Setting prices can be one of the most challenging aspects of running any business. This is especially true of the retail industry, where sales tax needs to be factored into your final sale price.
According to the Small Business Administration (SBA), "as a small business owner, you are required to assess sales tax, collect it and pass it on to the appropriate authorities within the prescribed time." With the exception of wholesale items, raw materials and sales made to nonprofit organizations, U.S. retail businesses are required to collect sales tax on the goods they sell.
Sales tax rates and laws vary from state to state, which gets tricky when you're an e-commerce company selling to customers across the country. One of the biggest sales tax-compliance challenges facing these sellers is knowing where they have nexus, or a relationship with a certain jurisdiction that requires them to collect sales taxes, said Scott Peterson, vice president of U.S. tax policy and government relations at Avalara.
"In general, if you have nexus in a state, you will be responsible for collecting the right rate of sales tax … on any sales to customers within that state," Peterson told Business News Daily. "This is easier said than done, but it's essential. The states where you have nexus … are the states where you need to be aware of all the sales tax rules. [There are] plenty of one-off exceptions and constant changes to keep things very interesting for anyone trying to keep track and comply."
How do you know which states you have a nexus in? What matters is whether you have a physical presence in a certain state — a store, an office, a warehouse, employees or other criteria established by the individual state. If you don't have a presence in a state, you are not required to collect sales tax from customers there who buy from you.
"Each state defines 'nexus' differently; however, any bricks and mortar footprint in that state, such as an office or warehouse, will affirm that a nexus exists and sales tax must be collected," wrote Caron Beesley in a SBA article.
Compliance mistakes to avoid
Luca CM Melchionna, partner at Fellicello & Melchionna law firm, said that many small online retailers are not aware of their tax obligations, thus creating potential compliance issues (and subsequent audits, penalties and/or fines) for their business.
"We all make mistakes," said Peterson. "When you're a small business filing sales taxes, it's easy to do. After all, chances are, you're not a sales tax expert."
Peterson shared three common mistakes small businesses make regarding their sales tax collection:
1. Failing to keep track of different rules for different states. As mentioned above, every single state has its own rules and procedures. You may be dealing with several different due dates, filing frequencies, formats, late penalties and other variables, and it can be easy to mix them up, said Peterson.
"Making sure you are getting it right for each state also means making sure you are updated on the latest requirements, which can and do change," he added.
2. Reporting incorrect numbers. Many states require you to break down collections based on local jurisdiction, which adds another layer of complexity. Peterson noted that it takes careful computation and checking to make sure you are getting your numbers right.
3. Not filing because you didn't collect any tax. Don't think that if you didn't collect any tax, you don't have to file for that reporting period. Most states require you to file every reporting period, even if you didn't collect anything. Disregarding this requirement could result in late/non-filing penalties, said Peterson.
Tips for managing sales tax
One of the best things you can do to stay on top of your sales tax obligations is to keep meticulous records, said Melchionna. A good accounting solution can help you track your invoices and sales so you know exactly where your sales come from.
"Be sure to work with an attorney and a CPA with experience in this area," Melchionna said. "In many states, sales-tax-reporting obligations are recurring. It is important that small retailers maintain impeccable documentation at the time of each sale."
Peterson agreed, and added that it's important to track your specific filing frequencies and due dates.
"When you register with a state, you should be assigned a filing frequency (monthly, quarterly, annually or other)," he said. "These frequencies each come with their own due dates. Although the due date may officially be the same day of the month each reporting period, these can fluctuate due to holidays, weekends, etc. So it's crucial to check the exact dates rather than just assume that you know when they are."