If you run an e-commerce business, you know the risks and rewards associated with this format. You don’t need to worry about a storefront, leasing space, staffing your store, and providing face-to-face customer service. You can work on your business outside normal business hours, and your customers will not know the difference. You can be the proverbial “work in your pajamas” business owner. However, as much as e-commerce appears to be more streamlined than the traditional retail format, it comes with its own set of challenges and considerations. One of these “behind the scenes” details is the Internet sales tax. As a 3PL partner to many e-commerce businesses, we get asked about Internet sales tax a lot. Although it is always best to consult with your accountant and/or attorney when it comes to taxes, let’s review the Internet sales tax basics.
What is Internet Sales Tax?
Internet sales tax, also known as e-commerce sales tax, is related to selling an online product or service from an internet retailer or e-commerce brand. With the growth of e-commerce and online sales, states sought ways to capture tax revenue from remote sellers who were making sales to their residents but did not have a physical presence within their borders. Every remote retailer of a state that sells interstate goods now needs to remit sales tax to the government of the destination state. This means that consumers, who earlier were only billed by physical storefronts, now also need to pay online tax amounts. In 2018, the U.S. Supreme Court ruled that states could impose such obligations on sellers lacking physical presence in the state. Now, ecommerce businesses need to collect and file taxes in states they ship to, not just the ones where they are based.
So, what does the sales tax mean for you as a seller? Sales taxes are collected on a state level; there is no federal sales tax in the US. If your business is based in Florida, but you ship an order of iPhone cases to a customer in Minnesota, do you need to collect sales tax on the order and file it in Minnesota? The answer can get complicated. It all comes down to the nexus.
What is Physical Presence Nexus?
Physical presence nexus nexus refers to a situation where a business or individual has a genuine connection to a specific state, making them subject to that state’s tax laws. In essence, if there’s a real and substantial presence in a state, the tax obligations kick in. Physical presence nexus can include a variety of factors, including employees located in the state or owning or renting property (including inventory) in that state. It might also include holding inventory there, participating in trade shows, or using delivery vehicles for in-state shipments.
If a business falls under the physical presence nexus, they’re required to adhere to the tax regulations of that state, such as sales tax and income tax. It’s the more traditional way states have of taxing businesses operating within their borders. But, in today’s world of online businesses and e-commerce, there are also economic nexus rules that don’t necessarily rely on a physical presence but are based on sales or transaction thresholds.
What is Economic Nexus?
Economic nexus kicks in when you don’t have a physical presence in a state, but your sales cross a certain threshold. This means you’ll have to file taxes in that state. So, even without a brick-and-mortar store, if you make enough sales there, you’ll need to collect and remit sales tax.
This rule mostly affects remote sellers, those who sell goods in a state without having a physical location there. If your sales meet or exceed the state’s economic nexus threshold, you’re in the game. But here’s where it gets interesting: even if you escape economic nexus, you could still be on the hook for state income tax if you’ve got a physical presence in that state.
Internet Sales Tax Exemptions for e-Commerce
Each state has its own economic nexus thresholds and rules. To help reduce the burden of remote sales tax compliance, states provide an exception for businesses selling under a certain threshold. This may mean that if that iPhone case buyer was your only sale to Minnesota last year, you may be exempt from Minnesota sales tax. However, economic nexus thresholds vary by state. For example:
● California’s threshold is $500,000 in total combined sales of tangible personal property delivered into the state in the current or previous calendar year, including nontaxable sales.
● Florida’s threshold is $100,000 in taxable sales of tangible personal property in the current or previous calendar year.
● The threshold in Illinois is $100,000 in cumulative gross receipts from sales or 200 separate transactions in the current or previous calendar year.
These thresholds are not only different from state to state; they also tend to change every year.
Amazon FBA and Internet Sales Tax
If you use Amazon’s FBA service as part of your ecommerce business, this adds another layer of variables to your potential sales tax liability in various states. Sellers across the United States, particularly online retailers, send their inventory to Amazon fulfillment centers to take advantage of the extraordinary reach and efficiency their operations permit.
But did you know that owning inventory stored in Amazon’s warehouses can create a nexus issue? When a company opts for FBA, it ships its inventory to one or more Amazon warehouse locations. However, Amazon might transfer the inventory to different fulfillment centers.
By using Amazon FBA, your business could establish a “connection” or nexus with any state where an FBA fulfillment center houses your inventory. Each state has its own standards and thresholds for nexus, which could potentially subject your business to taxation.
So, with FBA, you need to be mindful of where your inventory is stored, as it could create tax obligations in multiple states based on their respective nexus criteria. Understanding these rules is crucial to avoid any unexpected tax liabilities for your business.
How To Stay Ahead of Internet Sales Tax
Remember that Internet sales tax laws can vary significantly between states, and non-compliance can result in penalties and fines. As an e-commerce business owner, you need to be proactive in understanding your sales tax obligations and taking appropriate measures to comply with the regulations in each jurisdiction where you conduct business.
Here are some steps you can take to to avoid nasty Internet sales tax surprises:
- Understand Nexus Rules: Learn about economic and physical nexus rules in each state. Know the thresholds and requirements for each state to determine if you need to collect sales tax.
- Monitor Nexus Thresholds: Keep track of your sales in each state. If your sales volume approaches the economic nexus threshold in a state, be prepared to collect and remit sales tax to that state.
- Use Automated Sales Tax Software: Consider using automated sales tax software or services that can help calculate and collect the appropriate sales tax based on the customer’s location. These tools can streamline the tax compliance process and reduce errors.
- Stay Updated on Legislation: Keep yourself updated on changes in sales tax legislation at the federal and state levels. Sales tax laws can change rapidly, and staying informed will help you avoid compliance issues.
- Register with State Tax Authorities: If you determine that you have nexus in a state, register with the state’s tax authorities to obtain the necessary permits and collect sales tax legally.
- Collect Exemption Certificates: For business-to-business (B2B) transactions, collect valid exemption certificates from customers who are exempt from paying sales tax.
- Keep Accurate Records: Maintain detailed records of your sales transactions, tax collections, and tax remittances. These records will be key for audit purposes and to demonstrate compliance.
- Seek Professional Advice: Consult with a tax advisor or legal expert with expertise in e-commerce and sales tax regulations. They can provide tailored advice based on your specific business model and sales operations.
If you are looking to streamline the logistics of your e-commerce business, contact ShipWizard today to discuss how we can help.