PHILADELPHIA — Brian Freifelder, who sells clothing, shoes, and groceries on Amazon.com out of a small warehouse in Bensalem, Pa., is caught in what his tax lawyer called “an interstate commerce speed trap.”
The 36-year-old Bucks County resident recently received a jaw-dropping notice from California that he could owe as much as $1.6 million for sales tax that he didn’t collect from consumers who bought his goods through Amazon.
That’s just for the first six months of this year.
“It’s absurd. I haven’t sold enough inventory over time to warrant a tax bill like that. You could take every sale I’ve ever done. You could take the biggest sellers on Amazon, and I don’t think they would have a bill like that. They’re trying to scare people,” Freifelder said last week.
Freifelder, who started as a merchant buying and selling CDs on eBay when he was 16, is among what is believed to be hundreds of thousands of third-party merchants on Amazon who were informed by the California Department of Tax and Fee Administration that they should have been collecting taxes on sales to California residents as far back as 2012.
California’s aggressive tax-collection move against Freifelder and other third-party merchants on Amazon is an example of government trying to catch up to new forms of commerce that on the surface at least appear to evade obligations under old laws, whether it’s Amazon declaring it’s not a retailer for third-party merchants, Uber saying it’s not an employer, or Facebook denying it’s a publisher.
When Amazon opened its first warehouse in California in 2013, it escaped the obligation to collect the taxes on sales by third-party merchants on the company’s site, apparently by convincing state officials that it was not the retailer obligated to collect sales tax in those cases — a distinction that has since been undermined by court decisions in South Carolina, Pennsylvania, and elsewhere.
The state says that as soon as Freifelder’s goods showed up at an Amazon warehouse in California, he had the same obligation to collect sales tax as any retailer with a store there — even if he had no idea where Amazon was storing his goods.
Jared Walczak, director of state tax policy at the Tax Foundation in Washington, said the pursuit of Amazon’s third-party merchants for back sales taxes is extreme and violates protections under the U.S. Constitution, even though states a have significant leeway in how they impose taxes.
“Retroactivity is always bad policy, but in this case, it raises serious constitutional due process concerns, because due process requires that you have notice and can anticipate a policy. Here the retailers lacked notice to collect. No one believed they were supposed to be collecting this tax for all of these years,” Walczak said.
California tax officials said Monday that they could not comment on specific tax liabilities.
The question of whether third-party merchants or Amazon should collect sales taxes has since been resolved by the passage in California and many other states of laws that require “marketplace facilitators” to collect sales taxes. In California, that law took effect Oct 1. In New Jersey and Pennsylvania, such laws took effect last year.
A 2018 U.S. Supreme Court decision did away with the decades-old standard that states could force retailers to collect sales tax only if they had a physical presence in the state, making marketplace facilitator laws possible.
California’s decision to pursue third-party merchants preceded that Supreme Court decision, experts said.
That uncertainty caused by California’s tax strategy has caused Freifelder to hit the brakes on the growth of his business, Philadelphia Media Exchange Corp., which reached $3 million in revenue last year, he said.
The business had been growing steadily since 2000, when Freifelder’s love of rap music, but distaste for the prices of compact discs at Best Buy and Sam Goody, led the teenager to eBay, where he would buy 100 CDs for $200, keep those he wanted, and resell the others.
In 2005 he started selling on Amazon and at flea markets, such as the Tacony Palmyra Flea Market in New Jersey. He opened his first store, Fivedollarcd, in the Tacony section of Northeast Philadelphia in 2010, expanding to the sale of video games and consoles. Another store in Mayfair followed.
But then streaming services eroded those business, so he closed the stores and by 2015 had moved on to what is called “retail arbitrage” of clothing, shoes, and grocery items bought on sale or clearance at Marshalls, TJ Maxx, Ross, Burlington, and other stores, and sold for more on Amazon.
The front room of his warehouse has 14 large recycling bins used to sort and repack Under Armour clothing, Polo shirts, Nicole Miller lunch totes, and other goods before he ships them to Amazon, which then handles every aspect of the sale to the consumer, he said. He controls only what he ships and the price.
At its peak before the sales tax scare, Freifelder had eight employees, three full-time and five part-time in the warehouse, and three contractors who shopped for him. Now he’s down to one employee in the warehouse. He still has the three contractors. Plus, his wife helps a couple days a week.
“I’m drastically cutting things back until the dust settles, just because I don’t want to find out I have a ridiculous bill a year or two down the road,” said Freifelder, who wore a black Phillies cap and a gray Super Mario ‘85 T-shirt while showing visitors around his operation, in an industrial park right next to I-95.
Paul Rafelson, a tax lawyer and volunteer executive director of the Online Merchants Guild, said California is hurting not just Freifelder, but thousands of small businesses nationwide.
“These guys are shipping goods off to Amazon. Amazon moves them all around, doesn’t tell them, doesn’t warn them, the State of California doesn’t even warn them, and then years later they’re stuck in this interstate commerce speed trap,” said Rafelson, whose firm, Francissen Rafelson Schick LLP, is based in Boca Raton, Fla.
California’s elected treasurer, Fiona Ma, in March sent a letter to Gov. Gavin Newsom urging him to block the tax collectors from going after third-party sellers.
“They are not the ones responsible for uncollected taxes under state law, nor is it constitutionally permissible to impose such burdens on these businesses,” Ma’s letter said.
Freifelder maintained a supremely calm demeanor for someone who just received a $1.6 million tax bill, perhaps because he considers the numbers “bonkers.”
“I would have had to have done at least $15 (million) to $20 million in sales to get a bill like this. That would be in California alone. I would have had to have done $150 million to $200 million in sales in the United States.”