Ensuring Sales Tax Compliance for E-Commerce Businesses

Tracking every single rule that could apply to online sales tax is an uphill battle, but any online seller needs to know the fundamentals of e-commerce sales tax compliance, which are outlined below. If you plan to sell online, you will likely also want to invest in software or hire an expert in multistate tax compliance to assist you.

Sales Tax Laws

Many online sellers wonder, "Do I need to collect sales tax for selling online?" The answer begins with the law. Most states and many local jurisdictions impose sales tax (or sales and use tax). Across those jurisdictions, states and municipalities impose different rates on different goods, exempt some products from tax, or have tax-free holidays. Also, some states impose differing rules on sales made within state lines where the origin and destination use different local rates.

Statewide Sales Tax

Five states do not require sales tax:

• Alaska

• Delaware

• Montana

• New Hampshire

• Oregon

All other states and the District of Columbia collect statewide sales tax. Keep in mind that even though a state does not require sellers to charge sales tax, they may have other tax requirements. For example, while Delaware does not charge sales tax, the state does impose a gross receipts tax on those that sell goods or provide services.

Local Sales Tax

Where the state allows, cities and counties may also impose sales tax. Several states that impose statewide sales tax do not have local sales tax, including:

• Connecticut

• Indiana

• Kentucky

• Maryland

• Massachusetts

• Michigan

• Rhode Island

• The District of Columbia

In contrast, even though Alaska does not have a statewide sales tax, it allows local jurisdictions to impose sales tax.

Goods-Specific Sales Tax and Sales Tax Exemptions

Tax rates vary within and between jurisdictions based on the product type. Some products are exempt in some states, but not others; and some states offer tax-free holidays on certain items during the year.

Groceries serve as a good example. In most states, groceries are exempt from sales tax as necessities. A few states impose reduced taxes on groceries. An even smaller group of states taxing groceries at the full rate includes:

• Idaho

• Mississippi

• Oklahoma

• South Dakota

These rates are subject to change—several states are already phasing out grocery taxes or considering eliminating them.

Origin-Based vs. Destination-Based Sales Tax

Although most states impose taxes based on where the buyer is located, some impose taxes based on where the seller is located. Whether a state uses an origin or destination rule primarily affects sales within the state where a business is headquartered. Assume your business headquarters is located in Minnesota, which uses destination-based sales tax rules. If you sell a product to someone in another part of the state with differing local taxes, you collect taxes according to the rates where they are. However, assume your business headquarters is in Texas, which is an origin state. When you sell to someone in another part of the state with different local taxes, you collect taxes at your location's tax rate.

Double Taxation

Generally, jurisdictions tax sales when those sales occur in the jurisdiction. However, sometimes jurisdictions have a different definition of where a sale occurs. For example, one state may tax transactions based on where a physical exchange occurred, while others may tax transactions based on where the product ended up. As a result, a transaction may occur in and be subject to taxes in both states.

If you are buying something to resell, you may not have to pay sales tax. However, resellers may also face double taxation. To become a reseller, you usually must register. If you do not register or do not provide proper documentation during a sale, you may pay tax on the purchase of the goods and need to collect and remit taxes on the sale.

Tax Nexus

A state can only impose taxes on commerce if the state has a substantial nexus with the business. In this context, having a nexus means the entity availed itself of the substantial privilege of carrying on business in the jurisdiction. In other words, you establish a substantial nexus in a jurisdiction by doing business there in a way that is either ongoing or otherwise significant. Unfortunately, the definition of a substantial nexus is nebulous, often coming down to specific facts in specific cases.

Physical Presence and South Dakota v. Wayfair, Inc.

Before 2018, many e-commerce businesses did not collect internet sales tax—or if they did, they only collected taxes in limited circumstances. That year, the U.S. Supreme Court decided South Dakota v. Wayfair, Inc., which involved a South Dakota law that Wayfair, Inc. claimed violated the Commerce Clause of the U.S. Constitution.The Court concluded that the South Dakota law did not violate the Commerce Clause and eliminated the requirement that an entity needed to have a physical presence in a state to establish a nexus.

Since Wayfair expanded rather than contracted the circumstances when a state is allowed to impose taxes, a state may generally still tax businesses with a physical presence in a state. Broadly, a business has a physical presence when it has an office, distribution center, storage facility, or similar place of business in the state or a representative or agent working there.

State-Specific Economic Nexus Rules

In the wake of Wayfair, many states adopted rules similar to the South Dakota law in issue, primarily establishing a nexus based on:

• Value of all sales (including resellers)

• Value of all retail sales (excluding resellers)

• Number of transactions

States that set a nexus based on the value of goods sold generally use a $100,000 to $250,000 range, while states with a transaction-based calculation generally require at least 200 transactions. Ultimately, if you do not meet the state's economic threshold but have a physical presence there, the state may usually impose a sales tax. If you do not have a physical presence but do meet the economic threshold, the state may generally impose a sales tax. If you do not have a physical presence or meet the economic threshold, the state will not tax your sales.

The Streamlined Sales Tax (SST) Program

Because of the complexity of sales taxes throughout the nation, groups have worked to minimize the burden of selling across state lines. The group that became the Streamlined Sales Tax (SST) Governing Board proposed the Streamlined Sales and Use Tax Agreement, which is designed to create uniformity in, and bring simplicity to, the issue of sales tax. As of 2024, 24 states have adopted the agreement, and the SST board continues to perform outreach to encourage more states to join.

Collecting and Remitting Sales Tax

If you expect to owe sales tax in any jurisdiction, make a plan to collect and remit that tax as soon as possible. Generally, that plan begins with registering for a sales tax permit.

Register for a Sales Tax Permit

Businesses that expect to owe sales tax must register with the relevant state before they start collecting taxes. Regulations requiring registration inform the jurisdiction about the business's activities and protect consumers.

Collect and Remit Sales Tax

Consult the rules in each jurisdiction to determine your collection and remittance obligations. Many jurisdictions require that you report and remit your collected tax four times per year or even monthly for more substantial sales. After you collect the tax, and until you remit it, you essentially hold it in trust for the jurisdiction that imposed it. So, you should establish a financial account to separate sales tax from other business accounts.

Establishing an E-Commerce Sales Tax Compliance Plan

Keeping track of every individual sales tax rule your business might encounter could be a full-time job, especially since such regulations are in a constant state of flux. Penalties can be significant for failure to collect and/or remit sales tax. If you have or are considering establishing an e-commerce business, investing in someone or something to help you track and collect the correct sales tax is wise.

Disclaimer: Bizee and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.