This post is by Mark Faggiano, founder and CEO of TaxJar.
When you first started selling online, the chances are that you got into it for the thrill of selling your products, or seeing your brand take off and gaining national attention.
When you are working hard to build your business, it’s easy to overlook the nagging administrative details you’ll face. And one of the most vexing of those is sales tax.
This in-depth guide walks online sellers through the basics of sales tax. It will help you determine where and when you’re liable for sales tax, how much you have to pay, and detail some common scenarios and problems.
- The basics of sales tax in the United States
- When do you become liable to sales tax?
- How to collect sales tax
- What to do with the sales tax you’ve collected
- Common sales tax problems for online sellers
- What international sellers need to know
- Summing up
The basics of sales tax in the United States
Forty-five states in the United States, and the District of Columbia, levy a sales tax. Merchants who have “sales tax nexus” in these states are required to charge sales tax to buyers.
Sales tax is considered a “pass-through” tax, because the merchant is only holding the taxes collected before remitting it to state and local taxing authorities at a set time (usually either monthly, quarterly or annually, depending on gross sales).
Sales tax funds are used to fund state projects and initiatives, including schools, roads, public safety departments, etc. Many states get a majority of their revenue from sales tax, which is one reason they’ve been taking a closer look at ecommerce sellers.
In the U.S., there is no “federal” sales tax. Instead, individual states administer sales tax. Because of this, all 45 states (and don’t forget D.C.!) that levy a sales tax have different rates, rules and laws. Sales tax rates can vary by county and locality, too.
One example of how online sales tax rules vary is that some states require you to charge sales tax on shipping charges, while others do not. Another example: some states might require you to renew your sales tax permit periodically, while others do not.
While this comprehensive guide will walk you through many common scenarios, always remember that you should contact a sales tax accounting professional about your specific company and situation.
Your state’s taxing authority (generally called the state’s “department of revenue”) can also answer general sales tax questions.
When do you become liable to sales tax?
We already covered the “why” of collecting sales tax: it’s the law and states require it. But who collects sales tax? The online seller or the marketplace? From where do you collect sales tax? When do you have to collect and remit sales tax? And what amounts do you have to collect? Let’s dig in.
Sales tax nexus
You are required to collect sales tax in states where you have sales tax nexus. Sales tax nexus is just a fancy, legalese way of saying “significant presence” in a state.
While every state is slightly different, most states maintain that a merchant has sales tax nexus if they meet the following criteria:
- Have an office in the state (including a home office).
- Have a contractor or salesperson in the state.
- Store inventory, have a warehouse or distribute your products from a warehouse in the state.
- Do business in the state such as at a craft fair or tradeshow.
- Have an affiliate in the state.
- Drop ship from a third-party provider in the state.
- Have economic nexus in a state. Most states have “economic nexus” laws that apply to online sellers even if they have no other connection to the state.
Like we mentioned above, states generate a good deal of their revenue from sales tax. So it’s in their best interest to collect as much sales tax as possible. For this reason, most states interpret sales tax laws as broadly as possible.
How does nexus work in practice?
Here are three common sales tax nexus examples:
- You live and run your ecommerce business in Texas. Because you have a physical presence in Texas, you have “sales tax nexus” there, and therefore are required to collect sales tax from buyers in the state of Texas.
- You live and run your ecommerce business in the state of Florida, but you hire a salesperson in Georgia to help you. Because you operate out of Florida and have an employee in Georgia, you now have sales tax nexus in Florida and Georgia and must collect sales tax from buyers in both states.
- Most states have ruled – either definitively or vaguely – that third-party fulfillment constitutes nexus. This means that if you store your goods in a warehouse in a state, then that constitutes sales tax nexus. So if you live in Wisconsin, but store your goods in California for the purposes of faster shipping, then you have sales tax nexus in both Wisconsin and California.
There is some good news for Amazon and other online marketplace sellers. Most states with an Amazon fulfillment center have passed “marketplace facilitator laws”. These laws require that marketplaces who handle sales on a third-party online seller’s behalf collect and remit sales tax on that seller’s behalf, too. More on that below.
Sales tax nexus checklist
Here are some questions to ask yourself if you think you might have sales tax nexus in a state:
- Do I live in this state and operate my business from home? _____
- Do I operate my business in this state? ______
- Do I have an employee in this state? _____
- Do I have an affiliate in this state? _____
- Do I have a sales representative, independent contractor or other agent for my company in this state? _____
- Do I store my products in this state? _____
- Are my products distributed from a distribution center in this state? _____
- Did I sell at a craft fair, exhibition or trade show in this state? _____
- Do I work with a drop shipper located in this state? _____
If you have questions about whether or not you have sales tax nexus in a state, contact a reputable ecommerce accounting professional or your state’s department of revenue for clarification.
A majority of states have now passed “economic nexus laws.” These laws allow states to require out-of-state sellers who make over a certain dollar amount of sales in the state, or a certain number of sales transactions, to collect sales tax.
For example, if you make over $100,000 in gross sales and more than 200 separate transactions in the state of Connecticut in the previous calendar year, you are then required to collect sales tax from Connecticut buyers. That is even if you have no other sales tax nexus in the state.
Here’s a state-by-state economic nexus summary.
Marketplace facilitator laws
Many states realized that it was easier to collect sales tax from one giant marketplace (like Amazon or eBay) than to collect it from individual online sellers who trade on those platforms.
As of February 2020, all but six states with a sales tax have enacted their own marketplace facilitator laws that require online marketplaces to collect sales tax on sellers’ behalf. However, this is not as simple as simply cancelling your sales tax permits and going on your way.
Every state is different, so always check with the state’s department of revenue before you stop collecting and remitting sales tax in a state where you have nexus. Some states still require marketplace sellers to file sales tax returns, even if the marketplace remits the actual sales tax.
It’s also important to keep in mind that these laws only apply to marketplace sales. If you have sales tax nexus in a state, but you also make non-marketplace sales (such as via you own online store, in a brick and mortar store, or at trade shows, craft fairs, etc.) then you are still required to collect sales tax on those non-marketplace sales.
How to collect sales tax
So you have sales tax nexus in a state. Now what?
Long story short, you’re required to collect sales tax from buyers in that state. But, as with everything sales tax, how much you collect is not that simple.
Your first order of business is to get legal with the state, and register.
Registering for a sales tax permit
To lawfully collect sales tax, you need to register for a sales tax permit in the state(s) where you have nexus. (This is sometimes called a sales tax license.)
States require any merchants who have sales tax nexus in a state to register for a sales tax permit. You’ll find registration instructions at your state’s department of revenue. These permits are usually either free or fairly cheap to obtain.
When you receive your sales tax permit, your state will also give you instructions on when and how to file your sales tax returns.
States consider it unlawful to collect sales tax in their name without a permit, so don’t skip this step.
A note on taxable items: some items aren’t subject to sales tax in certain states. For example, most clothing is tax exempt in Minnesota, while grocery items are tax-exempt in Arizona. Always check with a state’s department of revenue if you suspect you are selling tax-exempt items. In general, states get very strict about the definition of a tax-exempt product.
Determining how much to collect
Your next step is to determine how much sales tax to collect. Once again, this is easier said than done, especially for online sellers.
States set a sales tax rate, and then localities can add a percentage on top of those rates. For example, in the 90210 zip code, the tax rate is the 6% California state-wide rate, a .25% Los Angeles County rate, and an additional 3.25% local rate, for a total of a 9.5% sales tax rate.
If you run a Beverly Hills boutique, then your sales tax compliance is easy enough. You’d charge 9.5% sales tax to a buyer. For example, if someone bought a $200 pair of sunglasses in your boutique, you’d charge them $219. That’s $200 for the sunglasses and $19 in sales tax at the 9.5% rate.
But this can get tricky for online sellers, especially sellers with sales tax nexus in multiple states.
This is because the rules are different for sellers selling to buyers within their own state (where their business is based) vs. sellers selling to buyers in other states where they have sales tax nexus.
But first, a little background.
Origin-based vs destination-based sales tax states
When it comes to determining tax rates, most states fall into one of two major buckets: “origin-based” sales tax states and “destination-based” sales tax states.
In layperson’s terms, this means that some states require in-state sellers to collect sales tax at the rate effective at the point of “origin” (i.e. your office or place of business) while most states require in-state sellers to collect sales tax at the rate of the “destination” (your buyer’s address).
Here’s a map of origin-based and destination-based states in the U.S.
Now that you’ve wrapped your mind around that, let us caution you that this map only applies to sellers selling within their own home state.
To make matters more complicated, most states are destination-based when it comes to out-of-state sellers.
What does this mean? Let’s look at two examples:
- You live in Texas (an origin-based state) and sell to a buyer in Texas – Let’s say you live in (or have a warehouse or office in) Archer City, Texas, but sell to someone in Irving. Texas is an origin-based sales tax state, so you would charge any buyer in the state of Texas a rate of 6.75%. (That’s Texas’s state-wide 6.25% rate plus Archer County’s .5% rate.) You do not need to take your buyer’s address in Irving into account.
- You are based in Georgia but sell to a buyer in Tennessee (an origin-based state) – This scenario assumes you have sales tax nexus in Tennessee (perhaps you store goods with a 3PL there.) This is where things start to get complicated for out-of-state sellers. Even though Tennessee is considered an origin-based state, you, as a seller based in Georgia, would charge your buyer the sales tax rate at her “ship to” address in Tennessee. For example, say you are based in Albany, Georgia and your buyer lives in Maryville, TN. You would charge her the 9.75% Maryville tax rate.
Note: When we talk about out-of-state sellers, we mean sellers who do have some sort of sales tax nexus in a state but who don’t have their main place of business in that state.
Of course there are exceptions to any rule when it comes to sales tax. We recommend checking out each state’s unique sales tax rules when it comes to collecting sales tax.
We hope this explanation didn’t send you screaming for the hills. Sales tax is complicated. Luckily, most online platforms will assist you in collecting the right amount of sales tax. However, it’s always up to you – not the channel(s) you sell through – to determine if you are collecting the correct amount of sales tax from your buyers. We’ll say again that it’s generally a good idea to contact a good accounting professional if you have any questions about your specific business situation.
What to do with the sales tax you’ve collected
By now you’ve secured your sales tax permit and figured out how much sales tax to collect. Your next step will be remitting the sales tax you’ve collected to the state or states where you have sales tax nexus.
Make a note of the sales tax due dates your state’s department of revenue provides when you register for a sales tax permit. You might find that one state wants you to file a sales tax return every month while another only wants to hear from you every quarter.
Reporting how much sales tax you’ve collected
Before you can file, you must figure out how much sales tax you’ve collected.
Once again, this isn’t as straightforward as it sounds, even if you run a fairly simple ecommerce business.
To report how much sales tax you collected you need to:
- Figure out how much sales tax you collected through every channel you sell on.
- Figure out how much sales tax you collected in each state where you have sales tax nexus.
- In most states, breakdown how much sales tax you collected by county, city or other taxing jurisdiction.
These steps can get really complicated and involve spreadsheets and tax tables. Or there are solutions like TaxJar that take care of it all for you.
How to file your sales tax return
When it comes time to file, you have three options: you can file on paper (antiquated and slow), file online, or use an automated filing service.
Since nobody wants to deal with paper any more, these last two versions are preferred by states. All states allow you to file online, and some states even require online filing for certain sellers.
No matter how you choose to file, be sure to pay on time. Penalties for late payment or failure to file can get steep. Nobody wants to pay a $50 penalty on a $2 sales tax bill.
Some states require that you file a “zero return,” even if you didn’t collect any sales tax over the filing period. Some states will fine you for failing to file, even if you didn’t actually owe any sales tax. If you fail to file often enough, states may either take a closer look at your account to make sure you’re in compliance, or assume that you’ve closed up shop and revoke your sales tax license.
Common sales tax problems for online sellers
By now you’ve probably recognized several ways in which sales tax can become very confusing for online sellers. These are a couple of the common problems we see sellers face:
- You’re not sure where you have sales tax nexus – This is one of the big ones. If you have sales tax nexus in a state, but aren’t collecting sales tax, then that state has the right to audit you and collect back taxes plus penalties. This gets especially tricky when it comes to economic nexus.
- You’re not sure when to register for a sales tax permit – Sometimes you’re not certain that you do enough business in a state to register for a sales tax permit. OR perhaps you think you’ve registered too late. Contact an accounting professional for advice about your specific situation.
What international sellers need to know
Even though you may live outside the United States, if you sell on FBA or have established any other type of sales tax nexus in the United States (such as an office, a satellite branch of your business, or a warehouse where you store inventory), then you must comply by the sales tax laws of the state where you have nexus.
One common misconception about U.S. sales tax is that if you live in a country with a tax treaty with the U.S., then you – as an ecommerce seller – do not have to charge sales tax to U.S. customers.
Sales tax is complicated. But when you’re armed with the basics, it does get simpler. And now that you’ve taken the time to digest all that, go relax, eat a pizza or play a round of golf. You’ve got this.
Mark Faggiano is the founder and CEO of TaxJar, a service built to make post-transaction sales tax compliance easier for Etsy, Amazon, Shopify and other multi-channel ecommerce sellers. Mark’s passion is solving complex problems for small businesses.
This article was originally published in March 2015, and last updated in March 2020.