Selling items online through sites like Amazon, eBay and Etsy can be extremely lucrative, especially for any business who is trying to expand their eCommerce presence. If done correctly, a small business can turn their storefront shop into a global eCommerce enterprise. However, the thought of being able to tap into a consumer base all across the country is equally exciting and terrifying at the same time. With increasing scrutiny towards online businesses, it is becoming more and more difficult to stay in compliance with state and local sales tax rules and regulations. Businesses can find themselves on the hook for thousands of dollars in fines and penalties for uncollected or incorrectly remitted sales tax. This blog post will walk you through the basics of when, how and why you should file sales tax for your online business.
All states, with the exception of Alaska, Montana, Oregon, New Hampshire and Delaware, levy sales tax; many localities within these states levy sales tax as well. Because US rules on sales tax is dictated by state and local legislators, there is no uniformity with how, when or how much sales tax should be collected. Although there are varying rules on when to collect, which products are exempt and how frequently merchants should remit sales tax, the general rules govern. To begin, sales tax is paid by the consumer, collected by the merchant and remitted to the state or local tax authority monthly, quarterly or annually. even though the merchant is collecting and paying the tax, the consumer is the one ultimately footing the bill. However, sales tax compliance is often burdensome and time consuming. Merchants must determine if they are required to collect sales tax, how to register in the specific states, how many times they must remit sales tax and what sales tax rates to use. Essentially, the merchant is taking on the administrative duties of the state and local taxing authorities. Before beginning to think of the headache that is involved with sales tax compliance you should ask yourself if you have to collect sales tax at all? This is where Nexus comes into play.
What is Nexus?
Nexus is a term used for an out-of state business that has “sufficient physical presence” in a state and therefore is liable for collecting sales or use tax; In legal terms, this physical presence is known as a “nexus.” Each state defines nexus differently, but all agree that if you have a store or office of some sort, a nexus exists. Nexus is created when an out-of-state business maintains a significant presence of people (employees or independent sales agents) or property (inventory, offices or warehouses). Temporary presence can be created through selling products at trade shows, holding consigned inventory in warehouses or traveling to a state to meet with buyers. The most obvious form of Nexus is a physical presence such as a store, office or warehouse, and therefore you must collect applicable state and local sales tax from your customers. If you do not have a presence in a particular state, you are not required to collect sales taxes. To make this clear, lets look at an example.
Joe decides he wants to make a little extra money on the side so he sets up a business and sells accounting related t-shirts online (I did a quick google search and this is actually a real thing). He makes t-shirts out of his apartment in New York and hires a part time employee in New Jersey to manage his website. He sells shirts in several states but he would most likely only collect sales tax in New York and New Jersey.
I Have Nexus, What Now?
If you determined you have Nexus in a state then you will need to register in that particular state. You will need to go to the state’s website (usually the department of taxation and finance) and follow the application instructions. If you don’t already have a Federal EIN number then you will most likely need to register with the IRS before you can register with most states. When you apply for your sales tax permit with your state’s taxing authority, they will assign you a frequency at which to file and remit sales tax. This is generally monthly, quarterly or annually, and often depends on your sales volume or the volume of sales tax you collect. The easy part is the registration process itself but the most difficult part is keeping track of the rules and regulations.
What Sales Tax Rate Do I Charge?
If you determined you have Nexus and you registered to collect sales tax in that state then the next step is to start collecting and remitting sales tax. But what sales tax rate do you charge? The answer: it depends. When it comes to determining tax rates, most states fall into one of two categories; origin-based sales tax and destination-based sales tax.
Origin-based sales tax is the easiest of the two and requires less tracking. Let’s say you have a store in Irving, Texas, but sell to someone in Houston Texas. Texas is an example of an origin-based sales tax state, so you would simply charge any buyer in the state of Texas your home rate of 8.25% (Texas’s statewide 6.25% rate plus Irving County’s 1.0% plus a local Dallas MTA rate of 1.00%). This is the easier of the two because you don’t need to take your buyer’s address into account; you simply charge the same sales tax rate to any buyer in Texas.
Now, lets say you also have a store in White Plains, New York. Since New York is a destination-based sales tax state, you’re required to collect sales tax at the effective rate at your buyer’s address. So if you operate your business in White Plains but sell to a customer in Monroe, then you are required to charge the seller 8.125% sales tax – the total sales tax rate at their locality in Monroe. (That’s a New York state base rate of 4.0% plus the Orange County rate of 4.125%). Now imagine selling to customers all over New York and keeping track of multiple sales tax rates based on the buyers address; what a nightmare.
Sales Tax Made Easy
Luckily, most online eCommerce platforms do a great job of keeping track of sales tax rates. Sites like Amazon and Etsy allow you to keep track of online sales and charge and collect applicable sales tax. You can catalog your inventory based on taxable vs non taxable and destination vs origin sales tax rates. Even if you are developing your own website there are applications that allow you to charge sales tax on specific sales.
Remitting Sales Tax
For sales tax purposes, many states allow you to file and pay online; some even require it. Most states require that you file a sales tax report even if you do not owe sales tax. Even more so, If you do not file, you could be subject to penalties. Also, Pay close attention to instructions you receive your sales tax permit to determine when you should file. While many states set their sales tax due date as the 20th of the month, states can vary wildly in their sales tax due dates. For example, If you are a quarterly payer, be sure you are aware of which date your state considers a “quarterly” due date. Many states have varying quarters that don’t fall in line with the calendar year and can be confusing when filing sales tax returns.
This blog post is by no means an all encompassing guide to sales tax for online businesses. However, it should make you question whether or not you should be collecting and remitting sales tax for an online business. If you are feeling overwhelmed by sales tax compliance there are several services that provide sales tax compliance assistance as well as sales tax tracking software (A quick google search will give you several examples). Ultimately, If you have questions or concerns on your specific tax situation be sure to contact your CPA.