Sales tax is relatively straightforward for brick-and-mortar retail stores. A shopper goes into a store, buys something, and pays the sales tax for the state, county, and city where the store is located. It’s simple.
In contrast, online retailers must collect and pass through sales tax for every state, county, or city where the retailer has legal nexus. In theory, this tax collection burden could be an expensive and significant challenge that might have a large online retailer collecting taxes for hundreds or even thousands of jurisdictions.
The process can be highly complex. Jurisdictions can have different tax rates as well as different items that are subject to the tax. The concept of legal nexus is itself confusing because states vary on their definition. Some states require only a physical presence, such as an office or a warehouse. Other states are much more aggressive and consider affiliates, employees working from home, and even vendors as constituting nexus.
The U.S. Congress has considered, but not passed, legislation to clarify all of this. Until that occurs, merchants must attempt to stay abreast of the nationwide sales tax laws, especially in the states where they have a physical presence.
But, in practice, for many, if not most, small ecommerce retailers, collecting and remitting sales tax can be managed with a four-step process.
Step 1: Research State Sales Tax Rules
Each and every state has its own rules, regulations, and rates for sales tax. But, for the most part, states only require an online merchant to collect sales tax if that merchant has a presence in the state, which, as alluded to above, is called having nexus.
Nexus or a presence in a state is usually defined by:
- Having a physical location like a warehouse in a state;
- Having an employee or affiliate in a state;
- Working with third-parties who have nexus in a state.
As an example, if an online store is headquartered in Idaho, with no out-of-state operations or affiliates, it would need to collect sales tax for orders from Idaho residents.
If this same, Idaho-based online seller hired a search-engine-optimization expert who worked from his home office in Florida, the merchant may need to collect and pass through sales tax for Idaho and Florida tax jurisdictions, since this retailer would have nexus in both states.
Finally, if the Idaho-based online seller with the SEO pro in Florida started to use a fulfillment service that stored products at a warehouse in Texas, that retailer could have nexus in Idaho, Florida, and Texas.
A few states have laws that extend nexus to include the destination of online orders. Fortunately, most of these states only require collection from relatively large sellers.
Step 2: Get Licensed to Collect Sales Tax, Learn the Rules
Nearly every state requires retailers to register or be licensed to collect sales tax. So, once you have decided that your online store has nexus in a particular state, you will need to register to collect sales tax for that state.
That is also a good time to become familiar with the state’s particular tax rules and jurisdictions.
Online sellers will want to know a few things.
- Are there different tax jurisdictions? In some states, online stores will need to collect taxes at the state and local level, so that sales tax might need to be collected for a particular city, as an example.
- What is each jurisdiction’s tax rate? It may be the case that there is a basic state tax rate, a county tax rate, and a city or municipality tax rate. You’ll need to identify each.
- Who’s tax rate applies? Some states use the tax rate at the origin of a shipment, while others use the tax rate at the destination. If you have a warehouse in city A, and you ship an order to city B in the same state, which tax rate applies? TaxJar, which makes sale tax tracking software, as a good blog post about this.
- Should you charge tax on shipping? At the time of writing, more than half of U.S. states required online sellers to charge tax on shipping, too.
- How often do you need to remit sale tax? Retailers collect sales tax and hold it briefly, typically making monthly, quarterly, or annual payments to the state.
Step 3: Automate Tax Collection for Your Store
Good ecommerce platforms should include a way to set up and automate sales tax collection. It may be the case that you will need to manually enter sale tax rates for each state or jurisdiction in which your business has nexus. But you should only need to do this for your initial setup or when a tax rates changes.
There are some software solutions that can make this task easier and even help with sales tax submissions. A simple search on Google or Bing will generate a long list of possibilities, but here are some check out.
- Accurate Tax
Step 4: Pay the State, or at Least Report to the State
The final, and perhaps obvious, step is to pass through — pay — the sales tax your online store collects.
Remember that even if you do not have any sales tax to pass through to a particular jurisdiction, you may still need to report. In fact, some jurisdictions will charge your business significant penalties if you do not report.