How sales taxes have impacted eCommerce
According to the Census Bureau of the US, sales taxes account for one-third of state revenues. Unfortunately, the states lost billions of dollars because sales taxes were not being collected on online sales for many years. According to the Center for Business and Economic Research in a report that was published in 2009, lost revenue due to uncollected sales taxes was approximately $34 billion. Consequently, many states today are now cracking down on online businesses and lobbying for new federal tax guidelines that apply strictly to these business entities.
Under most of the current state laws, online companies are not required to collect sales tax from customers who make their purchases through mail order or online. Responsibility for the payment of sales tax falls on the consumer. However, enforcement of this is extremely difficult which ultimately results in what is called a “de facto tax-free” environment. As a result, the tax penalties incurred by companies who have integrated their land-based and internet operations are pretty substantial.
As an example, the nation’s largest retailer, Wal-Mart, announced in the beginning of 2000 that they were launching an internet site that was a spin-off of Wal-Mart.com, the retailer’s original website that was integrated with their land-based operations. By establishing a separate retail entity online, Wal-Mart was able to avoid any penalties for not collecting sales taxes. The result was that companies today who launch and integrate an online entity in conjunction with their land-based operations are responsible for charging sales taxes.
Research that was conducted at the time by Austan Goolsbee, a former associate economics professor at the University of Chicago’s Graduate School of Business, examined the impact that sales taxes would have on e-commerce. With the current situation, the price of online consumer products has been directly affected by the non-payment of sales taxes. According to Goolsbee, “Charging sales tax is the same as increasing the price of a product or service and if you increase prices, people will stop buying.” On an interesting side note, Austan Goolsbee was recently appointed by President Obama to be the chief economist and staff director of the Economic Recovery Advisory Board.
Sales tax mysteries for the e-tailer
For many online retailers, or e-tailers as they are more commonly referred to, sales taxes pose a bit of a mystery for these online small business owners. On the one hand, you never want to give the consumer bad or inaccurate information, while on the other hand, you don’t want the federal and state tax authorities auditing you either. Just trying to find sufficient and valid information about online sales taxation is challenging.
As it currently stands, e-commerce businesses or any other business that conducts a portion of their transactions on the internet are only required to charge in-state customers sales tax on their purchases. This brings up another mystery for e-tailers such as the rate of sales tax that they should be charging. The issue is clouded further by the fact that some state’s sales tax rates vary by individual county. It is this variance between cities, counties, and townships that makes online sales tax collection such a difficult endeavor.
The Streamlined Sales Tax Project of 2000 was an attempt to simplify and solve this issue. But challenging and complex or not, sooner or later, most e-tailers will have to collect sales taxes for online purchases, whether they want to or not. Additionally, Congress has attempted to take control of this issue by proposing legislation that would enable the individual states to require that e-tailers collect sales taxes on their transactions. This of course is provided that the states have adopted these simplified regulations for the collection of sales taxes.
The whole reasoning for the collection of sales taxes on internet purchases stemmed from the fact that many states were going broke. These states whose bottom lines were suffering were arguing that online sales which were being conducted without the collection of sales taxes created an unfair advantage for e-tailers over the land-based retailers. According to the NRF (National Retail Federation), numerous state legislatures are passing laws which comply with a multi-state agreement in the hopes of leveling the playing field where the collection of sales taxes is concerned.
The NRF believes that e-tailers or “remote sellers” as they are referred to in this instance, also have an unfair price advantage in those situations where they are not collecting sales taxes. They feel that all retailers offline and online need to “play” by the same rules in order to be fair about things. Although many e-tailers disagree on this issue, from an economic standpoint, it does make some sense that things should be equal whether you own a land-based business, an online business, or both.
The advent of congressional control
In 2004, the US Congress started addressing the issue more aggressively in an attempt to take control of the situation. As was mentioned above, they were proposing legislation to authorize the 50 states to require that sales taxes were collected on internet sales transactions. However, this was based on whether or not those states had adopted the regulations imposed by that regulation.
The good news was that smaller businesses or micro-businesses that had less than $5 million in internet generated sales were exempt from that sales tax legislation. Ironically, there are a number of large, national retailers who are currently charging sales taxes on the majority of their internet transactions. Therefore, this is creating a bit of an advantage for those smaller online businesses.
It’s interesting to note here that some eBay operations associated with big retailers like Dell Computers are charging the applicable state sales tax rate to their customers who live in those states where Dell has established a “nexus” or physical presence. Although the consumer is left without an explanation of the issue, Dell has simply stated that “Applicable sales tax is charged on the total invoice amount for items shipped to CA, FL, ID, IL, KY, MO, NC, NV, OH, PA, TN, TX, and VA” (Beth Cox, ecommerce-guide.com, Feb. 2004).
Recently, internetnews.com published an article written by Kenneth Corbin in July of this year (2010) about the re-surfacing of a controversial proposal written by Rep. Bill Delahunt (D – MA) that would rewrite the US tax laws so e-commerce sales were included. Naturally, the protests from advocacy groups and online retailers followed immediately after the news of Delahunt’s proposed legislation, known as the Main Street Fairness Act, was released.
Suffice it to say, congress is once again re-visiting this long-simmering debate regarding the collection of sales taxes on online purchases. The legislation would put e-tailers on the same level as their land-based competitors and counterparts. It is not so much that this would be new tax legislation, but rather it would mean a shift in the way collecting sales taxes would be imposed on e-tailers. The bottom line is that it would put an end to the tax-free environment that currently exists with many e-tailers because most consumers do not report their online purchases as they are legally required.
Who taxes who and for how much?
As it currently stands, online businesses are only required to charge sales taxes on those purchases made by that e-tailer’s in-state customers (see above example regarding Dell Computer eBay affiliates). As an example, a Florida business that had a land-based and an internet presence recently reported that 9% of their sales online were from in-state customers which they paid their sales taxes on. They also stated that roughly 25% of their annual revenues stemmed from online purchases.
Even though the example sounds rather simple, Florida is one of those states that have a base state sales tax rate that the different counties will add to, so the sales in one county may be greater than that of adjacent counties. There is no consistency which further clouds the entire issue. As a result, many Florida e-tailers charge the sales tax rate that is applicable to the county that their business is located in.
Base sales tax rates by individual states
The following is a listing of the base sales tax rate in the 50 states and the District of Columbia. Remember that these are the basic percentages and in some states will vary by city, county, and township. For instance, even though the rate in the state of Texas is 6.25%, people in the Dallas-Fort Worth metroplex pay and additional 2% or 8.25%.
|Alabama – 4||Montana – none|
|Alaska – none||Nebraska – 5.5|
|Arizona – 5.6||Nevada – 6.85|
|Arkansas – 6||New Hampshire – none|
|California – 8.25||New Jersey – 7|
|Colorado – 2.9||New Mexico – 5|
|Connecticut – 6||New York – 4|
|Delaware – none||North Carolina – 5.75|
|District of Columbia – 6||North Dakota – 5|
|Florida – 5.8||Ohio – 5.5|
|Georgia – 4||Oklahoma – 4.5|
|Hawaii – 4||Oregon – none|
|Idaho – 6||Pennsylvania – 6|
|Illinois – 6.25||Rhode Island – 7|
|Indiana – 7||South Carolina – 6|
|Iowa – 6||South Dakota – 4|
|Kansas – 5.3||Tennessee – 7|
|Kentucky – 6||Texas – 6.25|
|Louisiana – 4||Utah – 4.7|
|Maine – 5||Vermont – 6|
|Maryland – 6||Virginia – 5|
|Massachusetts – 6.25||Washington – 6.5|
|Michigan – 6||West Virginia – 6|
|Minnesota – 6.875||Wisconsin – 5|
|Mississippi – 7||Wyoming – 4|
|Missouri – 4.225|
In addition to the above information, you should know that there are other differences in state sales taxation which adds further ambiguity to the issue. An example of what we are saying is that some of the states tax food items but will allow tax credits for low-income households. Should you have any questions or need additional information regarding the guidelines for charging and collecting sales tax, you should contact your local tax authority.
How do you know if your online business needs to pay sales taxes?
The primary determinant of whether or not an online business charges and remits sales taxes is based on what is known as physical presence or nexus. If your customers reside in the same state that you have a nexus, you need to collect and pay sales taxes. That sounds pretty simple doesn’t it? If only it was that easy. Unfortunately, this determination of physical presence or nexus varies radically from one state to the next, making it very difficult for the e-tailer to determine what they are obligated to do.
Despite the fact that there are looser determination standards where state sales tax is concerned compared to income taxes, nexus applies to any business in a state where:
- there is a physical location in the state
- the business owns or rents property whether it is intangible or tangible
- employees of the business reside in that state
- the employees of the business solicit business in that state
Here is an example. Let’s say that you have an eBay business in and you live in California, but you run your business out of your home. Additionally, you also maintain your inventory in your home and don’t conduct business at trade shows. Technically, you only need to collect sales taxes from customers in the state of California. However, if you expand your business into a different state and decide to warehouse inventory there, you are creating a nexus and are now obligated to collect and remit sales tax for that state as well.
Once you have determined nexus, you will need to determine what products in your inventory are subject to state sales taxes in the states you are conducting business in. Again, you want to make sure that you contact the local tax authority in order to make sure that you follow that state’s sales tax guidelines. On a final note, remember that you cannot legally collect sales taxes without getting state authorization to do so, meaning that you need to register your business in those states where you have established nexus.
Items which create nexus
As has been mentioned above, the best way to determine if you have nexus in a particular state is to read the tax authority guidelines that are applicable. Just keep in mind that some states change their sales tax rules annually. Our advice is that you hire a professional that can handle this issue for you such as a CPA or income tax accountant.
Where nexus and sales tax is concerned, the prior section lists the 4 primary criteria for establishing nexus in a state. The following are some additional examples of what also creates nexus:
- doing trade shows in other states or conducting sales there
- having an employee or employees in a state different from your own
- having contract labor (independent contractor) or sales personnel travel to the state where you want to conduct business
- having a warehouse facility in a different state where you are engaging in business
- substantial advertising and marketing to promote your business and products in other states
Additionally, the terminology “use tax” was added to sales tax guidelines due to all the consumers who purchase items online from businesses based in other states. Use tax refers to that portion of sales taxes which is associated with the use of those products in any state where you are conducting business.
Therefore, if your state charges sales tax, and you purchase products from a different state without paying any sales tax on those products, you will owe your state use tax on them. This applies to internet or land-based purchases in other states. So as you can see, the whole issue is very complex. Just remember, it is always better to be safe than sorry and if you follow the guidelines listed above and in the prior section, you should know what you need to do to avoid any grief with your tax liability.
Solutions for e-tailers
As a small business owner, you’ll be happy to know that there are solutions to the dilemma of nexus and sales tax issues. The following will give you an idea of the things you should do or possible solutions to pursue in order to avoid any future grief. First and foremost, learn how to determine the amount of sales tax to charge and remit. The easiest way to ensure that you are collecting sales tax properly is to have your “shopping cart” vendor assist you in the matter. The majority of these vendors can program things for you so that the applicable sales tax is automatically charged when they purchase products from you.
Another issue is knowing how to pay your sales taxes that you collect as well as being aware of the consequences that can result if you don’t follow the guidelines. In the example above regarding having nexus in California, you will need to account for the sales taxes collected on your California sales tax return. Additionally, you will need to remit all of your proceeds when you file your sales tax return. How often you have to file depends on your amount of sales volume. If you are a micro or small business, you may only have to file once a year at most. On the other hand large businesses can be required to file monthly.
The issue with determining the amount of sales tax you charge based on the example of the shopping cart vendor above is referred to as a “built-in” sales tax collection measure. In other words, when a customer is finalizing their purchase with your company, the sales tax they are being charged automatically appears on their receipt during the ordering process. Needless to say, this saves you the headache of having to calculate this by yourself and possibly making an error that could result in a tax audit and cost you some serious money.
There is also what is known as “stand-alone” solutions for ensuring the collection of sales taxes. This usually comes in the form of tax software applications that can easily be installed and integrated into your website. The primary advantage with this type of software is that it automatically keeps track of all the different sales tax regulations. These applications are updated on a regular basis so that all the sales tax information you have is accurate and up-to-date.
What if you have hired a professional to handle your sales and use tax issues such as a CPA or tax accountant so you never have to worry about handling things properly? One of the newer terminologies that small business owners in this type of situation are becoming familiar with is what is called STMS or Sales Tax Management Systems. This has become a standard tool in most accountants’ arsenals as well as being a standard part of client service’s vocabularies.
STMS is a technological approach to cost-effectively and efficiently meeting state sales and use tax compliances that businesses are required to follow. This technology assists small businesses in becoming more responsible for collecting sales and use tax resulting from their e-commerce transactions. It is also a generic term that applies to automated solutions delivered in an on-demand manner via what are called SaaS (software as a service) and are web-based in nature.
These STMS solutions calculate sales taxes on your e-commerce transactions automatically so that you don’t have to worry about whether or not this is being handled in proper fashion and don’t incur additional tax liability down the road. Another key benefit where STMS is concerned is the fact that when these systems are fully automated, they can be integrated seamlessly with any of your business tax accounting software applications. Additionally, STMS platforms are capable of validating addresses which ensures that your sales tax rates are calculated accurately and produce invoices that reflect the most current tax rates that apply to the jurisdiction you are operating in.
The platforms also operate in real-time meaning that they can access sales tax rates and other regulation data from each of the 12,500 plus US taxing jurisdictions and automatically calculate them as a component of any financial transaction where sales and use taxes might be applicable. So you can easily understand the advantages and benefits of employing these platforms in your online business operations.