rule, allowing states to tax businesses with no physical tie to the state. Every state with a sales tax has since adopted an economic nexus law requiring remote sellers with a certain degree of economic activity in the state (e.g., $100,000 in sales or 200 transactions in the current or previous calendar year) to register for sales tax and comply with all applicable sales tax laws. All economic nexus laws specify that the state will not enforce economic nexus retroactively.

Every state with a sales tax has also adopted a marketplace facilitator law making marketplace facilitators responsible for collecting and remitting tax on behalf of their third-party sellers.

It can be easy to forget old-fashioned physical presence nexus with economic nexus and marketplace facilitator laws grabbing headlines, but it would be a mistake. Wayfair enabled states to expand their taxing authority; it didn’t curb their existing taxing authority.

“The Wayfair decision changed many things for out-of-state retailers, but it didn’t change what constitutes an in-state retailer,” explains Scott Peterson, Vice President of Government Relations at Avalara. “Placing inventory in a state remains one of several ways a business can create physical presence.”

So yes, states can do this.

If you have inventory scattered throughout the country, either in a marketplace facility or another third-party distribution or storage facility, you may have established an obligation to register for sales tax in one or more states.  If in doubt, discussing your situation with a professional tax advisor may help. See Avalara’s state tax expert directory if you need a recommendation.

To learn more about nexus and the various ways you can establish a sales tax obligation in different states, see our state guide to nexus laws.

This post has been updated; it was originally published on August 25, 2022.