On June 21, 2018, the U.S. Supreme Court issued a seminal ruling in South Dakota v. Wayfair, Inc. The case turned on one of the most contentious issues facing online shoppers and retailers alike: whether states can require online sellers to collect sales tax, even when they don’t have a presence in the jurisdiction.
As NBC News reports, five of the court’s nine justices voted to uphold a South Dakota law imposing sales tax on online purchases. The ruling made it legal for state governments to levy sales taxes on retail sales made by companies without local stores or distribution centers. Previously, statefs were only permitted to collect sales taxes from those merchants with a physical presence, or “local nexus,” in the jurisdiction. This exempted mail-order catalogs and online sellers based out of state.
Following the Wayfair ruling, smaller online merchants – from solopreneurs with independent retail websites to Etsy and eBay sellers – braced for an ugly fallout. “The decision was a victory for large businesses over small, and I believe that if nothing is done – and states become more aggressive [in their tax policies] – you could see mom and pop retailers going out of business,” said Tennessee tax attorney David Mittelstadt in an Inc. article published a few weeks after the ruling.
While the ramifications of Wayfair have yet to be seen, online retailers need not overreact. The ruling is not the end of the world. It’s merely the start of a new reality to which online sellers can, and most likely will, adjust. Big-name incumbent retailers have added sales tax to online transactions for years; it’s time smaller sellers caught up, anyway.
How to Collect & Pay State Sales Taxes
Like sales tax on in-person purchases, online sales tax is the merchant’s responsibility to collect. For online sellers used to flouting local sales tax laws, this means more compliance, and lots of it. Here’s a step-by-step look at what merchants need to know to legally and efficiently collect and pay state sales tax on online transactions with U.S. customers.
1. Determine Your State Sales Tax Obligations
First, figure out your sales tax obligations in the states where you do business.
Determining whether a given state collects sales tax is easy. Presently, just five states have no state sales taxes on the books:
- New Hampshire
In Alaska, local jurisdictions (cities and boroughs) are permitted to collect their own sales tax, so you’ll want to check with a local tax attorney or local revenue authorities to ensure compliance.
Not all products and services are taxable. Moreover, tax policy is not uniform across state lines. Some states tax items that are tax-exempt elsewhere.
As a general rule of thumb, tangible, non-essential goods are subject to sales tax. Products that are likely to be considered “essential” and thus not subject to sales tax might include:
- Fresh and packaged food and ingredients (but not prepared food)
- Clothing (but not jewelry, bags, and other accessories)
- Prescription and over-the-counter medications
If you suspect your products fall into a legal gray area, check with local tax authorities for guidance.
As the first serious attempt in years to collect sales tax from out-of-state sellers, South Dakota’s online sales tax law was designed to provoke a legal challenge – and it did. While the law didn’t have much company when it was enacted, many other states will likely enact similar laws in the coming months and years.
In the meantime, online sellers can technically avoid collecting sales tax in states and localities that don’t explicitly mandate it. However, this is a risky gambit, as small merchants without dedicated compliance departments are unlikely to stay abreast of new state and local sales tax laws. The resources required to monitor the more than 10,000 U.S. sales tax jurisdictions are vast.
For this reason, the best course of action for online retailers of any size is to assume they’re legally required to pay sales tax on transactions with buyers in all jurisdictions that levy sales tax.
2. Register With State Tax Authorities
Next, register with local revenue authorities wherever you plan to sell your wares. In most states, the state department of revenue is responsible for collecting sales tax.
Do not skip this step. Collecting state sales tax without obtaining a permit from the local department of revenue is illegal, even if you plan to file and pay state sales taxes by the deadline.
What You’ll Need to Register
State departments of revenue require certain information from businesses that wish to sell taxable products to residents. Exact requirements vary by jurisdiction, but you should expect to provide:
- Your Employer Identification Number (EIN), business tax ID, or both
- Your official business contact information, including the registered agent’s mailing address
- Your NAICS code
Certain states require additional information. For instance, Illinois asks retailers to provide the addresses of all in-state locations from which their products may ship. This requirement applies both to drop-shipping locations (such as retail UPS Stores) and third-party fulfillment centers (such as Amazon warehouses).
You may be required to pay a registration fee with your application. Fees vary but are usually fairly low. Colorado’s is $16, for instance.
Most departments of revenue have reasonably streamlined online registration processes. If you register online, you should receive your official permit within a few business days, though timeframes vary by state and application volume.
Registering by Mail
If you can’t register online, or prefer not to, you can register by mail. You’ll need to provide the same information on the same forms; the only substantive difference is that you’ll need to allow several weeks for processing.
Maintaining Ongoing Compliance
Once you have your state sales tax permit, you can legally sell and collect sales tax in that jurisdiction. Moving forward, you’ll need to mind any ongoing compliance requirements, such as reporting and filing state sales taxes by the applicable deadlines.
In some states, you may also need to keep your sales tax permit current; for example, Colorado requires renewal every two years. Check with each state department of revenue for permit renewal deadlines.
Outsourcing Sales Tax Registration
If the process of applying for and renewing state tax permits is too time-intensive for your small shop, consider outsourcing the job. It’s a much costlier option; TaxJar, a third-party referral service, advises sellers to expect to pay about $100 per state registration. If you plan to register with every U.S. state taxing authority, including Washington, D.C. and excluding Puerto Rico and minor U.S. territories, that’s a total bill of roughly $4,600.
3. Calculate & Collect Sales Taxes
The United States is a hodgepodge of thousands of state, local, and special tax districts. Fortunately, you have no personal obligation to keep track of the various tax rates charged in all the jurisdictions in which you sell. Virtually every e-commerce suite is equipped to do this on your behalf.
The process of setting up sales tax collection varies by suite. TaxJar has a handy set of guides for several major suites, including Shopify, Square, eBay, and Amazon. Even though these suites largely automate sales tax collections, it’s advisable that you double-check with state and municipal departments of revenue to confirm that you’re collecting the appropriate amount of sales tax. Most states have partly or fully automated online systems for doing so. For instance, the New York State Department of Taxation and Finance has a digital sales tax lookup tool and multiple publications outlining local tax rates.
Origin- vs. Destination-Based Taxation
Even if they don’t need to calculate local tax rates manually, online sellers can benefit from understanding the distinction between origin- and destination-based taxation.
About a dozen states, including Texas and Illinois, impose origin-based taxation, which is the simpler of the two options for sellers. Under origin-based regimes, buyers always pay sales tax at the rate charged at the origin point. So, if you drop-ship all of your merchandise from a single UPS Store in Dallas, you’ll pay the same sales tax rate on all transactions with Texas-based buyers, whether they live in El Paso, Beaumont, Brownsville, or Amarillo. Likewise, if you ship to every Illinois-based buyer from a single Amazon warehouse in the Chicago area, you’ll pay the applicable tax rate in that locality.
Most states impose destination-based regimes. Destination-based taxation is more predictable for buyers since it means they always pay the same sales tax rate. For sellers, however, destination-based regimes necessitate more compliance and auditing. Even if your e-commerce suite automatically collects sales taxes at destination rates, you’ll want to spot-check actual collections against the rates published by state revenue authorities to confirm accuracy.
Collecting Tax at the Origin & Destination
Depending on state and local policies in the shipping destination, origin-based merchants selling across state lines may be required to collect origin and destination taxes. For instance, if you drop-ship your merchandise from a UPS Store in Philadelphia (Pennsylvania is an origin-based regime) to a buyer in Miami (Florida is a destination-based regime), you’d charge the buyer the combined tax rate in both destinations.
Remember, in the absence of state and local laws mandating sales tax collection by remote sellers, you might be able to avoid collecting tax at the destination rate. However, you’ll need to monitor local policy carefully to ensure you’re in compliance with any new remote seller tax laws that arise.
Setting Aside Sales Tax Collections
You aren’t required to remit state sales tax collections on a continuous basis. Depending on the jurisdiction, you can expect to remit sales tax collections monthly, quarterly, or annually.
In the meantime, you’ll need to set aside and hold your sales tax collections. Set up a new bank account for this exclusive purpose and make regular deposits as you collect taxes. Look for interest-bearing accounts that don’t charge monthly maintenance fees for customers who meet certain criteria, such as regular direct deposits or minimum daily balances.
4. File & Remit Sales Taxes
Assuming you’re using an e-commerce or accounting suite that automatically tracks sales tax collections, you should have an accurate running total of your sales tax receipts at any given point in time.
Again, it’s in your best interests to check your receipts against actual state and local tax rates to ensure that you’re collecting the appropriate amount of tax from each buyer. The sooner you uncover a discrepancy, the sooner you can address any shortfall or overage.
Filing State Sales Taxes
Business sales tax filings help state and local revenue departments keep tabs on merchants selling taxable goods and services within their jurisdictions. This is essential for budgeting and tax enforcement. Newer merchants familiar only with the personal tax filing process might be surprised to learn that businesses are not always required to remit funds with sales tax filings.
A sales tax return without an accompanying remittance is known as a “zero return.” Pay special attention to zero-return requirements. Not all jurisdictions require zero returns, but those that do are serious about collecting late fees and penalties from businesses that fail to abide.
After processing their initial registrations, most jurisdictions advise merchants of their required filing frequency and due dates. Filings may be required monthly, quarterly, or annually, depending on the jurisdiction’s policy and your average monthly tax liability. Greater tax liabilities generally mean more frequent filings.
In destination-based regimes, you won’t be required to file separate returns with every city or county in which you sell; your state return should account for local and special district taxes, if applicable. However, some destination-based states require you to list out every local and special tax jurisdiction in which you made a sale. Washington State is notorious for this due to its unusually high number of local tax regimes and picky reporting requirements. Check with state and local revenue departments to confirm your obligations on this front.
In most jurisdictions, you can file sales taxes online. Manually filing state sales taxes on a monthly, quarterly, or even annual basis can be extremely resource-intensive, so larger merchants may find tax automation suites cost-effective. For example, Avalara TrustFile gives users automated reporting, collection, and an unlimited number of monthly state tax filings for $3,000 per year. Taxify offers comparable annual pricing for a practically unlimited plan.
Remitting State Sales Taxes
If you have a state or local sales tax obligation in a given filing period, you’re required to remit the appropriate amount of tax by the payment deadline, which usually coincides with the filing deadline. Many states allow you to pay by electronic funds transfer (EFT) or wire transfer.
Pay close attention to any penalties or interest charges for late payments, as these can be steep and often accrue with no grace period. Also, be sure to note any early payment discounts. More than 20 states allow merchants to keep a small share of their total sales tax obligations – usually less than 2% – when they pay before the monthly, quarterly, or annual deadline.
Abolitionist Theodore Parker once said, “I do not pretend to understand the moral universe; the arc is a long one… And from what I see I am sure it bends toward justice.”
Even after the U.S. Supreme Court ruled separate public accommodations unconstitutional in the seminal Brown v. Board of Education decision of 1954, it took another two decades – and numerous interventions by state and federal authorities – to erase Jim Crow’s last legal vestiges. Though the issue at hand in South Dakota v. Wayfair, Inc. lacks the moral urgency of Jim Crow, its historical arc has been just as pokey. Wayfair took five decades to overturn the precedent set in 1967 in National Bellas Hess Inc. v. Department of Revenue of Illinois and upheld in 1992 in Quill Corp. v. North Dakota.
The upside to the Supreme Court’s glacial pace is that the precedent established by Wayfair is likely to endure for years, if not decades. Whatever equilibrium is reached in the years ahead, uncertainty is one thing consumers and merchants alike should not have to worry about.
Do you sell goods or services online? Do you feel you understand your responsibility to collect state sales tax?