If you sell across state lines, you're required to pay sales tax in those states. Here's how to comply with tax obligations as a small online seller.
- The U.S. Supreme Court case South Dakota v. Wayfair established that e-commerce retailers are required to pay sales tax.
- Each state has its own rules to determine which businesses are required to collect and pay sales tax.
- E-commerce businesses should consider technologies and consult with experts when determining these rates.
- This article is for e-commerce business owners who need to stay on top of their tax obligations.
Staying up to date on changing sales tax laws can be difficult for even the savviest small business owners. Add in the changing legislation from the past few years and you're looking at plenty of complications, especially if you're in e-commerce.
According to Vertex Inc.'s 2019 end-of-year report, there were 619 standard sales tax rate changes in 2018. The same report says there have been 5,886 new and changed sales tax rates in the 10 years prior. That's a lot of legislation for small business owners to track, and some of those changes result in businesses becoming taxable in states where they weren't taxed previously. How do you keep up with these regulations?
Here's what e-commerce business owners need to know about interstate sales tax regulations, what you can do to keep on top of these changes and common mistakes to avoid.
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Do you have to pay sales tax on e-commerce sales?
Yes. Business owners must assess sales taxes, collect them and remit them to the proper tax authorities within the prescribed time. Except for wholesale items, raw materials and sales made to nonprofits, U.S. retail businesses are required to collect sales tax on the goods they sell. As a small business owner, you must monitor constantly evolving legislation. [Read related article: Online Business Laws Your Small Business Needs to Know]
Key takeaway: E-commerce businesses are required to assess, collect and pay sales tax.
What is a sales tax nexus, and how does it affect e-commerce businesses?
A sales tax nexus is what determines the relationship between your business and the state, or taxing jurisdiction. For brick-and-mortar stores, determining this is typically easy: the physical presence of the store in that state established the relationship between the taxing jurisdiction and the business.
However, the Supreme Court ruling in South Dakota v. Wayfair Inc. changed how e-commerce businesses charge and collect sales tax. The decision, made in June 2018, enabled states to charge sales tax to out-of-state sellers, which means you don't need a physical presence in a state to pay sales tax. In South Dakota, the state can charge sales tax to any business that delivers more than $100,000 of goods or services or totals 200 transactions on an annual basis.
Now, with goods theoretically available to all customers in all 50 states, e-commerce businesses may not know how much sales tax to charge, if any. [Read related article: The 10 Best (and Worst) States for Small Business Taxes]
"This is a major change in the sales tax world," said Judah Fish, CEO of Saltwater Tax Group.
Fish stated in this interview, conducted in 2018, that other states would collect tax by setting similar parameters to South Dakota for the minimum dollar sales amount and transactions needed to enforce the tax. Other experts had similar predictions. We've seen this happen, but several states have added variations to South Dakota's terms. Some of those sales tax rates are more difficult for online businesses to monitor, while others are quite close to the terms established in South Dakota v. Wayfair.
If your small business mails three $15 products to a customer across the country, you don't need to worry much about these sales tax laws. It's highly unlikely any state will create a law where purchases that small result in paying a sales tax, but businesses selling larger amounts need to take note.
The sales tax nexus changes from state to state, and how it's determined can depend on several factors, including employees, headquarters, where inventory is stored, or the amount of product sold to or in a particular state. These laws are continually being updated, so you should look up the requirements on each state's website to ensure you are in compliance. Additionally, you may want to check with a tax authority or a certified public accountant (CPA) to determine how much sales tax you may need to collect.
Key takeaway: A sales tax nexus determines your business's relationship with a taxing jurisdiction. South Dakota v. Wayfair ruled that a business does not need a physical presence in a state to collect sales tax from customers in that state.
How to adjust to new sales tax laws for e-commerce
Keeping on top of these ever-changing e-commerce sales tax laws is no easy feat. As you prepare your business to determine eligibility, how much sales tax to charge (if any), and how it will be collected, tracked, and paid, you'll need to set up new systems and processes that help ensure you're meeting your responsibilities.
"Along with the obvious changes that are going to need to be implemented from an accounting perspective, a huge portion of the impact of this decision is going to be technological," said Christian Gainsbrugh, the founder of LearningCart. "Many people take sales tax calculations for granted, but managing and calculating those rates behind the scenes is no small feat."
Decide how you plan to track e-commerce sales tax laws
Large online retailers hold an advantage over smaller sellers in this scenario, as companies like Amazon can throw money and employees at these issues to quickly adjust to changing laws and compliance issues. Small businesses with fewer resources will have a harder time complying with different sales tax laws, according to Gainsbrugh.
"Although some states like Maryland have a standard flat sales tax rate, some like South Dakota base it on the city, and other states like Washington calculate sales tax based on the county the purchaser is in," he said. "With the way county lines are drawn, you literally could have a customer on one side of a street with one tax rate and another across the street with a completely different tax rate."
Choose a point-of-sale platform that tracks tax liabilities
Technology can help small businesses with this tricky situation. Certain point-of-sale (POS) systems integrate with accounting software capable of processing different state sales tax laws. Shopify, Square, Clover, PayPal and Vend all offer sales tax solutions in addition to their POS services.
"As the Supreme Court pointed out, there are software solutions that are available … that will help small businesses comply with these obligations on a multistate basis," said Mike Dillon, the president of Dillon Tax Consulting. Dillon shared these thoughts on a June 2018 webinar discussion hosted by TaxJar. For online retailers, having software to help manage the complexity of different sales tax laws is crucial.
For small businesses reaching the minimum sales thresholds, it requires thorough preparation and ongoing work to ensure you stay on top of the sales tax nuances of each state. This may also entail applying for sales tax permits in states that require your business to pay sales tax. Becoming taxable in a state matters, and it's important to meet the challenge head-on rather than pretending your e-commerce business can continue to operate the same way. Added taxation isn't the end of the world, but you need to follow those legal guidelines.
Make sure you're monitoring sales tax rates in all states
Following the South Dakota v. Wayfair decision, most states changed their tax law. For example, California's changes to its e-commerce sales tax regulations took effect on April 1, 2019. This was major news, as any business selling over $100,000 worth of goods online to California customers was subject to the California use tax. Having 200 or more separate transactions into California also subjected online sellers to the tax.
California updated its e-commerce sales tax requirements in February 2020, less than a year after the first adjustments were made, and now requires businesses that make "three or more sales in a 12-month period" to hold a seller's permit. This change underscores just how important it is for businesses that sell their goods online to continually monitor state sales tax regulations.
Many states have followed the monetary guidelines set forth in the Supreme Court case. Other states won't always enact the exact standards as South Dakota, but you can use those numbers as a guide to prepare in the event that your state has not set laws yet. If you exceed that hypothetical threshold, you should closely monitor the sales tax laws in that state to remain compliant.
For example, if you sell more than $100,000 worth of goods or have more than 200 transactions annually in a state that hasn't adjusted its laws since the South Dakota v. Wayfair ruling, you should frequently check the tax laws in that state for changes and follow the legislation. If you collect sales tax from customers, remit the tax back to the state. Failure to do some can result in the violation of legal guidelines.
Key takeaway: Preparing for shifting e-commerce laws involves investing into resources, such as software, that can help you monitor law changes in all 50 states and make adjustments to your sales-tax-collection processes accordingly.
Tips for managing e-commerce sales tax
Managing e-commerce sales tax takes great effort, cooperation and assistance. These tips can help you properly track state laws, collect and remit e-commerce sales tax to the proper tax authorities.
Track every penny – literally.
One of the best things you can do to stay on top of your sales tax obligations is to keep meticulous records, said Luca CM Melchionna, a managing member of Melchionna PLLC. A good accounting solution helps 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."
Track each state's payment deadline dates.
When you have to remit sales tax you collect on e-commerce sales varies by state. Create a calendar or mark up an existing calendar you use with each state's due date to ensure payments are sent to the proper authorities on time.
"When you register with a state, you should be assigned a filing frequency (monthly, quarterly, annually or other)," said Scott Peterson, vice president of U.S. tax policy and government relations at Avalara. "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 and other factors. So, it's crucial to check the exact dates rather than just assume that you know when they are."
Know how to remit sales tax.
Each state has its own requirements governing how to file and remit e-commerce sales tax. Some may accept a check, and some state may require that you pay online.
Ensure you have the proper permits.
Your business should also obtain any new sales tax permits you might need. If, for example, you sold hundreds of thousands of dollars of goods in California before the recent legislation, you'll want to get a sales tax permit to continue that practice. If you need to pay sales tax in a state, you'll need a sales tax permit.
Understand the penalties for mistakes and delays.
Knowing the penalties for late payments or incorrect payments for each state is as important as knowing the law itself. Not complying with the law, even accidentally, could cause ongoing issues for your business, including legal action.
Consult an expert.
If you're unsure of what your tax responsibilities are in a particular state, contact a tax professional, CPA, or attorney. Their insight can help you make the best decisions for your e-commerce business, as well as ensure that you're collecting and remitting this sales tax correctly.
Key takeaway: The best way to manage e-commerce sales tax is to keep meticulous records, track your filing frequencies and due dates, and ensure you receive the proper sales tax permits. Consult professional help if necessary.
Compliance mistakes to avoid
"We all make mistakes," said Peterson. "When you're a small business filing sales taxes, it's easy to do. After all, chances are good that you're not a sales tax expert."
Peterson shared three common mistakes small businesses make regarding their collection of sales tax:
Failing to keep track of different rules for different states
As mentioned earlier, every state has its own rules and procedures. You may be dealing with several due dates, filing frequencies, formats, late penalties and other variables, and it's 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.
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.
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 or non-filing penalties, said Peterson.
Compliance mistakes are out there waiting to happen, but properly managing sales tax responsibilities and staying informed gives you the best chance of avoiding trouble. You want to make sure your tax returns are correct, and monitoring the different trends and working with experts in sales tax rates is the easiest way to ensure your business's tax returns are correct.
Key takeaway: Avoid common mistakes when it comes to e-commerce sales tax compliance. Don't skip filing if you did not collect sales tax, don't ignore sales tax laws in any state, and don't forget to regularly track the rules in every state.
What's next for sales tax for e-commerce?
Since the South Dakota v. Wayfair ruling in 2018, states have implemented many changes to e-commerce sales tax regulations. This is likely to continue, and your business needs to stay current with the changes.
Staying current entails not only monitoring the changes but registering for a sales tax permit in each state where you do business, if needed.
While it may seem nearly impossible from the vantage point of a small business owner to stay up to date on sales tax changes in 50 states, by staying organized, conducting ongoing research and purchasing software programs, you can ensure your business complies with ever-changing tax codes.
Key takeaway: Sales tax rates change frequently; use technology to help your business stay up to date with them.
Additional reporting by Stella Morrison.