Online Sales Tax Compliance: eCommerce Guide
As a result of COVID-19, a higher percentage of consumers' wallet share quickly shifted to online transactions. Many businesses—from brick-and-mortar shops to online stores—have found themselves selling to a significantly expanded audience. Some are reaching customers in new states, while others are making sales in the U.S. for the first time.
When businesses expand their footprint across new channels and geographies, they may increase their online sales tax obligations. Understanding and maintaining tax compliance through high-growth digital expansion is essential.
Why you need to think about eCommerce sales tax
It’s easy to be snared by the complicated web of online sales tax rules. Sales tax regulations vary widely by state, and individual counties and cities may levy local rates on top of what the state charges.
And it’s not only the rate that can change from area to area. You might need to charge tax on an item when it is sold in one state and not in another. You might not need to collect tax at all for a state until you reach a certain threshold of sales—but that threshold is different in every state. And after you figure out where you need to register and collect sales tax, you have to file and send the collected taxes to all of those places.
It can be overwhelming, especially if you’re new to this, or if your eCommerce website has grown to the point where you have to start thinking about your sales tax strategy. And knowing that you can be fined or penalized for non-compliance only adds to the pressure.
As your business evolves and changes, your sales tax obligations may also change or expand. To ensure you remain compliant at every stage of the sales tax cycle, we’ve identified six steps that businesses should take to achieve sales tax compliance. We also review how these six steps relate to specific business challenges retailers face today.
The 6 dos and don’ts of sales tax compliance
Do your research.
Don’t ignore it.
Don’t forget about exemptions.
Do collect the right amount.
Don’t flake when it comes to filing.
Do use technology to your advantage.
01. Do your research.
Depending on your business, it might be easier than you think to figure out your nexus (where you are required to collect tax).
What is your nexus?
Nexus is the connection between a seller and a state that requires the seller to collect and remit sales tax and is based on your unique business activity in a given jurisdiction. For example, if you sell mainly to people in your state and have a small operation, determining nexus could be reasonably simple. But if you make significant sales for delivery into multiple states, it can quickly become complex.
You can create nexus in various ways, most of which fall under either physical nexus or economic nexus.
Physical nexus is established by having a physical presence in a state. In addition to a store or office, physical nexus may be triggered by off-site employees, warehouse locations, affiliations, and even trade shows attendance.
Economic nexus is determined based solely on sales volume in a state. If you reach a specific sales volume or number of transactions with residents of a jurisdiction, you can trigger nexus.
It’s important to note that you’ll need to register and remit sales tax if you have physical nexus or economic nexus.
02. Don’t ignore it.
The head-in-the-sand approach usually doesn’t end well, so don’t just ignore dealing with tax. And don’t assume anything, either. Thinking “I’m too small,” or “I don’t sell in that state,” or “They probably won’t notice” can all be recipes for disaster (especially that last one). If you aren’t collecting sales tax, the state is going to want a good reason.
COVID-19 has increased the likelihood that states will be more stringent when it comes to collecting sales taxes from sellers. According to The Pew Charitable Trusts, which analyzes trends and issues that impact public policy, sales taxes typically are relatively stable sources of revenue even during downturns, like the one resulting from this pandemic. And those taxes comprise about 33% of total state tax revenue, Pew notes. That means states now need every last dollar. It’s therefore reasonable to expect more vigorous enforcement of sales tax laws from this point forward.
It’s important to stay current on the variety of sales tax laws and what activities trigger each state’s nexus. Here are just a few of the things you need to know.
Do you sell something you can physically touch? If so, it’s called “tangible personal property,” and it’s generally taxable. However, exceptions vary from state to state.
If you sell items through a marketplace, there’s a high likelihood it’s taxable. More than 43 states now require out-of-state sellers to register then collect and remit sales tax under economic nexus laws. Businesses that sell on eBay or other marketplaces also need to be aware of marketplace facilitator laws.
Services, SaaS, installation, clothing and apparel, and labor are taxed differently in each state.
As your business expands, it’s critical to understand how revenue growth may change your tax compliance obligations. Tax compliance automation solutions can save you time and help you mitigate risk.
03. Don’t forget about exemptions.
As small businesses grow and sell in more states, learning the process of collecting and filing sales tax can be a significant challenge. Interestingly, it can be challenging to learn the process of not collecting sales tax—because every state has its own rules (and certificates!) for tax exemptions.
Exemptions can be based on the product, the intended use of the product, or the buyer’s status.
Here are the three main types of sales tax exemptions:
Product-based exemptions. In some states, for example, grocery items are exempt from sales tax. It gets tricky because these exemptions can then have rules within rules: Prepared foods, such as a ready-to-eat rotisserie chicken purchased from the deli, may be taxable while a package of chicken breasts the buyer will cook at home might be exempt.
Use-based exemptions. Products that are intended to be resold are frequently exempted from sales tax. Typically, this is because the reseller will charge sales tax when the end-user purchases these items.
Buyer-based exemptions. Nonprofit organizations or government agencies are often not required to pay sales tax (states cannot charge sales tax on items purchased by the federal government, and this exemption is often extended to state agencies as well). Also, buyers from states without a sales tax can sometimes be exempted from paying tax when purchasing products in other states.
Unfortunately, properly documenting exemption and resale certificates can become incredibly complex when numerous states, entities, and variables like nexus and drop shipments come into play. You must properly store certificates if your business still relies on paper-based filing systems. Thorough and accurate exemption certificate management requires input from various departments; tax analysts, credit managers, and IT departments all play essential roles.
04. Do collect the right amount.
Once you’re registered in the tax jurisdictions where you have a nexus obligation, you’re ready to start calculating and collecting sales tax.
Collecting the right amount of sales tax is critical. You must understand the variables that go into determining a tax rate, such as tax jurisdiction rules, product taxability, and sales tax holidays, for what you’re selling. And have a plan in place to efficiently and appropriately apply the tax rates on your transactions.
Here are three key considerations to make sure you’re collecting the right amount of sales tax:
Geolocation and its impact on tax calculations ZIP code-based calculations don’t go the distance when determining appropriate tax rates across tax jurisdictions. Watch this video to learn how geolocation technology helps ensure the most accurate rate possible.
The taxability of the products you sell Not all products are taxed the same across tax jurisdictions, so it's essential to understand how the taxability of products can impact various tax rates.
Sales tax holidays Learn which states offer a temporary holiday from paying sales tax. These can change from year to year, so make sure you have the most current data.
05. Don’t flake when it comes to filing.
With registration complete and sales tax collected, it’s time to remit those funds to the appropriate tax authorities. Each taxing authority has unique regulations around sales tax remittance, including when sales tax returns are due, how they should be remitted (either via paper returns or electronic returns), and frequency of remittance.
Some states, like Illinois and Oklahoma, also have outlet reporting requirements, which means businesses with multiple locations must break out their sales by location and file separate sales tax returns. It's important to pay attention to outlet reporting requirements because they can significantly impact your filing and remittance burden in states with these rules.
Ensure you understand the filing requirements for each jurisdiction where you collect tax and have a plan or solution to file those returns when they’re due. Determining your sales tax liability, what tax forms are required, and how to remit it can be incredibly time-consuming for retailers. Make sure you have dedicated resources for this every filing period.
An understanding of the state-by-state guide for sales tax returns filing and remittance is critical. When you register to do business in a state, you essentially become a sales tax collector for the state. Your company is expected to collect sales tax on taxable transactions and remit the appropriate amount to the jurisdiction. While this may not be the most exciting part of doing business, it's critical to maintaining compliance.
06. Do use technology to your advantage.
There are solutions designed to help businesses like yours, whether you’re selling in all 50 states or just one, whether you have millions of dollars in revenue or hope. Outsourcing with an automated tax compliance solution is a viable, cost-effective method of enabling your company to improve audit response and results, strengthen customer relationships and reduce overhead costs of the non-revenue building activities of sales tax management.
Automation is the number one tax compliance strategy employed by leading companies compared with their trailing peers. Aberdeen Research found that these market leaders are three times more likely to automate sales tax.
The payoff of sales tax automation is compelling. Research shows that Avalara AvaTax customers:
Reduce the time spent managing sales tax by 58%
Avoid overpaying sales tax by 90%
Pass audits without penalty by 50%
The best part? You won’t have to worry about keeping up with new laws, rate changes, and other shifts, because you’ll have someone staying on top of it all for you.
There’s no way to sugar-coat it: Managing sales tax can be tricky to do manually. And every business selling online today needs to be mindful of understanding and meeting their obligations. The right tax approach can help ensure you’re positioned to grow and thrive.
Looking to automate your sales tax? Integrate your online store with Avalara and become compliant today.
Leila Goldberg
Senior Partner Marketing Manager at Avalara
Leila is a guest blogger for Wix on behalf of Avalara. Leila is a senior B2B marketer. She has spent the last 15 years, helping brands and retailers build brand advocacy and drive revenue.
