Sales tax on e-commerce has presented a contentious and confusing issue for more than two decades. The matter has reached the U.S Supreme Court, most recently in the case of South Dakota v. Wayfair. The June 21 decision, in favor of the State of South Dakota (link downloads and opens PDF), reversed the 1992 decision Quill v. North Dakota.
The decision means that your e-commerce business may be required to collect sales tax. The New York Times calls the decision “a victory for brick-and-mortar businesses that have long complained they are put at a disadvantage by having to charge sales taxes while many online competitors do not.”
An internet-based company differs significantly from a traditional brick-and-mortar business. That difference also extends to how they collect sales tax. Quill v. North Dakota said states could not require out-of-state retailers to collect tax on sales to state residents. So as a business owner, you could not collect sales tax from customers outside any state where you had a physical presence. However, the internet landscape looks very different than it did in 1992. What can you expect as a business owner, now and in the future?
Who Must Collect Sales Tax?
TurboTax sums up the basic rules of sales taxes this way: “If your business has a physical presence, or “nexus,” in a state, you must collect applicable sales taxes from online customers in that state. If you do not have a physical presence, you generally do not have to collect sales tax for online sales.” According to Big Commerce, 45 states and Washington DC have sales taxes.
Physical presence is typically defined as a storefront, an office or even a warehouse. However, different states use different factors to determine eligibility. Even if you don’t have a physical presence in a specific state, there are instances where you may be required to collect and remit sales taxes to the state. For example, if you sell from a location that does require sales tax, like California, you’ll have to collect from residents of California; if you use Amazon’s FBA program, you may need to collect sales tax from individuals in other areas, because you send your inventory to Amazon. It’s important to check the requirements.
How Do States Handle Sales Taxes and E-commerce?
Because not every state requires online sellers to collect sales taxes, the topic can be complicated. Thomson Reuters surveyed state taxing agencies to learn about how they handle transactions like cloud computing, digital products, and others. The State Corporate Income Tax: E-Commerce Study 2018 (registration required for download) looks at how states can require sellers to pay taxes when they engage in a purely digital transaction.
Seventeen states participated in the survey. Thirteen of those states indicated that engaging in a purely electronic transaction could create a corporate income tax nexus; the other four participating states said that the action would not.
How to Collect State Sales Tax on E-commerce
First, determine whether your products require sales tax at all. Some states do not collect sales tax on items they consider “necessities.” These may include food, some clothing, medications or supplements, and digital products. Then, register for a state sales tax permit in any state where you have a nexus (physical location). If your nexus is in a state that does not collect sales tax, then you don’t have to collect sales tax. A small business lawyer can advise you on the proper steps.
If you sell product through a third party storefront, like Etsy, they may take care of charging sales tax to customers in certain states like Washington.
You will also need to be aware of local sales taxes. Within state boundaries, sales tax requirements vary according to county or municipality. According to the Tax Foundation, some states have dozens or even hundreds of sales tax jurisdictions. Texas alone has more than 1,500!
The Future of E-commerce and Sales Tax
It’s not entirely clear how things will play out in light of South Dakota v. Wayfair. The Wall Street Journal explores the ruling and notes that even members of the House Judiciary Committee are wary. There is definite concern over issues and costs that could arise from such a change. Take the perspective of Jonathan Johnson, president of Medici Ventures (a subsidiary of Overstock). Overstock, he says, has a physical presence in six states, where it collects sales taxes and remits them to taxing agencies using a software program.
“When we went from collecting just in Utah to collecting in Utah and North Carolina…the cost to implement what we did there was something like $1.2 million,” he said. “Now given that that’s in place, it would not be that much for every other state. But there is a time and effort cost, and some dollar cost…”
NetChoice Executive Director Steve DelBianco adds: “It is not just 12,000 state and local jurisdictions. There’s also 550 Indian tribes who would assert any business anywhere in the country owes them sales tax for sales made to residents of that jurisdiction.”
In an article calling a national sales tax a bad idea, Fortune quotes Justice Stevens in the Quill decision as writing that “Congress is now free to decide whether, when, and to what extent” states could burden out-of-state sellers with taxes.”
Wherever you do business, seek legal and financial advice to ensure you follow the laws correctly. Running an e-commerce business can be complicated so take the time to learn the ins and outs.