The sales tax system in the United States was created at a time when the idea of an e-commerce business was not fathomable. The developers of the system had no idea that e-commerce would come to dominate the retail environment and, as such, they did not consider the implications of online spending on sales tax. The e-commerce market is currently thriving, with global sales expected to increase nearly 14% this year. Because of the dramatic shift away from brick-and-mortar stores, legislators realized that the sales tax landscape needed to be modernized and revamped and these changes have led to significant ramifications for online sellers. These efforts have picked up speed in the last few years, thanks to a landmark Supreme Court case.
South Dakota v. Wayfair, Inc. and its Implications for E-Commerce Businesses
Three years ago, the US Supreme Court ruled in favor of South Dakota in the case South Dakota v. Wayfair, Inc. This case has significant ramifications, not just for South Dakota, but for all states and jurisdictions. The ruling concluded, quite significantly, that online sellers who meet certain criteria are now required to collect sales tax and remit this tax to states. Having a physical presence in a state is no longer the only requirement for establishing sales tax nexus that requires the seller to collect and remit sales tax. “It is imperative that online business owners be familiar with South Dakota v. Wayfair and assess their situation often to determine their sales tax obligations”, said Sarah Shannonhouse, CPA, Manager of Tax Practice & Ethics at the Association of International Certified Professional Accountants.
As noted earlier, the shift in spending behavior from physical to online stores caused states to miss out on an important revenue stream from sales tax pre-South Dakota v. Wayfair, Inc. This is described in the syllabus for the case, “Concerned about the erosion of its sales tax base and corresponding loss of critical funding for state and local services, the South Dakota Legislature enacted a law requiring out-of-state sellers to collect and remit sales tax ‘as if the seller had a physical presence in the State.’ The Act covers only sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State.” Sellers operating online businesses may be required to collect and remit sales tax in states where they conduct significant business.
Following the South Dakota v. Wayfair, Inc. ruling, nearly all states have adopted economic nexus laws that take effect in certain circumstances even if you do not have a physical presence in the state. Antonio Di Benedetto, J.D., LL.M. explains in the Journal of Accountancy that, “With the change from physical presence to economic nexus, states have become more aggressive in identifying and requiring entities to comply with sales tax collection and filing rules.” When thinking about nexus (defined as the connection between a seller and a state that requires the seller to collect and remit sales tax in the state), it is helpful to ask yourself, “Does my business have a significant connection to the state?” If so, this means that you will likely need to collect sales tax from your customers in that state and remit the tax to the state. In addition to your home state, you may have nexus in other states as well.
What Constitutes a Significant Connection?
In the case of South Dakota v. Wayfair, Inc., economic nexus was defined as more than $100,000 of goods or services sent to the state or 200 or more separate delivery transactions to the state. Keep in mind that each state has its own threshold for when sales tax needs to be collected by online sellers so you will want to review your sales in each state to determine if you meet the threshold and then develop plans for collecting and remitting the tax, as required.
In addition to economic nexus, there are other ways that your business could have sales tax nexus in a given state. These include having personnel (any person doing work for your business), a physical location of any kind, inventory, an affiliate or a drop-shipping facility located in the state. BigCommerce explains, “It helps to think of it from the state’s perspective. From their point of view, any online seller who uses resources in their state (roads for delivery, public safety should an emergency occur, etc.) has nexus.”
There are five states that do not collect sales tax: Delaware, New Hampshire, Oregon, Alaska and Montana, so if you conduct business in these states, you do not need to worry about collecting sales tax for these transactions. Missouri currently does not have an economic nexus sales tax law, however that is set to change in 2023. At that time, online sellers with nexus in Missouri would be required to collect and remit sales tax if they exceed the threshold set by the state.
For each state, the sales tax you charge is impacted by tax sourcing— whether the state is origin-based or destination-based. The vast majority of states are destination-based, meaning that sales tax is charged based on the address of the customer, not the address of your business and/or your facilities. If you live in a destination-based state and you sell online to a customer in another state where you do not have nexus, because you do not have a physical connection or it is an economic nexus state but you do not meet the sales threshold in number and/or quantity, then no sales tax is applied to the sale. There are 12 states that are origin-based states, meaning that the sales tax you charge is based on your location’s nexus. Those states are: Arizona, California (modified origin state), Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Tennessee, Texas, Utah and Virginia. It is important to look into the tax sourcing as it relates to sales tax to ensure that you are charging sales tax appropriately in the states where your business has nexus.
Your Responsibility as an E-Commerce Seller When It Comes to Collecting Sales Tax
As an online seller, it is important for you to be familiar with South Dakota v. Wayfair, Inc. and understand how this ruling impacts your business. Depending on where you sell your products online, you may or may not be responsible for collecting and remitting sales tax. If you sell products exclusively on a marketplace that is required to collect and remit sales tax on behalf of its sellers (Amazon, Walmart, Etsy and eBay), you do not need to have a sales tax permit and you do not have to report, collect and remit sales tax, since the marketplace has an obligation to do so. If you conduct in-person sales and/or sell on a website that is not Amazon, Walmart, Etsy or eBay and you have nexus in the state, you are required to have a sales tax permit and file state tax returns in states where your business has nexus. Regardless of whether you sell solely on a marketplace or not, it’s recommended that you review your situation with a tax accountant and/or local tax authority to make sure you are collecting the appropriate sales tax and remitting the tax correctly.
At the time of this writing, all states that collect sales tax have Marketplace Facilitator Laws in place. All of these laws are effective except for Missouri’s, which will begin in 2023. Marketplace Facilitator Laws began popping up in 2017 when states realized that they were not collecting sales tax from marketplace transactions. This was a missed opportunity for the states in terms of collecting tax revenue, especially since marketplace sales are quite significant. They make up the majority of sales on Amazon. The states enacted laws requiring the four marketplaces to collect and remit sales tax rather than have sellers collect and remit the tax themselves. This streamlines processes and simplifies compliance. It would be nearly impossible for states to identify bad actors (online sellers not collecting and remitting the required sales tax) otherwise.
Your Next Steps as an E-Commerce Seller
Before collecting sales tax in the state(s) where you have nexus, it is important to determine the taxability of the products you sell. In most cases, tangible goods are taxable while services are not. There may be differences in certain states, so it is always wise to do your research.
If you are required to collect and remit sales tax (meaning you sell on a platform or website aside from Amazon, Walmart, Etsy and eBay), you will want to first register for a sales tax permit in the state(s) where your business has nexus, charge sales tax to your customers in that state(s) and lastly, file state sales tax returns in that state(s). It is critical that you register for a sales permit before starting to collect sales tax, as it is illegal to collect and remit sales taxes otherwise.
Keep in mind that Shopify is not considered a marketplace facilitator and therefore the platform does not have an obligation to collect and remit sales tax. If you sell products on Shopify, you will be responsible for collecting and remitting sales tax in states where your business has nexus. In the next section of this article, we will walk through the steps to set up sales tax collection on the Shopify platform.
Setting Up Sales Tax Collection on Shopify
As mentioned earlier, Shopify is not required to collect and remit sales tax under Marketplace Facilitator Laws set by states. As a result, online sellers using the Shopify platform are required to collect and remit sales tax on their own. But don’t fret, by following the steps below, you will be well on your way to collecting the required tax from customers. This is good news because you won’t have to deduct the tax from your profits, as Shopify can help you collect the tax from customers when they purchase your product.
Step #1: Tell Shopify Which States to Collect Sales Tax From
Once you have determined the states you need to collect sales tax from, you will need to enter this information into your Shopify account. To do so, go to settings > taxes. In the tax regions section, next to United States, click either edit or set up. Then add each state where you have nexus, click “collect sales tax” and enter your sales tax license information.
Step #2: Include Shipping Rates in Tax Calculation, Where Necessary
In some cases, states require that the sales tax calculation include shipping fees. By going to settings > taxes > tax calculations, you can select “charge tax on shipping rates”. For states that do not require that delivery charges be taxed, you can add a tax override by going to settings > taxes. In the tax regions section, click edit. In the tax overrides section, add a shipping override.
Step #3: Make Sure All Taxable Products are Collecting Sales Tax
As mentioned earlier, you will need to determine if the products you sell are taxable in the state(s) where you have nexus. Once you determine this, you will need to go into your Shopify account and in the products section, click on the box that says “charge tax on this variant” for the taxable items. Note that gift cards are not taxable, so you do not need to charge tax on gift card sales.
Step #4: Note the Locations Where You Stock Inventory and Fulfill Orders
Where your products are stored and shipped from is important information to have when calculating sales tax, especially in origin-based states. To add this information to your Shopify account, click settings > locations.
Once you’ve registered for a sales tax permit and added the necessary information to your Shopify account, you will be one step closer to appropriately collecting sales tax.
Remitting Sales Tax
Once you’ve collected sales tax, the next step is remitting the sales tax to the states where you have nexus. The details of this process and the frequency required differ state-to-state, so you will want to check the state sales tax laws where you have nexus to understand what is required and plan accordingly. Some states may require you to submit a sales tax return even if you did not collect sales tax during the filing period, so it is important to look into the specifics required by each state where you have nexus.