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Selling products online comes with the obligation in many states to collect and remit sales tax. Failure to properly handle sales tax can lead to audits, penalties, and other issues.
In this comprehensive guide, we'll cover everything you need to know as an ecommerce seller to stay compliant and avoid problems with sales tax management.
Table of Contents
- What is Sales Tax?
- What is Sales Tax Nexus?
- Types of Nexus
- Sales Tax on Products
- Sales Tax on Digital Products
- How to Get Compliant
- Handling Dropshipping Sales Taxes
- Resale Certificates
- Important Dates
- Consult a Tax Advisor
What is Sales Tax?
Sales tax is a tax paid by the end consumer on the purchase of goods and services. It is collected by the seller at the time of purchase. Sales tax rates vary by state, county, and city location. Sales tax makes up a large portion of state revenues.
Sales tax is different from income tax, which is a tax on personal earnings and corporate profits. Income tax is paid directly by individuals and businesses.
Difference Between Sales Tax and Income Tax
- Sales tax is paid by the customer to the seller. Income tax is paid directly by individuals/businesses.
- Sales tax applies to consumer purchases. Income tax applies to wages, salaries, profits.
- Sales tax rates vary locally. Income tax follows federal and state brackets.
- Sellers collect and remit sales tax to the government. Taxpayers file and pay income taxes themselves.
- Sales tax generates state revenue. Income tax provides federal and state revenue.
Sales Tax On Products and Services
The first step to determine is if you need to collect taxes. If you are selling products through an online store, you may be required to collect and remit sales tax in states where you have nexus.
Some key points:
- You must collect applicable state and local sales tax rates based on the customer's shipping address.
- Taxability depends on the product - most states tax physical goods but have different rules for digital products and services.
Whether digital products or services are subject to sales tax depends on each state's laws. Fro instance, many states consider digital products like software, ebooks, music, etc. equivalent to physical products. But some states exempt digital goods if no physical version exists.
For states that tax digital goods, products are often defined as taxable if they can be:
- Downloaded
- Accessed remotely
- Perceived electronically
Research taxability in states where you have nexus. Some states provide explicit digital product tax guidance.
Identifying Your Sales Tax Obligations
The first step is understanding where you have nexus and must collect sales tax. Every state has different rules and thresholds that trigger nexus for out-of-state sellers, such as:
- Having inventory stored in or shipped from a state, including fulfillment centers like Amazon FBA
- Number of sales transactions in a state, often as low as $100-200 sales
- Gross revenue from sales into a state, typically $100,000+
- Any physical presence like a temporary sales rep or trade show booth
- Click-through referrals and affiliate sales in states
Review economic nexus laws and analyze your sales channels to determine where you exceed thresholds that require sales tax registration.
What is Sales Tax Nexus?
Nexus refers to a connection between a business and a state that requires the business to collect and remit sales tax in that state. Nexus can be established through physical presence, economic activity, affiliate relationships, and more. You are only required to collect sales tax in states where you have nexus.
Types of Nexus
Physical Nexus
Physical nexus occurs when a business has a physical presence in a state, such as:
- An office, store, or other location
- Employees or contractors
- A warehouse or storage facility
- Storing inventory in a state
- Temporary physical presence like at a trade show
Economic Nexus
Economic nexus establishes a sales tax obligation based on a business exceeding economic thresholds in a state, like:
- Dollar amount of sales
- Number of transactions
- Having an in-state affiliated business
Click-Through Nexus
Click-through nexus taxes businesses that receive a significant volume of referrals from affiliates in a given state. This applies to sales from referral programs, affiliate links, influencers, and more.
You must register for sales tax permits and file returns in any state where you have nexus.
How to Determine Sales Tax Rates
Once you know where you need to collect tax, the next step is identifying the correct sales tax rates. Rates can vary considerably across state, county, city, and district lines.
Steps to find the appropriate rates:
- Check state department of revenue website for state tax rate
- Identify if county and city taxes apply based on customer location
- Research district taxes like transit, stadium, tourism, etc.
- Use tax rate lookup tools to find full combined rates
- Consider integrating automated sales tax rate determination into your ecommerce platform
- Remember to update rates when they change!
Use resources like Avalara's tax rate tables and Zip2Tax tools to look up the combined rate for a customer's location. Integrate an automated sales tax rate provider into your ecommerce platform to calculate accurate rates at checkout.
Be sure to periodically check for rate changes in the states where you collect tax.
Collecting and Remitting Sales Tax
Now you need to set up tax collection and reporting processes:
Integrate sales tax calculation and collection into your shopping cart flows. Collect tax at checkout based on customer shipping address.
Generate sales tax reports from your ecommerce platform to file. Remit tax payments to each state on time, usually quarterly.
Document collection processes and nexus analysis for audit defense. Keep records of all tax-related transactions and exemption certificates.
Issue refunds to customers quickly when processing returns and cancellations.
Carefully manage sales tax when selling across multiple sales channels to stay consistent.
Consider automated sales tax software to handle everything seamlessly.
Sales Tax Exemptions
Some customers are exempt from paying sales tax when making qualified purchases. Common exemptions include:
Wholesale retailers with valid resale certificates for inventory purchases
Tax-exempt organizations like charities, churches, nonprofits
Purchases by foreign diplomats and embassies
Items being shipped out of state
Have customers upload or email exemption certificates during checkout. Validate certificates and keep them on file along with other tax records.
Managing Dropshipping Taxes (still working on this)
When working with dropshipping suppliers:
Provide a valid resale certificate so you don't pay sales tax on inventory upfront. Obtain certificates for each state.
Review if the supplier handles sales tax collection at the time of sale. Factor tax charges into your pricing if needed.
For dropshipped items stored in supplier warehouses, understand nexus implications and collect appropriate sales tax at checkout.
Platforms Like Shopify and Amazon:
If using Shopify or selling on Amazon, leverage their built-in sales tax tools:
Shopify automatically calculates rates and can manage filings depending on the package you are signed up for. You control tax settings and nexus analysis.
Amazon collects and remits tax for Marketplace transactions when items ship from their warehouses.
For Amazon FBA or other multichannel sales, integrate your own tax collection and reporting.
Getting Help with Compliance
Sales tax laws and requirements are complex. Consider automating compliance with software or outsourcing to an accountant or tax attorney. This ensures you:
Collect, file, and remit sales tax accurately in every state where you have nexus.
Stay current as state laws and nexus rules frequently change.
Can handle an audit if ever questioned by state tax agencies.
Handling sales tax properly is crucial for ecommerce success. Follow this guide and leverage available solutions so you can focus on growing your online business without sales tax headaches.
