E-Commerce Creates Confusing Sales Tax Obligations
E-commerce businesses rely heavily on remote sales to reach customers but must navigate complex state and local tax obligations. Following the 2018 Supreme Court decision in South Dakota v. Wayfair, all states with a statewide sales tax require remote sellers to collect and remit sales tax once they surpass a certain economic nexus threshold. Failure to comply with these requirements can lead to significant penalties, and the rules vary greatly depending on where and what a business sells.
The Wayfair Case and Economic Nexus
In the landmark case of South Dakota v. Wayfair, the U.S. Supreme Court ruled that physical presence in a state is no longer required for a business to establish “nexus” (a connection triggering sales tax obligations). This ruling overturned the previous Quill v. North Dakota decision, which had maintained that a business must have a physical presence in a state to be required to collect sales tax. The Wayfair ruling acknowledged the growth of e-commerce and the substantial virtual connections businesses can have with states, making it unfair for businesses with significant sales in a state to avoid sales tax obligations just because they don’t have a physical presence there.
As a result of the decision, states quickly implemented their thresholds for when remote sellers must collect and remit sales tax. Typically, these thresholds are based on a dollar amount (e.g., $100,000 in sales) or the number of transactions (e.g., 200 transactions annually). For example, states like New York and California have higher thresholds, such as $500,000 in sales, with additional requirements for the number of transactions. E-commerce businesses must be aware of the varying thresholds across states, as failing to comply can lead to severe consequences.
Defining Nexus and its Implications
“Nexus” refers to a business’s economic presence in a state to trigger tax obligations. This presence can be physical—such as having employees, offices, or inventory in a state—or economic through remote sales. States generally set their thresholds for economic nexus based on gross sales, but some exclude certain sales, like those made through online marketplace platforms (e.g., Amazon or Etsy). Marketplace facilitators like Amazon are responsible for collecting and remitting sales tax on behalf of sellers, but this creates additional complexity, as sellers must account for sales through their websites and marketplaces.
Some states, like Alaska and Delaware, do not impose a statewide sales tax, but local jurisdictions within these states may still have nexus rules. Therefore, sellers must understand local tax obligations even in these “no sales tax” states.
Sales Tax Complexity and Exemptions
The complexity of sales tax obligations increases because different states tax different types of tangible personal property (TPP) and services in varied ways. For instance, many states exempt food from sales tax, but prepared food (like take-out meals) might be taxed. Additionally, digital products and services such as Software as a Service (SaaS) face varying rules, with some states taxing them and others exempting them. E-commerce businesses must carefully navigate these rules to ensure compliance.
Exemptions can also complicate matters. For example, sales to resellers or specific tax-exempt organizations (like non-profits) are often exempt from sales tax, but sellers must retain valid exemption certificates from these buyers. The failure to do so could result in the seller being held liable for unpaid taxes.
Collecting, Filing, and Remitting Sales Tax
Once an e-commerce business determines it has nexus in a state, the next step is registering with that state’s Department of Revenue. This process can vary from state to state, with some states requiring periodic renewals and others having low-cost or free registration. Sellers must file periodic sales tax returns, monthly, quarterly, or annually, and remit the collected taxes.
Even if no tax is due, businesses must file returns on time to avoid penalties. Additionally, if a business fails to collect and remit the appropriate sales tax, it could face significant legal consequences, including personal liability for its owners, even in the case of a limited liability corporation (LLC).
Addressing Past Tax Liabilities
In cases where a business discovers it has failed to meet its sales tax obligations in the past, it can potentially use a voluntary disclosure agreement (VDA) to mitigate penalties. Through a VDA, a business can admit to unfulfilled tax obligations without facing harsh consequences, with many states offering reduced look-back periods and forgiving taxes owed beyond that period.
Real-World Example
Consider XYZ Company, which sells widgets online and has a physical nexus in Alabama. It also sells through Amazon, which has led to growing sales in other states. Upon reviewing its sales data, XYZ discovers it has surpassed the nexus thresholds in states like South Dakota, Nebraska, and Colorado, requiring registration and sales tax collection. XYZ has not yet reached the threshold in states like California but is close, so it must monitor its sales there closely. By registering in the relevant states, XYZ remains compliant and avoids future penalties.
Conclusion
E-commerce businesses face an ever-evolving landscape of sales tax regulations, with economic nexus thresholds and state-specific rules that are constantly changing. To avoid penalties, businesses must actively monitor their sales and comply with tax obligations in each state where they have nexus. This requires an understanding of sales tax rates and exemptions and how different types of products and services are taxed in each jurisdiction. Failure to comply can lead to significant financial and legal consequences, making diligent record-keeping and timely tax filings essential for ongoing business success.
