Here's how to comply with tax obligations as a small online seller.
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 year and you're looking at plenty of complications, especially if you're in e-commerce.
Vertex Inc.'s end-of-year report showed that 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 past 10 years. 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 taxable previously.
According to the Small Business Administration, "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." 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. This means these businesses are required to understand and monitor constantly evolving legislation.
While the concept of sales tax is simple enough, it's the constant changes that make things difficult for small businesses. The Supreme Court ruling in South Dakota v. Wayfair Inc. added complications to e-commerce companies doing business nationally. The decision 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. These changes were in addition to the hundreds of other sales tax changes throughout the U.S. in 2018 that affect brick-and-mortar retailers. [Interested in online tax software? Check out our best picks.]
"This is a major change in the sales tax world," said Judah Fish, CEO of Saltwater Tax Group. "Many state laws will likely change in the coming months, as states will obligate online sellers to collect sales tax and restore one of their largest revenue streams."
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Fish, whom we interviewed in July 2018, was correct. States are implementing these laws, with many having come into effect in late 2018 or early 2019. A few states are still putting these laws for collecting sales tax into place, but many of them have already altered their online sales tax rates. It's important to follow the guidelines of the taxing authority, in these cases each state, and adjust your sales tax practices accordingly.
Fish believed 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, especially with new regulations coming in the next few months. Online retailers need to be aware of the changing laws.
How to adjust to new sales tax laws for e-commerce
"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."
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 remaining compliant 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."
Technology can help small businesses with this tricky situation. Certain 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. [Interested in POS systems? Check out our best picks.]
"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 webinar discussion hosted by TaxJar.
For online retailers, having software to help manage the complexity of many different sales tax laws is crucial. For small businesses reaching the minimum sales thresholds, it's going to take thorough preparation and work to ensure you can handle the sales tax nuances of each state. This may also mean 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 take the challenge head-on rather than pretending your e-commerce business will operate the same way. Added taxation isn't the end of the world, but you need to follow those legal guidelines.
This can be difficult for businesses selling in states that haven't yet adjusted sales tax laws to reflect the South Dakota v. Wayfair Inc. ruling. Luckily, many states have announced plans to change their online sales tax laws. Most states have made changes in recent months, so this concern is significantly less burdensome than it was a few months back. These are the states with changes taking effect on April 1, 2019 or beyond:
- Rhode Island
These states have begun, or will soon begin, collecting sales tax following the South Dakota v. Wayfair ruling. Fortunately, they aren't deviating much from the guidelines set in South Dakota v. Wayfair. Regardless, nearly every state across the country decided to follow the legislation and charge sales tax for online businesses.
California's changes took effect on April 1, 2019. This is major news, as any business selling over $100,000 worth of goods to California customers online are subject to the California use tax. Having 200 or more separate transactions into California also subjects online sellers to the tax. This means California is following the guidelines set in South Dakota v. Wayfair exactly.
If a state hasn't updated its laws yet, e-commerce businesses can prepare for these uncertain situations by looking at their previous annual sales numbers in each state and using the South Dakota minimum sales threshold of $100,000 and 200 transactions as a guide. Many states have followed those 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. If you exceed that hypothetical threshold, make a note to closely monitor the sales tax laws in that state to remain compliant.
For example, if you notice you're selling more than $100,000 worth of goods or have more than 200 transactions annually in a state that hasn't adjusted laws since the South Dakota v. Wayfair ruling, you should frequently check the tax laws in that state for changes. If you make an average of 10 transactions for $200 in a state annually, it's not worth taking the time to review the state's sales tax policies. Prioritize the states where you sell the most.
Even if you're aware of the current changes caused by South Dakota v. Wayfair, you should carry the principle of remaining vigilant toward changing sales tax laws throughout your career.
"Although it may be tempting to put off, for many businesses there won't be a quick fix," Gainsbrugh said. "Ultimately, planning to be and staying compliant is going to be an ongoing process and something that will have to become a regular part of your business."
Online retailers shouldn't stress too much about more states collecting sales tax related to e-commerce, as the information is readily available for these businesses. It's a matter of taking the time to follow the legislation. If you collect sales tax from customers, be sure to remit the tax back to the state. Failure to do some can result in the violation of legal guidelines.
Compliance mistakes to avoid
"We all make mistakes," said Scott Peterson, vice president of U.S. tax policy and government relations at Avalara. "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 collection of sales tax:
1. Failing to keep track of different rules for different states. As mentioned above, 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 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 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. If you're a retailer, you need to be aware of changing legislation.
Tips for managing e-commerce 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 Luca CM Melchionna, a managing member of Melchionna PLLC. 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, adding 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."
Managing sales tax for e-commerce is doable, but it takes effort. Working with capable technology and sales tax experts is one way to help your business succeed at handling the workload. It's important not to fall behind on the various pieces of legislation.
Your business should also work to get any new sales tax permits you might need. If you were selling hundreds of thousands of dollars of goods in California before 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.
A few months ago, online sellers needed to start preparing for changes to state regulations. Now, states have implemented many changes, and small business owners need to react accordingly. Whether that means changing your POS system, adjusting your accounting practices or speaking with tax experts depends on your business. Regardless of how your e-commerce business reacts to the changes, it's important to react before you fall behind changes.
There's always the potential for new changes. Your business should continue to monitor sales tax changes, as there were over 600 changes last year alone. With an average of 588 changes annually over the past decade according to Vertex Inc., it's important to follow trends and changes. There are going to be sales tax changes every year across the U.S., and your business needs to do its best to follow the news and stay current with those changes. This means not only monitoring the changes, but also registering for a sales tax permit in each state where you do business if needed. Following details like that will ensure you properly react to e-commerce sales tax regulation.
Sales tax for e-commerce businesses can be a daunting topic, but with the proper technology and research, you can ensure your business follows the ever-changing tax codes.
Additional reporting by Nicole Fallon. Some source interviews were conducted for previous versions of this article.