Here's What You Need to Know
Until recently, collecting and remitting sales tax was at least comparatively simple. Retailers collected tax for in-state sales, and online sellers were usually exempt.
But sales tax requirements have undergone huge changes. Businesses now face the confusing and time-consuming task of determining sales tax requirements for goods and services in each state. And those requirements differ radically from one state to another and even within states. In fact, the United States has over 12,000 sales tax jurisdictions!
Sellers now have to keep up with an army of time-consuming tasks:
- Locate the correct tax jurisdiction
- Determine what products and services are taxable
- Find the correct tax rate
- Collect the tax
- Register, file reports, and remit taxes by the various deadlines
- Maintain current, accurate exemption certificates
In case that doesn't sound complicated enough, sellers also have to keep up with sales tax holidays, which sometimes change taxability requirements just hours before the holiday begins. And the icing on the cake is that not all states distribute revenue to their taxing jurisdictions. In those states, you may have to repeat that whole process at the city, county, or other jurisdictional level.
Avalara estimates that the average small or mid-sized business would have to spend 302 hours—nearly 2 months of full-time work—on tax compliance (Souce: Avalara webinar). Failure to handle compliance correctly increases the chance of an audit. Managing an audit costs the average business over $300,000!
If all this sounds like a huge, confusing mess—well, you're right. It is. But we're here to help. In this blog, we'll explain the most important facts you need to know about sales tax, and we'll point you toward solutions.
But before we get started, we need to remind you that we're not tax professionals or tax attorneys. We hope this information will be helpful, but please consult tax professionals before making sales tax decisions.
The Backstory—It's All About Nexus
Nexus refers to the legal obligation for sellers to collect and pay sales tax in a state or jurisdiction. In 1967, the US Supreme Court affirmed that nexus required physical presence in a state. The case was National Bella Hess, Inc. vs. Department of Revenue, Illinois. Illinois wanted to require Bella Hess, a Missouri mail order company, to collect sales tax on purchases made by llinois residents. The Supreme Court decided against Illinois, ruling that since National Bella Hess connected with customers only "by common carrier or by mail," the company had no physical presence in Illinois—no nexus—and therefore, no legal obligation to collect sales tax.
But the definition of nexus remained controversial. That led to the 1992 case of Quill Corp. vs. North Dakota. Again, the Court ruled against the state. The ruling downplayed the physical presence requirement, but it upheld the Bella Hess decision, stating that taxing out-of-state sales "places an unconstitutional burden on interstate commerce."
The Gigantic Shift
In a word, the Internet.
When Quill was decided in 1992, less than 2% of Americans had online access. In 2019, the US has 312.3 million Internet users—a number equal to 95% of the population! And 77% of us make online purchases! Online sales topped $409 billion last year and are expected to exceed a half-trillion dollars this year. Sales and use taxes make up an average of 47% of state revenues, so it's not surprising that states want a chunk of that money.
So back to court we go for the Supreme Court decision on June 21, 2018. In the case of S. Dakota vs. Wayfair, Inc., the Court took the unusual action of overruling its Bella Hess and Quill decisions. Siding with South Dakota, the court ruled that each year, the physical presence requirement "becomes further removed from economic reality . . . results in significant revenue losses to the States," and gives "out-of-state sellers an advantage."
Physical presence—such as a store, office, warehouse, or distribution center in a state—still qualfies as nexus. States have been broadening the definition to include things like attending a trade show, traveling into, or having a remote employee in a state. But since the S. Dakota vs. Wayfair decision, nexus has become much broader and more complex. If your business sells out-of-state, you need to know about each of the following types of nexus.
Economic nexus is determined primarily by the volume (dollar amount) of sales and/or the number of sales. States establish a threshold at which a seller is required to collect and remit sales tax. (See Figure A below.) Some state thresholds are based on total sales volume, while others count only taxable sales. Definitions of what is taxable also vary widely from state to state. For example, even though services are often considered non-taxable, they are broadly taxed by Connecticut, Hawaii, New Mexico, South Dakota, and Virginia. Yet few services are taxed by Alabama, Florida, North Carolina, Oklahoma, and Utah.
Some tax laws are unique to just one state. Hawaii, for example, imposes a gross excise tax instead of a sales tax. Hawaii taxes almost all digital goods and nearly every type of service except medicine and education (Source: Avalara webinar). Delaware also has unique tax laws. Delaware does not impose economic nexus and, in fact, does not have sales tax. Instead, it imposes a combination of source and destination taxes: gross receipts taxes on wholesale sellers (source) or retail tax where goods are consumed (destination). Delaware also levies corporate income tax based on the ratio of sales in Delaware to total sales. Locating a server in Delaware also counts as physical nexus.
Despite the wide variety of terms and conditions, economic nexus does tend to fall into some general categories. The following chart briefly summarizes economic nexus thresholds. Consult the source for details about specific nexus criteria.
|Figure 1: State Economic Nexus Thresholds
As of February 13, 2019 (Avalara)
|Number of Transactions*|
|New York||$300,000||AND||100 transactions|
|These states have not established economic nexus thresholds.|
|*Sales amount and number of transactions may be "at least" or "more than" the number stated. Qualifying sales and other activities vary from state to state. Consult the source for more specific details.|
So far, we've talked about physical presence nexus and economic nexus, but we're just getting started.
Marketplace nexus is incurred when an ecommerce business markets goods to customers in a state and processes their payments. Let's set up a fictional scenario to explain.
Imagine you own a small business that manufactures jewelry. You sell your products through your own website, but they are also sold on Amazon Marketplace, Etsy, and eBay.
Any ecommerce site (such as Amazon, Etsy, and eBay) that markets and sells to customers and processes payments on behalf of another vendor is a marketplace facilitator. Many states require these facilitators to collect tax on sales for which they meet nexus requirements, register in those states, and pay the taxes.
That sounds like a good deal for you because you don't have to worry about the taxes. But wait . . . not so fast.
You may still have nexus in some states based on your own website sales or on your total sales. (Remember that nexus requirements and criteria vary from state to state and within states.) You may also have to be able to prove that the taxes on sales made through a marketplace facilitator were actually paid by that facilitator.
And this brings us to the subject of Use Tax Reporting Laws.
Currently, 14 states have adopted use tax reporting laws. (See Figure 2 below.) Use tax is a tax on the storage, use, or consumption of a taxable item or service on which no sales tax has been paid. If your company sells to customers in a state with use tax reporting laws, either you collect and remit sales tax, or you must follow use tax reporting procedures. That involves notifying customers at the time of sale that they may owe use tax directly to the state. Then at year's end, you must send customers a summary of their transactions with the notice that they may owe use tax. You must also file with the state a list of customers and a total of transactions. These laws include penalties for failure to file state reports and for failure to notify customers that they may have a use tax liability (Source: Avalara webinar).
Now, back to yet more types of nexus . . .
Affiliate / Click-Through Nexus
These laws are often referred to as the "Amazon Laws," and that nickname helps to explain them. This scenario probably sounds familiar: You're looking at a website that mentions a book or a product, and—What do you know?—there's a link that takes you straight to Amazon so you can purchase the item. If you make the purchase, the website owner gets a little kickback for referring you to Amazon.
Affiliate nexus results from a connection between a vendor and another entity that may be related in some way or that performs certain work that can be attributed to the vendor to cause, or presume to cause, the vendor to have nexus in the taxing jurisdiction. The connection may be a web connection. Some states consider shared business names, products, or advertising to constitute affiliate nexus.
Click-through nexus is a tax obligation based on a web link or online referral. Some states consider sellers or marketplace facilitators to have nexus equal to in-state presence if they pay someone in the state a commission or referral fee. So, for example, if your business is located in Montana, but you pay a commission or referral fee to a person or business in Iowa, the state of Iowa may consider you to have a physical presence—a nexus—in the state of Iowa.
Yes, you read that right: four states have required sales tax collection based on a seller's planting cookies on in-state computers. Cookie nexus laws have been challenged in court, but the result seems to be that if you place cookies on a computer in one of these states, you are considered to have a physical presence in that state.
The following chart briefly summarizes state use tax reporting, marketplace, affiliate/click-through, and cookie nexus laws.
Figure 2: Summary of State Use Tax and Nexus Laws*
As of February 13, 2019 (Avalara)
Use Tax Reporting
|*State definitions and thresholds differ. Consult the source for more detailed information.|
We should call attention to a couple of things:
- Note that this data extends only to the 50 states and Washington DC, 51 of the 12,000 taxing jurisdictions in the US. Even some individual zip codes have as many as 6 tax jurisdictions!
- This data is accurate as of February 13, 2019. It's the most recent data available. But the sales tax landscape is changing so rapidly that it may have changed by the time this blog publishes. Right now, the only constant is change.
So What's a Business To Do?
Well, one option is that if you sell or are looking to expand out-of-state, you might want to target Florida and New Mexico. They are the only states that have not yet enacted remote sales tax laws. Or you might limit your marketing to Alaska, Montana, New Hampshire, and Oregon. They don't have any sales tax. Period. That might tend to limit your customer base though.
A more realistic approach is either much more complicated—or much simpler.
The Complicated Method
You can try to manage sales tax compliance yourself. You'd have to start by doing a nexus study, figuring out and continuing to track all the precise jurisdictions where you make sales. You would have to register in each of those jurisdictions where you have nexus, collect the right amount of sales tax, then file reports and remit taxes by each jurisdiction's deadlines. You would also have to pay attention to use tax laws in states where you don't have nexus or think you won't have it. You would have to maintain files of accurate, up-to-date exemption certificates for any customers who do not pay sales tax. Using outdated certificates or certificates containing errors can result in penalties if you end up in an audit.
The complicated method is possible, especially if you make very few out-of-state sales, but it's risky, and it's probably a lot more work than those sales are worth. Based on our extensive research, we highly recommend a much easier alternative.
The Simpler Solution: Automated Sales Tax Management
You've probably noticed that one of the frequently-cited sources for information in this blog is Avalara. Avalara's automatad sales tax management software, AvaTax, integrates with a wide variety of ecommerce applications. Avalara takes over the responsibility of keeping up with changing tax laws, and you benefit from transferring the risk to a 3rd party who specializes in those tax laws. The software uses precise geolocation to identify the correct jurisdiction and tax rate. It calculates taxes, creates tax reports, and can even remit taxes for you on time. And the prices are really quite reasonable, especially when you consider the hours you'd have to spend managing tax compliance yourself. (I think I could pay for at least a couple years of AvaTax service just with the time I've spent researching for this blog!)
Avalara is also a certified provider for SST—Streamlined Sales Tax. SST is a program designed to simplify sales and use tax compliance. Currently 24 states are full members, and one state is an associate member of the SST program. If you do business in these member states, check this out! If your company qualifies, through Avalara you may receive sales tax services at no cost to you. Avalara would calculate taxes in your online shopping cart, register your business with the SST states, file your returns, and handle any audits—all at no cost!
And as far as we're concerned, the best part is that Avalara's software integrates very well with a Drupal website.