By Ian McCue, senior associate content manager at NetSuite
Most states that charge sales tax now have laws in place to tax e-commerce sales as well. They took effect fairly suddenly, leaving many companies struggling to comply.
While states are not pursuing back taxes under these new laws, that could change soon, and a few states are chasing money owed under old rules.
Companies addressing this challenge can complete five steps to get compliant with the laws, starting with a nexus analysis and ending with state tax registration.
For years, as online shopping exploded, states missed out on billions of dollars in tax money from e-commerce sales despite their best efforts to cash in.
Until recently, e-commerce companies were not required to charge sales tax in states where they did not have a “physical nexus,” or physical presence. This was the remnant of a Supreme Court decision from 1992, when e-commerce was in its infancy and a world away from the $500-billion U.S. business it is today.
E-commerce tax laws were due for a change.
It seemed inevitable that this requirement would change, and it did last June, when the Supreme Court overturned its 1992 decision in South Dakota v. Wayfair. (Three large e-commerce companies—including Wayfair—challenged a South Dakota law that required online businesses to charge sales tax if they generated $100,000 in sales or processed 200 transactions from South Dakota residents.)
Back in June, a number of states had already passed laws that taxed online sales, and the Supreme Court decision affirmed their legality. It also opened the floodgates for states to establish their own rules around e-commerce and start collecting duties.
Several other states had laws that became enforceable on July 1, just 10 days after the ruling. Today, 37 of the 45 states with state-level sales taxes (plus Washington, D.C.) have e-commerce tax laws that are already effective or will become effective later this year. Many adopted the South Dakota v. Wayfair thresholds—taxes apply to any company generating $100,000 in e-commerce revenue or with 200 transactions in a state—but some established higher or lower thresholds. Massachusetts, for example, requires $500,000 and 100 transactions. Minnesota’s threshold is 10 transactions worth $100,000 or 100 transactions.
For many companies, the results are far from convenient.
The South Dakota v. Wayfair ruling sent many companies into a frenzy. Smaller online retailers historically charged sales tax in just one or a handful of states where they have the office, warehouse or employees that qualified as a physical nexus.
The ruling (and speed with which related laws took effect) caused major headaches for online retail executives like Sean Dhaliwal. He’s the VP of marketing at Rubber-Cal, a distributor of industrial rubber products including mats and tiles.
“I get where the Supreme Court’s coming from, but at the same time, from a business standpoint, for businesses like us who do a lot of sales across the country through multiple channels … it’s a big hassle,” Dhaliwal said. “Super inconvenient, because there are 50 states in the country, and there are numerous counties in each of these states, and they have their own tax codes.”
“I get where the Supreme Court's coming from, but ... it's a big hassle.” -Sean Dhaliwal, VP of marketing at Rubber-Cal
Tax laws differ widely from state to state.
As Dhaliwal suggested, taxation varies greatly by state. Maryland, for example, charges a simple 6 percent tax on all eligible e-commerce purchases. Meanwhile, “home rule” states like Colorado are far more complicated. Colorado has a base state sales tax of 2.9 percent, and additional taxes that vary by city, county, school district, transportation district and special purpose district. Certain parts of the Denver metro area have taxes for public transportation and cultural improvement, meaning taxes can total as much as 11.2 percent.
Becker Safety and Supply is a distributor of industrial safety equipment in Greeley, Colo., that does most of its sales locally. Even so, calculating the correct sales tax is anything but straightforward. A block away from Becker Safety’s office is an intersection where one side of the street is within the city limits of Greeley, the other side of the street is the city of Evans, and a third side is unincorporated county land. Each area has a different tax rate, despite their geographic proximity.
The new online sales tax laws are especially tough for distributor Becker Safety. (credit: Facebook/Becker Safety and Supply)
Additionally, companies must label tax-exempt state and local agencies like fire departments, police departments and EMS teams to ensure they don’t pay taxes like other customers. Becker Safety must categorize all of the items in its warehouse, as well, because some states’ tax rates differ by product.
“[The laws] get so deep and the water gets so muddy that it does impose a hardship on businesses such as ours who are just trying to do business,” said Clint Swain, systems administrator at Becker Safety.
Here’s how e-commerce companies can get compliant.
A lot of small businesses—probably the majority—are not yet remitting sales tax to all the states with laws in effect. Many companies only recently became aware of how the Supreme Court’s decision affects their business or just found the time to pursue compliance.
What are the first steps companies like these should take?
1. Do a nexus analysis.
Tax attorney Mike Dillon suggests that companies first have a tax expert perform a nexus analysis to learn which states they need to collect taxes in based on either their physical presence there or the new “economic nexus” thresholds.
This is well worth the cost (about $1,000) because it makes companies aware of any “historical exposure” they have, i.e. any states in which the organization should have paid taxes under the old physical nexus rule. States may charge penalties and interest on top of the historical taxes owed.
2. Rank states in which your company has a nexus, then pursue compliance one by one.
After the nexus analysis, businesses may want to rank states in order of priority, based on where they make the most sales and which states are aggressively pursuing back taxes from online sellers. If an e-commerce company voluntarily discloses its sales in a state that is trying to recover unpaid taxes, the two parties can often negotiate a settlement, said Dillon, a solo practitioner in Annapolis, Md., who has done tax consulting for more than 25 years.
3. Get tax automation.
After back taxes are cleaned up, the next step is to implement a tax automation solution to ensure compliance going forward. A tax automation system will calculate the appropriate tax based on a customer’s location and the product category, then put that money into a return and file it with states on an ongoing basis. These solutions integrate with e-commerce and accounting systems to maintain accurate records. Tax software is a necessity for any business processing a significant number of transactions, and it can quash the need for additional help.
4. Register with states appropriately.
After that, companies should start tax registrations in states with e-commerce tax laws. They should start gathering taxes before they register, to show they are compliant.
The whole process outlined above usually takes about two months, according to Dillon.
👉 An important caveat
States are not currently pursuing back taxes on the economic nexus legislation that recently went into effect. To do that, states would have to audit thousands of businesses to figure out when each one surpassed thresholds, which is not realistic, Dillion said. It’s akin to “blindly throwing darts at a moving dartboard.”
However, a select group of states are using data from marketplaces like Amazon to figure out if sellers ever stored inventory in their state and therefore had the “physical presence” that warrants sales tax. (These states include California, Washington, Pennsylvania and Massachusetts.) For example, California’s tax registration application asks customers if they’ve ever sold through a marketplace, which ones and when they started selling on those sites. If these states find that a business owes money, it’s coming out of the business’s pocket—not customers’—since the businesses were never aware of these taxes and didn’t charge them.
Amazon operates fulfillment centers in 33 states, which can create tax snags for online retailers who use its fulfillment services.
This campaign is especially tricky for companies that use Fulfillment By Amazon, a service by which Amazon stores inventory and fulfills orders on behalf of sellers. In the past, the e-commerce giant may have moved these vendors’ inventory to any of its 33 warehousing states without warning. Nevertheless, that inventory is considered the seller’s responsibility under back tax rules.
“It’s a huge rock-and-a-hard-place situation,” Dillon said. “[Companies say], ‘I want to register and do the right thing and mitigate exposure going forward so I can begin collecting the tax on future sales. But how do I do so and not open Pandora’s box with regard to historical sales to California customers, when I had no idea I had this inventory in the state and had an obligation?’”
“It’s a huge rock-and-a-hard-place situation ... I want to register and do the right thing ... but how do I do so and not open Pandora's box?” -Mike Dillon, tax attorney
In online sales tax compliance, proactivity goes a long way.
Those back taxing states are the exception—most states just want e-commerce businesses to register so they can collect sales tax post-Wayfair. Those states are hoping they can encourage companies to register right away, because they are not giving them any reason to not register.
Companies following a compliance plan include International Wine Accessories, which sells a variety of wine-related products like fridges, racks and glassware online.
“We’re hoping that by being proactive and complying with the spirit of what we believe the Supreme Court decision was, that if we start collecting sales tax in the states where we meet the threshold, that the state then isn’t going to come to us and say ‘Hey, for the last three years, the last five years, you owe us back taxes and by the way, here’s some penalties and interest and so on,’” said Ben Argov, the company’s president.
International Wine Accessories is pursuing compliance with new online sales tax laws. (credit: Iwawine.com)
Some states’ leniency might not last forever, of course. That’s why businesses should become compliant as soon as possible, even if it seems daunting. If companies don’t comply, states might pursue not only back taxes but also penalties and interest.
Don’t hope for a streamlined law for online sales tax.
Some business owners hope that states with complex tax laws will offer a simplified law to out-of-state sellers. For example, Alabama, a home rule state that has hundreds of tax jurisdictions like Colorado, introduced the Simplified Seller Use Tax Remittance Act in 2015, allowing online sellers to collect a flat 8 percent tax on all purchases.
E-commerce companies should not count on other states to follow suit, according to Art Linares, a former Connecticut state senator who now serves as VP of marketing and government affairs at tax automation company TaxCloud. A keen observer given his legislative experience, Linares doubts that all the counties, cities and other tax districts would approve of a change that could decrease their tax revenue.
Both Dillon and Linares said it’s unlikely Congress will create a federal statute that streamlines state laws.
But wait! There’s a silver lining.
The Supreme Court ruling does clear up what has long been a murky situation. Online sellers now have a clear set of rules to follow, and states are no longer looking for creative (and confusing) ways to gather e-commerce sales tax. Everyone is playing by the same rules now.
Business leaders like Argov say they’re OK with the changes.
“We didn’t use it as an advantage that we didn’t charge sales tax outside of California and Texas,” he said. “We always looked at it as we don’t want to be disadvantaged, but we don’t care if we’re on a competitive playing field.”
"We didn’t use it as an advantage that we didn’t charge sales tax outside of California and Texas ... we don’t care if we’re on a competitive playing field." -Ben Argov, president of International Wine Accessories
For state governments, the new laws will likely help make up for declining sales tax revenue due to shuttered brick-and-mortar retailers. Those stores closed in part because they couldn’t match online retailers’ lower prices and convenience, so perhaps some think it’s fitting that e-commerce “pick up the slack” with taxes.
Numerous longstanding chains of brick-and-mortar stores are closing nationwide.
Gone are the days in which e-commerce companies don’t charge sales tax. However, the exact laws around this could continue changing. Retailers have already challenged the Supreme Court’s decision, and that’s likely to continue. For instance, businesses could challenge whether it’s fair for South Dakota and California to have the same thresholds ($100,000 or 200 transactions) when the population of the Golden State is 45 times larger than that of South Dakota.
🌱 The bottom line
In tackling this online sales tax issue, the worst thing businesses can do is ignore new laws and their lack of compliance. It’s only a matter of time before states start cracking down on non-compliant companies, so the earlier these companies address this problem, the better.
“Obviously, states are experiencing an influx of revenue from new registrants, but when that stops and plateaus, then they’re going to heighten enforcement,” Dillon said. “In the world of sales tax, there’s few things states can do to generate additional revenue. And most of those options are politically unfavorable.
“So the best thing they can do is heighten enforcement, and the way to do that is send out more nexus questionnaires and increase their audits, because it’s proven to be effective.”
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