Ben Franklin said it – “In this world nothing can be said to be certain, except death and taxes.” There’s just no avoiding the IRS. Fortunately, personal taxes are fairly simple to manage for most people. Business taxes, on the other hand, can get complicated quickly. Every business will need to deal with expenses, tax credits, withholding taxes, and more. Brick and mortar shops have to collect sales tax, too. But online businesses face some unique tax questions – the issue of an internet sales tax being one of the biggest and most confusing. Here’s what you need to know.
What’s So Confusing About An Internet Sales Tax?
The meteoric rise of e-commerce have drastically changed the way we do business. And it’s only going to continue - some experts estimate that internet sales are expected to reach $523 billion in the next five years! And online businesses have some unique tax characteristics.
It used to be that you would walk into a physical storefront, select the product that you needed, and pay at the register. During this transaction, a store employee would assess and charge a sales tax for your purchase. Simple, right?
Sure, if you’re running a shop with a physical location. Sales taxes are set by and paid to your state, and sometimes your city as well. So if you’re located in New York, your business must collect New York taxes and pay them to the state. In legal jargon, the area in which your business is located is called “the nexus” (more on that later in the article) and that nexus determines your sales tax obligations.
But what if you’re running an ecommerce site out of Vermont? Say a customer in Hawaii buys one of your products as a gift and has it shipped to their aunt in Minnesota. What state should get the sales tax? Is it Vermont, since the business is based there? Or Hawaii, because that’s where the purchase was made? Or Minnesota, because that’s where the product ended up?
The short answer is: It depends. The growth of online business has muddied the waters of sales tax and has moved too fast for regulations to keep up. It’s an ever-evolving, murky area of the law.
Many people running online businesses assume that there is no internet sales tax, but that’s not necessarily the case. So how do you figure out the rules for your business?
You Probably Have To Pay Taxes On Internet Sales
Internet sales taxes are still taxes, which means you want to get it right to avoid visits from the IRS. It pays to get it correct from the outset! The most important take away point to remember about virtually all internet sales transactions is that they are NOT tax-free.
It’s a common misconception. Many people interpret the Internet Tax Freedom Act (ITFA) of 1989 to mean all online businesses should be free from taxation. This isn’t the case – the intent of the ITFA was to exempt specific internet access services from taxation, as opposed to the sale of goods over the internet.
As an online vendor, your small business will probably have to pay sales taxes on at least some sales. But how much? And where?
Where You Have to Charge Internet Sales Taxes
The Supreme Court has ruled that a state can force a retailer to collect sales tax only when the retailer has a physical presence in the state. That may mean offices, stores, employees, or any other physical manifestation within the state – a “nexus.” On its face, that makes it seem like there shouldn’t be an internet sales tax unless you’re selling in the state in which you’re based. Where is the nexus of your website?
First, your business is going to have some physical presence. It may be a warehouse or distribution center, an office, or your house – there is actually a physical nexus for every online business. And if you sell your products to people in your state, you have to collect your local sales tax from them. If you have a physical nexus in more than one state, you have to collect local sales tax on each purchase from a nexus in the same state.
So, if your business is in Ohio and an Ohio resident makes a purchase from you, you have to collect Ohio sales tax. If your business is in Ohio and you have a warehouse or an employee in New Jersey, you’ll probably have to collect sales tax on purchases from both locations. In theory, you don’t have to collect it if your nexus is in Ohio and you sell a product to a Texas resident.
Of course, states aren’t happy about missing out on that tax revenue. So, some states have broadened the notion of “presence” more broadly to force online retailers to collect sales tax.
Here’s how it works. Say you’re running a t-shirt business with a single physical nexus in New Mexico. And say there’s another clothing company with a Pennsylvania nexus that wants to link to your website. You work out a deal where if they send sales your way, you give them a small cut of your profits. This is a great way for you to make more sales, and it makes that Pennsylvania company your “affiliate.” And some states have passed laws to make that affiliate count as a nexus for your company. It’s called a “click-through nexus.”
New York was the first state to pass this kind of law, which is now referred to as the “Amazon law” (since it was inspired by that particular online retail behemoth). That means that if you’re found to have an affiliate in New York, you have to collect New York sales taxes on sales in New York. That’s true even if your business only has a single physical nexus in another state – your affiliate now counts as another nexus.
A number of states have either passed Amazon Laws or have proposed them. For more details on state specific tax laws, visit the below interactive resource prepared by Nolo Law. This resource allows you to select your state and determine which laws apply.
Internet Sales Tax Compliance
Now that we’ve covered the basics on sales tax and internet sales tax, let’s discuss how these issues apply to your small online business. We’ve already established that if your business has a physical presence in state, including but not limited to a physical business location, office, or warehouse, then you have to collect internet sales taxes on purchases made in that state. In addition, some states have Amazon Laws that count your affiliates as nexuses, and you’ll have to pay sales tax on purchases made in those states as well.
But even this isn’t clear-cut. How do you track the location of an online purchase? Is it where the purchaser lives? Or where the product is eventually shipped to? And how do you track that information? Different states have different rules to cover these issues. Some require you to collect sales tax at the rate that applies wherever your physical nexus is – “origin-based sales tax.” Others require you to collect sales tax at the rate of the buyer’s ship-to address – “destination-based sales tax.” The location from which the buyer actually made the purchase generally doesn’t matter.
And there are other issues, like keeping track of the location of your affiliates and whether they’re in states that count affiliates as another nexus. Plus the logistical difficulties of keeping track of different tax rates for different purchases. It can get pretty complicated pretty quickly.
But here’s the good news: almost all major online sales platforms are equipped to manage most of these issues automatically. They may not be able to perfectly track all of your affiliates, but they’ll generally be able to manage the taxes due on each purchase. That takes a lot of work off your plate – it would probably be impossible to do otherwise. If you’re running your own e-commerce site from scratch, you’ll need to talk to your accountant to figure out the best way to manage the internet sales tax issue.
The Bottom Line
When it comes to tax and legal issues, an ounce of prevention is worth a pound of cure. The laws surrounding internet sales tax are very complicated and many are so new that they’re untested, meaning it may be impossible to really figure out the rules until those laws have been challenged and clarified in court. So, your best bet is to find a qualified accountant. They can help you track your internet sales tax liability and may be able to help you set up software designed to do the tracking for you. Even if you work through a large e-commerce platform like Amazon, you’ll still need to work with an accountant regularly to make sure you’re in compliance.
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