Online sales tax has been in the national spotlight this past year for a number of reasons. The media attention started in 2016 when online retailer MyPillow® agreed to pay the state of New York $1.1 million. New York argued that the retailer knowingly failed to collect sales tax from customers in the state.
MyPillow® is based out of Minnesota. Common practice was retailers only needed to collect sales tax from customers in which the company has a physical presence. In the case of MyPillow®, that would be Minnesota. However, the Attorney General argued they owed New York taxes “because the company sold products at trade shows in New York through independent contractors and other representatives, among other reasons.” The AG concluded, “From 2011-2015, My Pillow failed to collect and remit approximately $537,000 in sales taxes on taxable sales made over the phone and through the Internet to New Yorkers.”
This lawsuit more or less awakened different states and metro areas to the idea that they could be missing out on collecting sales tax revenue from online retailers, wholesalers, and even sellers passing through for trade shows. Since all state governments are in debt, some more severely than others, the idea that there is money out there they can collect on is very appealing.
In August of this year, President Trump tweeted “Amazon is doing great damage to tax-paying retailers. Towns, cities, and states throughout the U.S. are being hurt – many jobs being lost!” The President’s insistence that Amazon is not paying taxes kept the issue of online sales tax in the limelight, causing states to take a harder look at who may owe money.
The truth is, Amazon does pay taxes. The company collects sales taxes for any products directly sold by them. However, third-party sellers on Amazon Marketplace, which make up a large portion of Amazon’s total sales, are another story. “States and local government lose approximately $5 billion a year in taxes from Amazon marketplace commerce because merchants don’t collect them and shoppers don’t pay them after the fact,” James Thomson, a former Amazon employee, founder of the Prosper tradeshow, and ecommerce consultant, told Bloomberg.
Sales tax is considered a “pass-through” tax because the retailer is only temporarily holding the money collected before remitting it to state and local authorities. States have a good amount of leeway when it comes to their sales tax, so all 45 states plus Washington D.C. that have a sales tax have different rates and rules.
In many states, even if a retailer, such as an Amazon seller, doesn’t collect sales tax, the burden of paying that tax falls to the buyer. Customers are supposed to list online transactions on tax returns and pay any taxes due. Hardly anyone actually does this and states rarely go after shoppers for failing to pay sales tax.
Some bigger Amazon sellers have been subpoenaed by states looking to collect unpaid taxes. However, the solution isn’t very easy. Oftentimes, online sellers aren’t willfully choosing to skip out on sales tax. Thomson explains that many third-party sellers who use fulfilled by Amazon services (FBA) don’t even know where their inventory is being stored, which would in part determine the sales tax rate they need to collect. There is an option to pay Amazon to collect taxes for you, but very few people even know that option exists.
Even for online sellers who know where exactly their inventory is, it is still not always easy determining the appropriate sales tax. Sales tax sourcing is the name for determining which tax rates should be applied, based on jurisdiction. Jurisdiction depends on a number of variables. First, determine where your business, or in legal terms, your “nexus,” is located. A nexus is anywhere your business has any facility, employees, or inventory, so it is very likely you will have more than one. Hence, a lot of the confusion, especially for FBA Amazon sellers who could have products in any of Amazon’s many warehouses.
There are two criteria that need to be met for you to collect sales tax from your ecommerce customers. First, your business has a sales tax nexus in the state where your customer is located. For example, your company is based out of Hartford, Connecticut and your customer is in Stamford, Connecticut. The second criterion is that the product you are selling is taxable in that state. In most cases, it will be, but there are a few exceptions. For example, clothing is not taxable in Pennsylvania.
Most states follow destination-based sales tax, which means that you should charge the sales tax rate of where the customer lives. So, in the example above, you would charge the sales tax rate for Stamford, Connecticut where your customer lives, not Hartford, Connecticut, from where you are shipping. A few states, such as California and Texas, have origin-based sales tax. This means you would charge the sales tax rate for where you are shipping from, and not the rate for where your customer lives.
There are a lot of variables when it comes to online sales tax. It is understandable why many online sellers have been confused by the process or skipped it altogether. But, as state and local governments continue to crack down on ecommerce retailers, it is important that you get all of your ducks in a row. The easiest way to do this is by automating the process. If you are an FBA seller, you can have Amazon handle the taxes for you. If you are an independent seller or have your own ecommerce website, there are solutions such as Taxify, TaxJar, Avalara, and many others that can automatically collect and report sales tax for you. Unfortunately, sales tax is not an issue online sellers can ignore any longer. Collecting and remitting accurate sales tax is a necessity for every retailer. Organizing and automating your process now will save you many headaches down the road.