The E-Commerce Tax Trap

You sell physical goods into the United States through a marketplace, a Shopify store, or both. A platform has asked you for a tax form, a state has sent you a nexus questionnaire, and someone has told you that you owe U.S. income tax. Those three things come from three different places, and two of them have nothing to do with each other.

Two tax systems, and they do not share a threshold

Start here, because almost every wrong answer in cross-border e-commerce comes from collapsing these into one question.

Federal. The United States taxes a foreign person's business income only if that person is engaged in a trade or business within the United States, under IRC §864(b), and then only on income that is effectively connected under §864(c). If a treaty applies and is claimed, the threshold shifts to whether you have a permanent establishment under the treaty's Article 5.

State. Sales and use tax is imposed by individual states. Its reach is not governed by §864, not governed by any treaty, and not affected by whether you have a permanent establishment. Since South Dakota v. Wayfair, Inc., 585 U.S. 162 (2018), physical presence is not required. A state may impose a collection obligation on a remote seller that meets its economic thresholds.

The result is a matrix, not a line. You can owe no federal income tax and still be required to register and collect in a dozen states. You can also be inside the federal net while your state footprint is trivial. Treat the two tracks separately from the first day, and keep separate files.

Layer one: the federal income tax question

The federal threshold is factual. Treas. Reg. §1.864-2(e) states that whether a person is engaged in a U.S. trade or business is determined "on the basis of the facts and circumstances in each case," and case law supplies the working standard, which is whether U.S. activity is considerable, continuous, and regular.

For a goods seller, the facts that carry weight are inventory located in the United States, personnel or agents acting here, and who performs the selling function. In Handfield v. Commissioner, 23 T.C. 633 (1955), a Canadian producer who sold into the United States through a news company acting as his distribution agent was held to be engaged in business here. In Commissioner v. Piedras Negras Broadcasting Co., 127 F.2d 260 (5th Cir. 1942), a foreign enterprise selling to U.S. customers without a U.S. operating presence was not.

Agency is the pivot. Treas. Reg. §1.864-7(d) attributes an agent's U.S. office to the foreign principal only where the agent is not an independent agent acting in the ordinary course of its own business, and either regularly exercises authority to negotiate and conclude contracts or holds a stock of the principal's merchandise from which orders are regularly filled.

If you clear the threshold, IRC §864(c)(3) does heavy work: all U.S.-source income other than the passive-type items covered by §864(c)(2) is treated as effectively connected. Which makes sourcing the next question.

Layer two: title, and where the sale happens

For purchased goods resold, IRC §861(a)(6) sources income from inventory bought outside the United States and sold within it to the United States. The place of sale is a title question. Treas. Reg. §1.861-7(c) provides that a sale "is consummated at the time when, and the place where, the rights, title, and interest of the seller in the property are transferred to the buyer," or where beneficial ownership and risk of loss pass if bare legal title is retained. The same regulation refuses to respect an arrangement structured in a particular manner for the primary purpose of tax avoidance, in which case all factors are examined, including negotiations, execution of the agreement, the location of the property, and the place of payment.

If you manufacture rather than resell, the answer differs. IRC §863(b), as amended in 2017, allocates income from the sale of inventory produced by the taxpayer "solely on the basis of the production activities with respect to the property." Production abroad points the income abroad, whatever your shipping terms say.

Your terms of sale are therefore a tax document. Read them before your accountant does.

Layer three: what the platform reports, and what it withholds

Marketplace and payment platforms have their own obligations, and those obligations generate the paperwork that usually starts the conversation.

Form 1099-K. IRC §6050W requires third party settlement organizations to report payment card and third party network transactions. The threshold was changed by section 70432 of Public Law 119-21, enacted July 4, 2025, which restored the pre-2021 rule. The IRS states that these organizations "are not required to file Forms 1099-K unless the gross amount of reportable payment transactions to a payee exceeds $20,000 and the number of transactions exceeds 200." The change is retroactive to tax years beginning after December 31, 2021.

Foreign payees. A Form 1099-K is a U.S. information return for U.S. payees. Treas. Reg. §1.6050W-1(a)(5)(ii)(A) relieves a U.S. payor or middleman from reporting where it holds documentation on which it may rely to treat the payee as a foreign person under the rules of §1.1441-1(e)(1)(ii). In practice that documentation is a Form W-8. Failing to give the platform a valid W-8 is the most common reason a foreign seller ends up inside the U.S. information reporting system unnecessarily.

Backup withholding. Where a payee fails to furnish a correct taxpayer identification number, IRC §3406(a)(1) requires the payor to withhold at the fourth lowest rate of tax under §1(c), currently 24%, on reportable payments. This is not an income tax determination. It is a collection mechanism, and it is undone by documentation rather than by argument.

Form 1042-S. Separately, U.S.-source fixed or determinable annual or periodical income paid to a foreign person is withheld on at 30% under IRC §1441 or §1442 and reported on Form 1042-S. Sales income is not FDAP, but affiliate commissions, royalties, and licensing payments frequently are.

Layer four: state sales tax

Sales tax is imposed on the transaction, collected from the customer, and remitted by the seller. Your own profitability, residence, and treaty status are irrelevant to it.

After Wayfair, states set economic nexus thresholds based on sales volume, transaction count, or both, and those thresholds differ. The statute upheld in Wayfair used $100,000 of in-state sales or 200 separate transactions, and many states adopted variations of that pattern rather than copying it. Taxability also differs by product category.

Marketplace facilitator statutes complicate this in a useful direction. Many states place the collection and remittance duty on the marketplace itself for sales made through it. That can substantially reduce a seller's own collection burden, but it does not automatically answer whether the seller has its own registration obligation, particularly where the same seller also sells direct through its own storefront. Marketplace sales and direct sales have to be tracked separately.

Layer five: state income tax, and the protection that does not apply

States also impose income or gross receipts taxes, and here two points matter.

First, a treaty does not help. The taxes covered article of a typical U.S. convention reaches federal taxes only. The U.S.–Germany convention applies to "the federal income taxes imposed by the Internal Revenue Code" and a federal excise tax on insurance premiums. A no-permanent-establishment position is a position on federal tax.

Second, Public Law 86-272 is narrower than its reputation. Codified at 15 U.S.C. §381, it bars a state from imposing a net income tax where the only in-state business activity is the solicitation of orders for sales of tangible personal property, filled and shipped from outside the state. It does not apply to sales tax, to gross receipts taxes, or to sales of services and digital products. Its independent contractor provision at §381(c) is a real protection for goods sellers, but it protects only the activity the statute describes.

The Multistate Tax Commission revised its interpretive statement on P.L. 86-272 in August 2021 to address internet activity, taking the position that a range of online interactions with in-state customers go beyond protected solicitation. States have adopted that position unevenly, and it has been contested. Treat P.L. 86-272 as a state-by-state question rather than a settled shield.

One seller, mapped

An illustrative example. A company resident in a treaty country buys finished goods from a manufacturer abroad, holds them in a U.S. fulfillment center, sells through a marketplace to customers in 40 states, and also runs its own storefront. Annual U.S. sales are $3,000,000. The figures are illustrative.

• Federal. Inventory in the United States and orders regularly filled from it make the trade or business question live. Title passing in the United States would make the sales income U.S.-source under §861(a)(6), and therefore effectively connected under §864(c)(3) if the threshold is crossed. Whether the treaty produces a permanent establishment is a separate analysis under its own Article 5.
• Platform. A valid Form W-8 given to the marketplace addresses the 1099-K and backup withholding questions. It does not address the income tax question at all.
• Sales tax. Marketplace sales are likely collected by the facilitator. The direct storefront sales are the seller's own problem, state by state, and the 40-state footprint has to be measured against 40 sets of thresholds.
• State income tax. Inventory stored in a state is generally more than solicitation, so P.L. 86-272 may not be available in the states where goods sit.

Four exposures, four different answers, one business.

What to do next

Build the map before you build the position. Produce a sales-by-state report for the last twelve months, split between marketplace and direct. Confirm what W-8 forms each platform holds for you and whether they are current. Write down where title passes under your terms of sale, and whether you produce or resell. Then, and only then, take the federal question to a full review, since it depends on facts that the state analysis will already have surfaced.

None of this predicts an outcome for a particular seller, and any position has to be built on documents rather than on general reading. The firm's cross-border diagnostic works through the layers in this order. Related material is collected under IRS exposure analysis.