Not many people have an easy time understanding sales tax. This is even more true when it comes to collecting sales tax on online purchases. Before we dive deeper into this hard-to-grasp topic, let’s review a brief history of online merchants' sales tax obligations.
Sales tax for online purchases; a brief history
For a long time, online retailers only had to remit taxes in the state where they had a physical address otherwise known as nexus. This could be a brick and mortar location or a warehouse. Then online shopping became, you know, a thing. Colossal franchises like Amazon, Wayfair, Walmart reported significant online sales numbers, but paid zero state sales tax in some instances. Quite a few states were on the losing end concerning sale tax remittance and not happy about the situation. States rely on sales tax to fund infrastructure, schools, and other services.
As ecommerce grew and grew, states started pushing for legislation that would redefine nexus and permit collection of sales tax for online purchases made by their residents. Thus in 2017, Wayfair was faced with endless federal lawsuits in the same light. The concerned states won the lawsuit and gave rise to the Wayfair act.
Wayfair and its implications for online sales tax collection
This is where it gets complicated. Instead of adopting a unified law for all 50 states, the Wayfair ruling allows each state to decide what constitutes nexus. Most states adopted a nexus definition based on a business’s total annual sales (online included) in their respective state. This annual sales number, otherwise known as a sales threshold, is different from state to state as is the sales tax percentage. Simply put, online retailers need to be familiar with all 50 state threshold definitions and be able to definitively decide whether they are on the hook for sales tax in a particular state. The state of California, for example, has a threshold of $500,000 while Idaho requires sales tax remittance once a business hits $100,000 or completes 200 transactions.
Even more interesting is the question of whether or not to preemptively collect sales tax for all 50 states. Most retailers are not able to precisely forecast their online sales on a per state basis. Consider a company that sells approximately $450,000 to California residents annually; should they be charging California customers sales tax? Or should they not charge sales tax since they aren’t predicted to cross the sales threshold set by the state of California? And what happens if they do collect California sales tax but don’t cross the $500,000 threshold? Or even worse, what if they decide not to collect California sales tax and then do $700,000 in online sales to California residents? So many scenarios. And remember, California sales tax is 7.25% so this is no small amount of money. 7.25% of $500,000 is $36,250.
Practical next steps for online retailers
Enough with the history lesson and thought experiments though. Let’s get down to brass tacks and talk about what practical steps online merchants can start taking today to make sure they are correctly collecting and remitting sales tax.
1. Understand how each state defines Nexus
Check the internet every so often for updates.
2. Know what you’ve sold per state in the past
For any state where you have sold 50% of a state’s nexus threshold, start collecting sales tax immediately. You also need to have a sales tax ID for any state where it’s likely you’ll be remitting sales tax for.
3. Monitor your sales on a monthly basis
If using Shopify, head to the 'orders' section. Here, you can easily filter through the various states your franchise sells to in order to check whether you meet the nexus criteria for the past or current year. For example, if your statistics show you made $10,000 in the state of Alabama, narrow down your orders for a specific year for the state of Alabama. This will give you the total value of sales made in Alabama for the set financial year.
Having a basic understanding of sales tax requirements puts you head and shoulders above most online merchants. And following the steps outlined above will be enough to start the process of figuring out what states you will need to remit sales tax to and how to start collecting sales tax for these states. When in doubt, you should always consult a tax professional. An accountant with expertise in sales tax is ultimately the person to rely on for advice and instruction.