There are an estimated 1.3 million e-commerce businesses in North America alone, according to Pipe Candy. Many "but not all" of those in the U.S., have to collect sales tax on online purchases. But is yours one of them?
Read on to learn what obligations your small business has in collecting internet sales tax.
What is an internet sales tax?
Internet sales tax is a type of sales tax that online sellers assess and collect from consumers on online sales. Online sales are typically those made through online merchants such as Amazon, Walmart or Macy's. Once the tax is collected, online sellers must send it to the state. The growing volume of e-commerce transactions means that sales tax from online transactions can be an important source of revenue for a state.
What are the rules?
Sales tax rules are imposed at the state level. Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon are five states that do not impose a sales tax. If you operate in one of these states, you don't need to collect sales tax on online purchases or other purchases. But you may have to collect sales tax if you're an online seller in the 45 other states plus the District of Columbia.
The general rule is, you have to collect sales tax from consumers in states in which you have established what is known as "nexus." The definition of nexus varies state by state, but it generally means you have a significant physical presence in the state.
That physical presence could come in the form of a storefront, office or business representative in the state. Let's say you have an office in California and a manufacturing facility in Texas. You would have to collect internet sales tax on customers in California and Texas since you have a nexus in those states.
As you can see, online sellers don't often have a nexus in all states in which they sell. As a result, many e-commerce businesses were in the past able to get by without collecting sales tax from consumers in certain states.
In addition, not all goods or services sold are taxable. State law may exempt certain items from an e-commerce sales tax.
Upcoming changes to the internet sales tax rule
Some state lawmakers think the loophole created by the nexus rule gives an unfair advantage to online sellers. After all, brick-and-mortar businesses can't escape collecting sales tax on in-store purchases.
In response, Congress introduced the Marketplace Fairness Act (MFA) and Remote Transactions Parity Act (RTPA) in 2017 to level the playing field between online sellers and brick-and-mortar businesses. The laws would require remote sellers (sellers that sell in states in which they do not have a nexus) to still collect internet sales tax from customers in those states.
However, the MFA exempts small online sellers that have $1 million or less in revenue annually and do not have a nexus in the state. The RTPA lets sellers off the hook if they have under $10 million, $5 million or $1 million over the first three years.
The Supreme Court issued a final ruling on the internet sales tax requirement for remote sellers June 2018. Their decision was that internet retailers can be required to collect sales taxes even in states where they have no physical presence. Hence, sellers should be prepared to collect internet sales tax in accordance with state and local tax codes.
How do I find my state laws about internet sales tax?
Use the following resources for state-specific laws about collecting taxes on internet sales.
- The revenue-governing body for your state is the best place to check for internet sales tax laws applicable to your business. The specific body varies depending on the state. Check the State Board of Equalization for California, for example.
- SBA.gov resources on internet sales tax.
- NOLO offers a 50-state guide to internet sales tax laws. You can also find the link to the revenue-governing body for your state from this website.
How do you collect sales tax from online transactions?
Are you determined that you need to assess and collect sales tax? Follow these steps to start collecting internet sales on online purchases.
- Identify all of the states in which you meet the definition of a nexus.
- Apply for sales tax registration so you can get a sales tax permit. The sales tax permit will also include your sales tax filing frequency.
- Set up your online store to collect sales tax from consumers in every state in which you have a nexus. Using shopping cart software like Shopify can help ensure accuracy in tax collection.
- Calculate and report the internet sales tax you collected in each of your nexuses. Use automation technology like Microsoft Dynamics to help streamline the process.
- File your sales tax return and send your collected taxes to the state. Many states allow you to do this step online.
