As an a e-commerce seller perhaps you have heard about sales tax but only in passing or perhaps you think it is not relevant to you. In this article we will discuss how sales tax is collected and from whom and how this impacts you as an e-commerce seller.

First, the basics. States need to pay for the services they provide to their residents. They do this by taxing certain activities or income, or anything really. One of the things that is commonly taxed is the use of tangible personal property (e.g. pens, tables, fidget spinners). This is called “use tax.” Now, you may be asking yourself, how come I have never heard of this “use tax;” I certainly do not know anyone who ever paid it? The reason no one ever pays it is because states do not usually ask for it. Instead this tax is paid at the cash register or online checkout when a customer makes a purchase and it is called “sales tax.” But “use tax” and “sales tax” are two sides of the same coin.

Hypothetically, if a store failed to charge you sales tax, you would need to remit “use tax” to the state. Since it would be almost impossible for states to enforce this against all of the state residents, they place the burden of collection on the seller. And in fact, if the buyer does not pay the sales tax, the state can collect it from the seller. Thus, sales tax audits of businesses are common while use tax audits of individuals are extremely rare. (Use tax audits of businesses are common too. States conducting a sales tax audit of a business will also check to see that the business paid use tax on items purchased out of state but used in-state.)

Second, not every seller needs to collect sales tax. Under recently, only a person (or company) who has sufficient physical presence or “nexus” must collect sales tax for sales made in that state. Nexus can be created by having an office or employees in the state, making deliveries in your own vehicle, or even having inventory in the state.

Based on the above, a physical store selling hardware located in New Jersey collects sales tax at the cash register. The store has nexus in NJ and is making sales, presumably to NJ residents. (If the customer is not from NJ he may be able to apply for a refund.) The store sets aside all of the sales tax collected and files a sales tax return each month and remits the sales tax to the state.

On the other hand, many e-commerce sellers do not have offices or employees in any of the 45 states that have a sales tax. This means that they do not have to charge sales tax which is why shoppers love to shop online- no sales tax and a very low risk of a use tax audit. But this is putting tremendous pressure on brick and mortar stores that must charge sales tax as well as massively reducing states’ revenues. For this reason, a number of states have recently passed laws requiring sellers to charge sales tax even if they have no physical nexus in the state but have “economic nexus” created by merely selling to in-state residents. In fact, the Supreme Court just ruled that these laws are constitutional.

The common practice of e-commerce sellers not charging sales tax where they do not have offices or employees may not be correct under most state laws if they are using third party fulfillment. Most of the states that have a sales tax say that if you have inventory located in the state then that is enough physical presence to create nexus and an obligation to collect sales tax. Thus, e-commerce sellers using third-party warehouses like Fulfillment by Amazon (FBA) really should be registered with the states where their inventory is stored by Amazon (how to find that out is a separate subject). This is true regardless of the residency or citizenship of the seller. Thus even non-US sellers using FBA are expected by the states to register for and collect sales tax. Under the new laws that states are passing, even without in-state inventory, all sellers must collect sales tax if they have sales about a certain threshold (e.g. $100K or 200 sales per year to residents of South Dakota).

Many foreign e-commerce sellers who know about this sales tax obligation choose to ignore it. They reason that the states cannot reach them and would likely try to audit domestic sellers first. While the latter justification may be true, the first is not. The states may be able to levy against any US assets and may even be able to persuade Amazon to be the bad guy and freeze a seller’s account (as most sellers can attest, Amazon has been known to freeze accounts for less.) Furthermore, if an e-commerce seller wants to sell his business, a large unpaid sales tax exposure in multiple states can be grounds for a potential buyer to steeply discount his offer price. For many e-commerce sellers it makes more sense to collect the sales tax now when it is paid by the buyer than to wait until later and have to pay any uncollected sales tax out of their own pocket.

On the bright side, while sales tax compliance for companies operating in multiple states has traditionally been difficult and required manually filing in each state, there are currently a number of software products available for e-commerce sellers to automate their sales tax collection and filing.

At Saltwater Consulting LLC, we can help you determine when and where to register for sales tax. We can also help you configure your e-commerce seller account and third-party software to collect the appropriate sales tax and automatically file the reports and remit the sales tax to the states. To learn more, please contact us at office+wb@salt-wtr.com.