Colorado’s New Rule Requires Remote Sellers to Report Use Tax
Beginning July 1, 2017, any company selling into Colorado that is not registered to collect sales tax will be required to report its customer’s activity or potentially be subject to penalties.
The use tax notice and reporting requirements come on the heels of the Supreme Court deciding not to hear Direct Marketing Association v Brohl, which challenged the use tax notification requirements imposed by Colorado on the grounds that it unconstitutionally discriminated against out-of-state retailers. After many years of litigation in both the federal and state courts, the Tenth Circuit ultimately sided with Colorado and held the statute constitutional. In December, 2016, the Supreme Court of the United States denied hearing the case, resulting in Colorado now being able to enforce the statute.
Many states have already passed similar "remote seller” legislation that imposes notice and reporting duties or economic nexus provisions that require registration once a business reaches a transaction threshold or volume of sales to customers within the state.
What is a notice and reporting law?
Notice and reporting laws are imposed on remote sellers, typically defined as sellers who are not required to collect state sales tax because they lack a physical presence in the state. The use tax notice and reporting laws require remote sellers to provide the buyer, the state, or both, with information about use taxes. These requirements can be onerous, and some states impose substantial penalties for noncompliance. To date, Kentucky, Louisiana, Oklahoma, South Dakota, Texas and Vermont have also passed similar type of notification requirements.
How do these laws work? Unfortunately, the mechanics vary by state. Colorado in particular has one of the more robust notice and reporting laws. Beginning July 1, 2017, remote sellers that have over $100,000 of sales to Colorado customers and do not collect sales tax must:
- Notify their Colorado customers of the customers’ obligation to pay Colorado use tax. This notice must be provided to each customer at the time of purchase (typically on the invoice) and must contain specific language. There is a $5 penalty per transaction where notice was not given with a maximum annual penalty of $25,000.
- Beginning January 31, 2018, remote sellers that do not collect sales tax must provide an annual summary by January 31 each year of spending to Colorado customers that spend more than $500 with the retailer. There is a penalty of $10 per failure to give this notice with a maximum annual penalty of $50,000.
- Beginning March 1, 2018, if a seller has more than $100,000 of gross annual sales in Colorado, the remote retailer must provide the Colorado Department of Revenue (CDR) with a report that includes the customer’s name, address, and total purchases by March 1 each year. If the noncollecting retailer fails to provide the proper notice, it will be penalized $10 times the number of Colorado purchasers that should have been included in the report with a maximum annual penalty of $50,000. 1
Based on these provisions, companies could pay up to $125,000 in penalties in a single year even though they have no physical presence in Colorado.
Example: A remote retailer roasting coffee and selling it to Colorado customers
What are the potential costs of failing to comply with the Colorado reporting law? Consider the example of a coffee company that roasts coffee at a Minneapolis location and sells to customers across the country. The coffee business has no physical presence outside of Minnesota. Its only connection to Colorado is the Colorado residents who go to the company’s website and purchase coffee. The coffee is then roasted in Minnesota and shipped to Colorado.
Suppose that over a 12-month period, the online coffee retail company has 10 transactions of $15 each to 1,000 different customers in Colorado. This creates total sales to Colorado customers of $150,000 from 10,000 transactions. Because the online coffee retailer lacks sales tax nexus in Colorado, the retailer decides not to collect sales or retailers use tax.
Prior to passage of the Colorado notice and reporting laws, as long as the retailer lacked nexus to Colorado, the retailer would not have an obligation to collect sales tax and would not owe any penalty. However, under the new notice and reporting law, the retailer must choose to either begin collecting and remitting sales tax or comply with the use tax notice and reporting laws. If the retailer does neither, it will owe the CDR penalties for failure to comply with the use tax notice and reporting. Penalties could be as assessed as follows: 2
- The $5 penalty for failure to provide the required notice on each transaction is equal to five times the number of transactions without the required notice.3 The notice should have been included on 10,000 transactions. Five times 10,000 is $50,000, so the penalty would default back to the maximum annual penalty of $25,000.
- The failure to provide the summary of spending to each of the customers does not apply as long as each customer spent only $150. If any customer spent over $500, then there would be a penalty of $10 for each failure to provide a notice to that customer. 4
- Because the retailer had more than $100,000 in gross Colorado sales, it is subject to the requirement to provide notice to the CDR. The report includes customer names and total purchases. The penalty for failing to provide this report is 10 times the number of Colorado purchasers that should have been included in the report. In this case, 1,000 customers should have been included in the report, creating a potential penalty of $10,000.5
Failure to provide the proper notice and reporting could subject the online retailer to at least $35,000 in penalties in a single year, even though it has no physical presence in Colorado. This could go up if some customers purchased more than $500 from the company and were not provided annual summaries.
What’s a retailer to do?
Generally, a retailer will have two options:
- Comply with notice and reporting regulations, or
- Begin collecting and remitting sales tax
However, voluntary registration, collection, and remittance of sales tax can sometimes waive rights that businesses may otherwise have. For example, registering to begin collecting and remitting sales tax could waive a company’s ability to pursue voluntary disclosure for any prior period exposure.
In addition, since the case was upheld by the Tenth Circuit (which includes the states of Colorado, Kansas, New Mexico, Oklahoma, Utah and Wyoming), it is unclear if states not governed by this Circuit will actively enforce the statutes.
Because each state has a great deal of flexibility in writing its own tax laws, state tax laws vary broadly across the country. Moreover, each company’s specific facts could provide exemptions from taxes, and that creates tax planning opportunities.
How we can help
If you make remote sales into Colorado, you should consider conducting a review of your business practices to determine if you have unaddressed state and local tax exposure. We can answer your nexus questions for state and local taxes, address uncertain tax concerns, or assist in interacting with state taxing authorities. If tax exposure exists, we can assist your mitigation efforts, including working with states’ voluntary disclosure programs.
- 1Colo. Code Reg. 39-21-112.3.5
- 2Penalties for noncompliance are capped at a lower amount in the first year, then the penalty cap increases significantly. Colo. Code Reg. 39-21-112.3.5(2)(f)(ii); Colo. Code Reg. 39-21-112.3.5(3)(d)(ii); Colo. Code Reg. 39-21-112.3.5(4)(f)(ii)
- 3 Colo. Code Reg. 39-21-112.3.5(2)(f)(i)
- 4 Colo. Code Reg. 39-21-112.3.5(3)(c)(i)
- 5 Colo. Code Reg. 39-21-112.3.5(4)(f)(i)