What eCommerce Startups Need to Know About Online Sales Tax

An online presence can save eCommerce startups from additional expenses like rent and utilities. However, online businesses still have specific tax responsibilities that they cannot avoid. It is crucial for U.S.-based eCommerce store owners to understand these tax liabilities.

To stay compliant with applicable government agencies like the IRS and your state, follow internet business tax laws. Failure to pay taxes can result in penalties, fees, or even the closure of your business. Understanding your tax responsibilities will free up your time and allow you to focus on other aspects of running your business, without unnecessary stress about taxes.

Types of taxes for online businesses

When starting an eCommerce business, you must adhere to the same rules as any new small business owner. It can be helpful to consult with a tax or accounting professional to ensure you understand your full tax obligations. Here are the different types of business taxes you need to know:

• Estimated taxes
• Employment taxes
• Sales tax

Just like businesses with physical storefronts, you must pay estimated taxes and employment taxes. Estimated taxes cover income and self-employment taxes. As a business owner, you will likely be required to pay estimated taxes unless you receive a salary with taxes withheld on your behalf.

Use the estimated tax worksheet from the Form 1040-ES instructions to determine your tax liability and see if estimated payments are necessary. Estimated taxes are separate from sales tax and employment taxes. You pay estimated taxes from your income.

Employment taxes include federal income taxes, FICA tax (Social Security and Medicare), and state and local taxes if applicable. As an employer, you must withhold these taxes from your employee’s wages and make FICA contributions based on their wages. You are also responsible for paying federal and state unemployment taxes (FUTA and SUTA) when you have employees.

In contrast to estimated taxes and employment taxes, sales tax for online businesses works differently compared to brick-and-mortar stores. You must familiarize yourself with the rules for sales tax on internet sales and the penalties for not collecting it. While it’s essential to know all your business tax obligations, this article will focus on sales tax.

What is sales tax?

Before delving into the nuances of online sales tax, let’s clarify the basics of sales tax. Sales tax is an additional tax imposed on customers in most states. A percentage of the sale is added to the customer’s total bill, which the customer is responsible for paying. However, as a business owner, you must collect, deposit, and report the sales tax.

In essence, your business serves as the intermediary between customers and the government. You must apply the sales tax at the point of sale, and the end user (the customer) bears the responsibility of paying the tax.

Retailers who buy and resell goods typically purchase them wholesale. Wholesalers provide retailers with large quantities of products, which retailers then sell at a higher price. Since retailers have resale certificates, they are not required to pay sales tax when purchasing products from wholesalers. Instead, they charge their customers sales tax. By doing so, the product is only taxed once when it reaches the end user (i.e., the retailer’s customer).

For instance, Laura’s Little Table Shop buys wood wholesale to create furniture. They possess a resale certificate, so they don’t pay sales tax on the raw wood. However, when they sell a finished table, they charge their customers sales tax.

States can determine which items are taxable. For example, Pennsylvania taxes food and beverages at restaurants but not grocery stores.

States can also establish whether sales tax is applicable and specify the tax rate. Taking Pennsylvania as an example again, its sales tax rate is 6% (there is an additional local tax in Allegheny County and Philadelphia).

There are five states that do not charge sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Hawaii also does not charge sales tax but has a General Excise Tax (GET) applied to all sales.

Both brick-and-mortar and online businesses may have sales tax obligations, but internet business tax laws tend to be more complicated.

Sales tax on internet sales

Operating an online store offers freedom as you can sell products to customers across the nation. However, this freedom often leads to confusion about when to collect sales tax from customers, particularly for businesses operating in multiple states.

To determine online sales tax, ask yourself two questions:

• In which state(s) do I have nexus?
• If a customer purchases from a state where I have nexus, which rate do I collect (my locality or theirs)?

Read on to learn more about nexus and origin versus destination sales tax.

Nexus

Nexus is essential for online businesses to determine when and how much sales tax to collect. It refers to an eCommerce store’s presence. In which states is your business present? Your home state, where you conduct business, has nexus when it comes to online sales.

Despite not having a brick-and-mortar store, your business may still have nexus in other states if:

• You have an office in the state
• An employee is based in the state
• You store inventory or assets in the state
• You use a third-party provider located in the state to ship orders to customers
• Within the past 12 months, you or an employee attended a trade show in the state

For example, let’s say your home office is in Ohio, your inventory is in New Jersey, and you have an employee in California. You have nexus in Ohio, New Jersey, and California.

You should collect sales tax from customers in Ohio, New Jersey, and California.

For instance, if you sell to a customer who resides in Ohio, the same state as your home office, you must collect sales tax from them. However, if you sell to a customer in Texas where you have no nexus, you are not required to collect sales tax from that customer.

Origin versus destination sales tax

For states in which you have nexus, you must determine whether you need to collect destination or origin sales tax. To begin, find out the sales tax rate you must collect for your home state.

Origin sales tax

Origin sales tax entails collecting based on the seller’s location. However, you still remit the tax to your home locality or state.

Origin sales tax is less common than destination sales tax. It is used in states that employ the origin-based method.

Let’s say your home office is in Phoenix, Arizona. You have a buyer in Tucson, Arizona. Collect the sales tax rate of 8.6 percent in Phoenix, Arizona instead of the 8.1 percent rate in Tucson because your home state is origin-based.

Destination sales tax

When you collect based on the buyer’s location, it is destination sales tax.

Destination-based sales tax is more popular than origin-based. These states (and Washington D.C.) use the destination-based method:

Let’s say your home office is in Buffalo, New York. You sell to a customer from New York, New York. Use New York’s sales tax rate of 8.875 percent instead of Buffalo’s rate of 8.75 percent since New York is a destination state.

Remote sellers

Origin and destination sales tax rules don’t stop there. Next, consider the nexus you have in other states.

For example, nexus can be established by employees or warehouses in other states. In this case, you need to know the origin versus destination sales tax rules for remote sales made from state to state.

You are a remote seller if you have nexus in a state, but your home office is not based there.

The destination- and origin-based states vary for remote sellers. Most states use destination sales tax.

Let’s say you have a home office in Utah and a warehouse in Ohio. Your customer lives in Ohio. Ohio considers you a remote seller, so it would go off the destination method. You would collect at the Ohio rate and send the sales tax to Ohio.

Sales tax permit

Make sure you have a sales tax permit for states where you have nexus. Contact your state tax agency to obtain the permit.

You will need to provide your Employer Identification Number (EIN) and business information. Keep in mind that the information required for a sales tax permit varies by state.

Once you have a sales tax permit, you can begin collecting tax from applicable customers.

Sales tax exemptions

Sometimes, states have sales tax holidays, allowing customers to make tax-free purchases.

If you are required to collect sales tax for a state that is having a sales tax holiday, do not collect during that time.

How to report and pay sales tax

Keep track of the sales tax liability that you remit to your state. Your state will determine your due date and provide directions for filing sales tax.

Collect the sales tax at the point of sale, but do not immediately send payment to your state or local government.

Filing frequency depends on the number of sales you make. If you have a high volume of sales, you will pay more frequently. Filing frequency can be monthly, quarterly, or yearly.

You are also responsible for reporting sales tax to the applicable agency. Reporting can range from monthly to yearly.

Check with your state for your sales tax responsibilities and frequencies.

Consequences of not paying sales tax

As an online business owner, you need to be diligent about sales taxes. Failure to collect and remit sales tax can result in audits, penalties, fees, or even criminal charges.

Sales tax is a pass-through tax. You just need to know and understand the laws of nexus and origin- vs. destination-based sales tax, as well as your state and local rules.

If you don’t collect sales tax from customers, you will be responsible for paying the amount owed. Say you were supposed to collect a total of $10,000 in sales tax from all your customers. You can’t go back and charge each customer their portion—the total amount falls on you.

There are ways to make sales tax collection easier. A shopping cart solution will automatically calculate and collect sales tax. Many of these solutions even run reports so you know how much you have collected in sales tax.

Examples of sales tax omission

Not collecting and remitting sales tax can be detrimental for businesses. Since rules are extra confusing for online businesses, you need to be diligent.

Physical business example:

You might have heard about the recent controversies with Uber surrounding repayment to its New York drivers. Uber, an essentially a taxi-service company, wasn’t charging customers the New York rate of 9 percent sales tax on their rides. The sales tax rate was taken out of driver commissions, causing controversy. Now, Uber may be forced to pay millions to its drivers to cover the cost of the sales tax that was taken out of their commissions.

Online retailer example:

According to one source, a couple wanted to sell their Amazon Store, but they had never collected sales tax while being in business (18 months). Before they could sell their store, they needed to settle their sales tax liability. The sellers and buyer calculated that the business owed about $70,000 in uncollected sales tax. As a result, the couple paid $70,000 out of pocket, a substantial payment that could have been avoided had they followed sales tax laws.

Your takeaway

Navigating sales tax can seem overwhelming; there are so many rules to follow and obligations to meet. Contact your state with any questions and research shopping cart solutions that can calculate and collect sales tax for you.

In a nutshell, here’s what you need to do:

1. Set up your online business

2. Determine your business’s nexus, whether applicable states are origin- or destination-based, and the sales tax rate(s)

3. Get a sales tax permit

4. Collect sales tax from customers each time they make a purchase

5. Pay attention to sales tax holidays

6. Report and pay sales tax

As a business owner, you need to stay organized. Keep track of your sales tax deadlines by using a calendar and setting reminders.

Many states have tax filing deadlines on their state websites. And, you can even sign up to receive tax alerts like filing reminders (via email or text message) in some states, such as Ohio and Virginia.

Once you understand state laws on sales tax, as well as the rules on nexus, collecting and remitting sales tax won’t seem so stressful.

Andrew Brooks

Hello!

I’m Andrew Brooks, a seasoned finance consultant from the USA and the mind behind phonenumber247.com.

My career is built on a foundation of helping individuals and businesses thrive financially in an ever-changing economic landscape. At phonenumber247.com, my aim is to demystify the complex world of finance, providing clear, actionable advice that can help you navigate your financial journey with confidence. Whether it’s personal finance management, investment strategies, or understanding the nuances of market dynamics, I’m here to share insights and tools that can propel you towards your financial goals.

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