Does Your Ecommerce Company Have to Collect Out-of-State Sales Taxes?

Like many other aspects of doing business in the internet age, sales taxes have become much more complicated.

Before we get too deep into the details of the disruption that ecommerce has created when it comes to sales taxes, let's establish some context. According to Wikipedia, "Sales taxes in the United States are taxes placed on the sale or lease of goods and services in the United States."

That broad definition isn't entirely clear, however. Just 45 of the 50 states actually impose sales taxes. But so do the District of Columbia and the territories of Puerto Rico and Guam. In addition, 38 states also grant local governments (cities and counties) the authority to impose general or selective sales taxes on top of the state's base tax rate. In some cases, local sales taxes actually exceed state sales taxes.

It's unrealistic for those 45 states, districts, territories and thousands of local government entities to expect individual consumers to keep track of every taxable purchase they make each year and proactively pay the correct sales taxes to the appropriate jurisdiction. So instead, those 45 states (plus D.C., PR and Guam) require businesses that sell taxable products and services in their jurisdiction to become licensed resellers. That deputizes businesses to collect taxes from each consumer at the point of sale and pass that money directly through to the appropriate government agencies on a regular schedule.

The good old days

Before the internet brought us ecommerce, taxable goods were sold primarily through brick-and-mortar retail stores. That made it fairly simple for each reseller to keep track of the current tax rate that applied to sales made at their physical location. The store's cash register charged every consumer the same sales-tax rate, regardless of where they were from.

Let's walk through a quick example, based on tax rates as of the date this article was written. If a consumer purchased a $100 pair of boots at a store in the city of Smith River at the northern tip of California, the store would charge the consumer an 8.25% sales tax. (The store would later pass the extra $8.25 on to the State of California, together with all sales taxes collected from other customers that same month.) But by instead driving 10 miles north to a different store in Oregon, that consumer would only pay $100 total for the same pair of boots, as Oregon is one of the five states that don't assess a sales tax.

This loophole still exists today for in-store purchases and is often exploited by consumers and stores located near state lines. (The state with the higher sales-tax rate generally loses out on collecting its tax revenue for those cross-border sales.) The brick-and-mortar store in Oregon isn't required to keep track of where each in-person customer lives, so it's not required to report any in-person purchases by California residents to the State of California. That means California doesn't have a practical way to collect tax from its residents on in-person purchases made in Oregon.

Online sales have changed the game

Online resellers used to take advantage of a similar loophole, not charging sales tax to consumers who were located out of state. In this case, the exemption applied not only to consumers who were just across state lines, but also all the way across the country. Then, in 2018, the U.S. Supreme Court ruled in South Dakota v. Wayfair that under certain conditions, states can require businesses to collect and remit sales taxes on online purchases made by residents of states where the business is not physically located.

Let's suppose that hypothetical store in Oregon launched an ecommerce portal — we'll call it www.oregonproducts.com — and then made online sales totaling over $500,000 worth of taxable product to customers in California in a given year. That would now trigger "economic nexus" rules that require the Oregon-based store to register as a reseller with the State of California and then to collect and pay the applicable tax on sales made to California residents. So if the customer from the previous example ordered the same $100 boots from www.oregonproducts.com to be shipped to their home address in Smith River, California, the Oregon-based reseller would have to charge an extra 8.25% sales tax and then remit that $8.25 back to the State of California.

Moreover, if another customer buys a pair of the same $100 boots from www.oregonproducts.com and has them shipped to their home in Santa Monica, California, that customer would be charged $2 more because the combined sales-tax rate in Santa Monica is 10.25%. But customers who make online purchases from www.oregonproducts.com for delivery to any address in Oregon would still pay just $100 because the state has no state or local sales taxes.

Online resellers can't claim ignorance, either, because they need to know the physical address of each consumer they sell to in order to ship them their purchases. So there's a complete set of data available that states can use to enforce collection of all applicable sales taxes.

Wait, the rules don't stop there!

Since each state sets its own economic nexus rules, the annual dollar sales and transaction count thresholds vary widely from state to state. They also change regularly. And economic nexus isn't the only abstraction online resellers have to account for when determining where and when sales taxes apply to which purchases. In fact, as e-tailers scale up, so does the level of compliance complexity.

To further complicate things, the rate of returns is much higher on ecommerce purchases than in-store purchases. In most cases, the consumer is entitled to a refund of the state sales tax along with the actual cost of the item — but in other cases they aren't. In Connecticut, for example, the item must be returned within 90 days for the consumer to get a sales-tax refund.

What if the online reseller gets it wrong?

If the reseller charges too little sales tax (or none at all), each state still expects to collect the full amount due to them on all taxable sales — so the reseller pays out of pocket to cover the difference.

If the reseller collects too much sales tax, they're required to give that surplus money to the state — otherwise the state could interpret the overcharge as the reseller intentionally stealing from both the consumer and the state at the same time. In addition, the consumer is entitled to claim a refund from the reseller on any sales-tax overpayment, which can lead to class action lawsuits in extreme cases.

States also reserve the right to audit resellers, with varying rules around how far back the audits can go and what the penalties are for noncompliance. This can get very expensive very quickly for resellers who have not kept up with their sales-tax obligations.

In addition, state sales-tax agencies are starting to collaborate with each other. An audit in one state could trigger a chain reaction. And any sales-tax liabilities could linger for a long time. The government has various ways of coming after business principals years after the business is sold or even goes bankrupt. So having a business that knowingly fails to comply with sales-tax laws is a very risky business indeed!

Who keeps track of all this?

The new economy has created an exponentially greater administrative burden on retailers whose primary means of revenue involves online sales — as well as for individual states that have to collect taxes from all those online retailers scattered nationwide.

To meet this challenge, a majority of states have enacted marketplace facilitator laws directed at Amazon and other major online platforms. Amazon had already begun paying individual state sales taxes on transactions involving its own products, but these laws also require Amazon to collect state sales taxes on third-party sales made using its platform. In fact, marketplace facilitator laws can actually benefit the many small businesses that list their products on marketplace platforms like Amazon. That's because those platforms now do the sales-tax compliance busywork for the small businesses that use them.

But not all online sales platforms, and not all states, do things the same way. If you run a business that depends on ecommerce, it's ultimately your responsibility to meet your obligations to collect and submit state sales taxes.

Help is available

Fortunately, a variety of solutions are available to help small businesses stay in compliance with increasingly complicated sales-tax laws. Many companies now offer specialty software to help automate the process, for example. But if you haven't already done so, your most important next step is to consult an accounting professional who specializes in sales tax.