The eCommerce business conundrum: What to know about interstate sales tax
Tax requirements are complicated for all types of businesses. eCommerce businesses have an extra layer of complexity - interstate sales tax regulations. eCommerce businesses have access to a broader range of customers than brick-and-mortar stores.
The opportunity to sell to out-of-state customers also brings interstate tax regulations at the state and local levels. With more than 12,000 tax jurisdictions in the United States, tax requirements are not for the faint of heart.
On the other side of the equation, we have tax jurisdictions. Especially after the pandemic, states are dealing with unprecedented budget deficits. As a matter of fact, this was a problem before the pandemic, as the Government Accountability Office estimates that states lost as much as $13 billion in sales taxes in 2017.
States are cracking down on collecting sales taxes from online sellers. Large companies like Amazon, Walmart, and Wayfair have their tax strategies locked tight. If you’re newer to eCommerce or run a small operation, you may feel the effects of these ever-changing regulations.
This blog post will answer your questions (including the ones you didn’t even know you had) about interstate tax compliance.
What is sales tax?
First, we should answer, “what is sales tax?” The first thing you need to know about sales tax is that it’s levied at the state level, not by the federal government. Forty-six states use sales tax to help fund things like roads, hospitals, and schools.
Sellers are obligated to calculate sales tax at the transaction of an item. If you buy an item that costs $20, and the sales tax rate is 5%, then you’ll pay a total of $1 in sales tax.
Certain states will exempt certain goods and services from sales tax. These could include food for human consumption, raw manufacturing materials, and medical devices.
States also have different rules when it comes to eCommerce sales tax. In most cases, when a customer buys a product online, they’ll pay their local sales tax rate. This is the same rate they’d pay if they purchased the item from a brick-and-mortar shop.
What if your customer lives in Ohio and purchases a product from your store based in California? Are you required to collect sales tax and pay it to the state of Ohio?
The answer is “maybe.”
This occurrence is where interstate taxes differ from intrastate taxes. You would typically only collect sales tax for another state if you have a physical presence or economic nexus in that state.
What is a nexus? We’re so glad you asked…
What is a nexus?
By the dictionary definition, a nexus is a connection or series of connections linking two or more things. Regarding taxes, a nexus is a business’s connection with a state or local jurisdiction that gives them the authority to have the business collect tax on its behalf.
Let’s explore two types of nexuses.
If your business meets the following physical presence requirements, you may need to register with your state to collect and remit sales tax.
- Having a warehouse, computer server, retail store, corporate office, or other facilities in the state
- Delivering purchases yourself in a company-owned vehicle in the state
- Having an employee, independent contractor, or remote worker do business on your behalf in the state
- Having an affiliate or related company do business on your behalf in the state
As an eCommerce seller, the first question you need to ask is, “where do I have a physical presence?”
Before June 2018 (see South Dakota v. Wayfair, Inc), a state could only ask you to collect sales tax on their behalf and remit it to them if you had a physical nexus. Since our economy has shifted from brick-and-mortar to online, states want to capture that revenue by taxing online sellers.
Thus the economic nexus.
Now, states can dictate that if you reach a sales threshold or revenue from sales, you need to remit sales taxes to the state.
The general rule is 200 sales or $100,000 sold in products or services in a calendar year. You don’t need to register to collect sales tax until AFTER passing the economic nexus threshold. You can look at this resource to understand the economic nexus laws state by state if you do a lot of interstate commerce.
Oh, and don’t forget about local sales tax
Many states collect both statewide and local city or county sales taxes. You must collect all applicable taxes and generally collect the sales tax rate that applies at the location of the sale.
South Dakota v. Wayfair: What’s it got to do with my eCommerce store?
Earlier, we mentioned a U.S. Supreme Court case between South Dakota and the online furniture store Wayfair. Seemingly unlikely opponents, South Dakota felt that eCommerce retailers should be required to collect and remit sales tax. In 2018, the U.S. Supreme Court ruled in South Dakota’s favor, eliminating the physical presence standard for sales tax nexus.
Now we have a solid understanding of terms like sales tax and economic nexus. Next, you need to understand an important concept. You should know that you are responsible for remitting sales tax to the state where you have a physical presence or nexus.
This may be easier than it sounds if you use an eCommerce platform like Shopify. There are also laws making it easy to collect and remit sales tax using a marketplace like Etsy, eBay, or Walmart.
These laws are called marketplace facilitator laws. These laws dictate that the marketplace facilitator will generally be required to pay sales tax or collect and remit use tax on all retail sales of tangible merchandise.
However, these laws do NOT apply to eCommerce platforms like Shopify, BigCommerce, Magento, or WooCommerce. However, almost all eCommerce platforms can automatically charge your customers the correct local and state sales tax rates for you. After that, it’s your responsibility to remit those taxes to the required tax authorities.
Some states require you to submit a monthly or quarterly sales tax return when you pay. You should segregate this money into a separate business bank account, so you don’t consider it part of your income.
What happens if you don’t pay sales tax?
All states will charge a penalty if you fail to collect and remit sales tax on purchases. They will penalize you anywhere from 5-25% of your tax amount. States may also hammer you with interest payments the longer you go without remitting sales tax. States may seek additional action, including litigation, which can jeopardize your business and freedom.
An even bigger crime than not collecting sales tax is collecting it but not remitting it to the state. This is considered criminal fraud and could lead to potential jail time.
Take the confusion out of eCommerce taxes
Staying on top of tax laws is a challenging task. If you need further help, we suggest consulting a tax advisor who specializes in eCommerce businesses or has a good understanding of your industry.
If there’s one big takeaway you should have from this article, it’s this. Most eCommerce platforms will collect the correct sales tax amount from your customers. All that’s left for you to do is file the proper returns with your state and remit the taxes.
We get it.
You already have income tax, estimated taxes, employment taxes, and now this? Keeping track of it all can be a real drain on your time and energy. Luckily, ComplYant can help you keep track of all your tax obligations as a business owner. Our custom calendars and due date reminders will help you never forget a business tax deadline again.