Disclaimer: Please note this article is not financial advice. The purpose of our blog is purely educational, so please consult a professional accountant or financial advisor before making any financial decision.
It's 2023, and you're ready to set foot in the e-commerce world. It's a huge, significant step considering how most shoppers these days rely heavily on technology. While sitting prettily on the couch, people love ordering almost anything online—food, clothes, electronics, and even furniture.
Moreover, it's become the most feasible shopping option because of the pandemic. Consumers now use it to meet their basic needs and wants while staying safe in the comforts of their homes.
Meanwhile, for sellers, it's an opportunity to expand the customer base on an international scale. With e-commerce, distance won't hinder a business from selling to another state or country. That's an incredible advantage of technology, but there are also new challenges to take.
More specifically, there are new, complicated regulations to comply with and ensure that every package is delivered seamlessly.
On top of these complexities, we need to address one more challenging factor: the e-commerce sales tax. At first, you might not consider it a concern. You might ask yourself: "Do remote businesses need to pay sales tax?" Yes.
Tax collection and remittance are now part of the requirements in e-commerce. Does this overwhelm you? Don't worry. Everyone knows the struggle here, and no one expects you to digest everything in a day or two. You still need to familiarize yourself with the system and plan what to do next.
This article breaks down the fundamentals of online sales tax in the USA. Know the basics and read some valuable tips on how to manage tax compliance.
We will be covering the following points:
Part 1: UNDERSTANDING E-COMMERCE AND THE SALES TAX SYSTEM
- How E-Commerce and Sales Tax Started
- How Remote Sellers Are Affected by Sales Tax Policies
- The Basics of Sales Tax for E-Commerce
Part 2: E-COMMERCE TAX MANAGEMENT GUIDE
- Step-by-Step Guide to Sales Tax Compliance
- Technology and Online Sales Tax Management
- Hiring a Bookkeeping/Accounting Team
E-Commerce and Sales Tax: How Did It Start?
If your business has a physical storefront, office, or warehouse in a certain state, you must pay and remit sales tax. That's the golden rule until the South Dakota v. Wayfair, Inc. happened in 2018, which states that online businesses must collect sales tax regardless of physical presence.
In addition, states can redefine the "sales tax nexus" from a broader perspective so that e-commerce retailers become a part of the scope. Nexus or tax nexus refers to the linkage between a business and a state involving tax obligations.
How Does It Affect E-Commerce Businesses?
The development of e-commerce sales tax laws makes the system immensely complicated. One of the most challenging aspects of e-commerce tax is compliance with constantly changing state policies.
The Tax Law Varieties Are Overwhelming
E-commerce sales tax by state differs, and businesses have to learn and comply with all of that. It's not easy, and what more if you deal with international matters? Each country has a different tax law, and you need to consider that too.
You Need to Implement Drastic Changes
Because of the new tax policy, businesses are pushed to reassess their processing systems and implement operational changes as necessary. If they fail to apply them, the opportunities might stop coming, and the risk of financial trouble can increase.
The Basics of Sales Tax in E-Commerce
Now that you understand how crucial sales tax is in your e-commerce venture, it's time to learn the basic terms and processes. Keep reading so that you no longer get confused when you encounter technical terms in the future.
What is E-Commerce Sales Tax?
Sales tax is a minor percentage of an online retailer's sales. It is a consumer or consumption tax, which means that consumers pay sales tax only on taxable goods. In the U.S., 45 states and Washington D.C. implement e-commerce sales tax.
Moreover, there are combined sales taxes because counties, cities, and other local areas have "special taxing districts." Special taxing districts (also called limited purpose districts) provide special benefits to the residents of a certain local area.
How Does It Work?
The state where you sell and the point of destination are the main factors in charging sales tax. You'll charge customers the amount of sales tax required and remit it to the particular state.
However, sales tax collection only applies with a nexus (more on this subject in the next sections).
How Do You Calculate E-Commerce Sales Tax Rates?
Here's a quick guide on how to calculate sales tax for E-commerce.
- First, have these details ready: (1) the state-mandated product rate, (2) the cost of the item, and (3) other important local rates, if any.
- Multiply the item cost by the state tax rate. Ensure to convert percentage into decimals.
- If there are additional local rates, multiply the cost of the item with these extra rates. Then, add the amounts you get from this and the sales tax rate multiplication.
As you can see, you can calculate the total sales tax in just a few steps. To sum it up in a formula structure:
(Item Cost) * (State-mandated Sales Tax Rate) = Total Sales Tax
For example, you have a $30 item, and the state tax rate is 7.5%. In that case,
(30) * (0.75) = $22.5
What is a Tax Nexus?
Tax nexus is the connection between your business and a state or any other taxing authority. Naturally, you get a tax nexus in your home state, but some conditions may also prompt other sales tax nexuses in some states.
These conditions are as follows:
- Your business has a physical presence in a certain state (office, warehouse, storefront, and more)
- You have staff working on a particular state for business purposes (employee, salesperson, contractor, and more)
- You have stored inventory in a specific state
- You have affiliates working in particular states
- You work with third-party shipping companies
- You sell products through Fulfillment by Amazon
- You conduct temporary selling at an event
- You exceed the number of transactions required in a state (economic nexus)
- You run ad campaigns on an in-state website
- You use website cookies or software on in-state devices
- You sell on a marketplace with a facilitator that collects taxes on behalf of a state (marketplace nexus)
Once you confirm a sales tax nexus, then you must perform the following steps:
- Register with the state's tax department
- Collect and remit sales tax
- File a tax return
Which Products Are Taxable?
A rule of thumb in product taxability is that any tangible item is automatically taxable. Still, some states have exceptions, such as products without or with a reduced sales tax rate. Your customers will pay for these, so ensure that they're paying only as necessary.
E-Commerce Tax Management: Know Everything About Tax Compliance and E-Commerce Sales Tax Solutions
We hope the discussions above helped you understand the online sales tax system. We know that it is overwhelming and stressful, but that's a lot better than getting into a heap of financial trouble later.
Now that you're equipped with the basic knowledge, let's move on to tax compliance.
E-Commerce Tax Compliance: A Step-by-Step Guide
Tax compliance can be extremely confusing, and the smallest mistake can cause a huge financial mess. To prevent the mess (and stress) of your e-commerce taxes, we've provided a step-by-step procedure to serve as your to-do list.
Step 1: Perform a Thorough Q&A Session
Before proceeding to action, ask yourself some important questions first. This will help you understand where you stand, such as knowing where you have a sales tax nexus.
Here's a quick checklist:
- Which areas do you have a physical presence in?
- Which areas do you have personnel working concerning your business?
- Where do you store inventory?
- What is the mandated number of sales/transactions of each state you sell or have a physical presence in? Did you exceed the limits? Here's a quick table on U.S. states with the required number of sales/transactions.
- Which areas do you have drop shippers or third-party shipping companies in?
- Where do your affiliates advertise your business?
- Which areas hold certain events that you participate in as part of your marketing plan?
Once you have the answers, you'll know which states you have a nexus. We would also recommend you consult with each state you're involved with to confirm these details.
Step 2: Register With the Tax Authority for a Sales Tax Permit
Here's the first step to e-commerce tax compliance, the document which allows you to collect taxes legally. Contact your state's tax authority to obtain a sales tax permit. Then, you'll be asked to provide the following (not limited to) information:
- Employer Identification Number or Federal Employer Identification Number
- Contact information (business and personal)
- Social security number
- Your business entity
- North American Industry Classification System Code
How Much is the Sales Tax Permit Fee?
These permits range from $0 to $100, depending on the state.
Do These Permits Need Renewal?
It depends on the tax authority you're associated with. For example, some sales tax permits need renewal every one or two years. Meanwhile, others don't require renewal as long as your business is running.
What Else Can a Sales Tax Permit Do?
Some states consider seller's permits as "resale certificates." Generally, resale certificates are signed documents. Having one allows you to buy tax-free goods as long as you're reselling them.
Like sales tax regulations, policies for resale certificates also differ by state. For example, one state considers your sales tax permit as the resale certificate. Meanwhile, another requires you to have an independent reseller's permit number.
Step 3: Set E-Commerce Sales Tax Systems and Start Collecting
Ensure that your shopping carts, online checkouts, and other marketplace processing systems function properly. There are different bases for tax rates, so your platforms must charge the correct amounts.
Origin-Based vs Destination-Based Tax Rates
Each state makes its own sales tax rules, so different "sales tax sourcing" has emerged. Sales tax sourcing is the basis of charging sales tax. It has two categories, namely, origin-based and destination-based tax rates.
The origin-based rate refers to the business location. For example, you're an online seller from Columbus, Ohio, and made a sale in Dayton. Ohio is an originated-based state, so you must charge the customer sales tax based on the Columbus rate.
Meanwhile, the destination-based rate refers to the shipping address. Suppose you're selling online from Marietta, Georgia, which is a destination-based state. If you make a sale and ship on Covington, you should use the Covington sales tax rate to charge your customer.
Do E-Commerce Platforms Have Different Tax Collection Systems?
Yes. Generally, marketplaces significantly differ from each other, and so are their tax collection systems. For example, if you sell on Amazon, you will find a very detailed tax collection engine different from another e-commerce site.
Automation Is Key to Efficient Sales Tax Management
Manual digital marketing management puts you at great risk. You might not find any issues at first, but that's because you can still handle the numbers. However, as time passes, digits and sales tax laws can change. Hence, it will be difficult (and error-prone) to manage data manually.
An automated, cloud-based solution is the go-to of e-commerce tax compliance. It helps you keep on top of all deadlines and tax rate differences via real-time. By doing so, you can prevent discrepancies and financial trouble with the states and customers.
Step 4: File and Remit Sales Tax
Take note of the filing frequency the state provided when you were obtaining a seller's permit. It tells you how often and on which due dates your e-commerce sales tax filing will take place. You will usually file and remit taxes monthly, quarterly, or annually depending on your tax authority.
What Kind of Sales Tax Report Should You Submit?
Unfortunately, states aren't satisfied with just an overall amount of collected taxes. Instead, they would ask for the tax you collected per state, county, city, and other local areas with special taxes.
Before you get floored upon tax remittance day, ensure you're fully equipped with this information. As previously mentioned, automated technology can help you filter out these details.
What if You Didn’t Collect Anything From a Registered Area?
Let's say you have a tax permit in a certain county but didn't collect anything within a specific period. Still, you need to file a sales tax return since it's mandatory. To do so, simply file "zero reports" or "zero returns" for compliance.
Step 5: Keep Track of Tax Compliance Updates
The current sales tax policies for e-commerce won't stay the same forever. It's still developing, so expect changes in requirements and processes in the future. To avoid trouble with outdated sales tax activities, stay on top of changes concerning tax compliance.
Seek updates from the states where you're permitted to collect sales tax. You may regularly visit their website, social media or subscribe to newsletters, if any. If you have an accounting team or tax advisor, consult them about it. Additionally, always monitor your sales and stay alert when they exceed a certain threshold limit.
Be Safe Than Sorry: Hiring a Bookkeeping and Accounting Team
If you're still unsure whether you're collecting and filing your taxes the right way or not, you can ask the help of accounting or bookkeeping experts. Don't wait for your tax authority to assess your tax compliance and avoid charging your customers the wrong amount in their purchases.
Hence, it is best to work with a trusted team of accountants to help you with the how-tos and management of sales taxes.
How to Hire the Right Bookkeeping or Accounting Team
When tax management starts to take a toll on you, it's time to get help from experts. You might feel reluctant to pay an entire team and have them take charge of your company's financial work. We understand that, which is why we've enumerated the important things you need to know when hiring bookkeepers or accountants.
Setting the Right Expectations
When hiring a bookkeeping or accounting team, you must first understand their roles. By doing this, you will know exactly what you're paying for and avoid miscommunication during the collaboration. For example, bookkeeping and accounting tasks are different—bookkeepers conduct administrative tasks while accountants interpret and analyze financial data.
Find out the specific tasks they will conduct. For example, in tax compliance, ask if they will help you prepare, manage, or submit sales taxes. Knowing this allows you to picture the job distribution: which tasks are my responsibilities? Which tasks can I turn over to the team?
Freelance vs Firm
You get to choose between freelance or firm for tax management services. Each has a different set of pros and cons, and you need to understand them to make a final hiring decision. For example, you have less control over freelancers, but they usually charge lower rates than firms.
Bookkeeping or accounting firms, on the other hand, have a fixed schedule and offer more personnel. While cost can be an issue, you won't have days when you can't contact anyone to work on tax management.
Area and Level of Expertise
Consider asking for the area of expertise of the bookkeepers or accountants you're hiring. No matter how good they can be, progress can become slow-paced and risky if they don't understand how your industry works.
If they have working experience concerning your niche, things will be easier to manage and improve. In addition, look for their certifications, such as the American Institute of Professional Bookkeepers (AIPB) and Certified Public Accountant (CPA) licenses.
Way of Communication
Whether you know a lot about financial management or not, how your accountant communicates with you is more important. Without proper communication, your business is at risk of financial dilemma. Thus, hire someone or a company that complements the way you communicate.
If you need guidance on sales taxes, they must communicate complex matters in a way that you can easily understand. Generally, they should not force you to act in any way without even listening to your opinions first. They might have good intentions for your company, but they should still respect your pace and adapt to it as necessary.
Technology matters significantly in e-commerce tax management. Your e-commerce platforms should display accurate tax rates and process orders seamlessly. Thus, the accountants you'll hire should know the latest and most effective technologies in managing your finances.
Moreover, they should provide you with a demonstration of these tools. Ask them why they'd choose a particular e-commerce sales tax software for a certain transaction. Then, evaluate if their choices are valid, not overpriced, and are the latest, most efficient programs you can use.
Technology and Sales Tax Management
Since the South Dakota v. Wayfair in 2018, businesses need to turn heads in not just one or two states but almost all of them. As a result, merchants spend up to 300 hours on tax management—isn't it natural to switch to automation now?
However, some companies don't include this in their list of priorities, and you shouldn't be one of them. As a seller, you should know that managing sales tax is a huge concern when not properly taken care of. In addition, you must be aware of the potential long-term consequences of incorrect tax compliance. To avoid that, you must switch to automated management.
What are the benefits awaiting you in sales tax automation?
- Reduce half of the time you spend managing taxes
- Prevent inaccurate tax payments more often (e.g., overpaying or underpaying)
- Submit reports and avoid potential penalties more often
- Make every working hour and effort more worthwhile
QuickBooks, A2X, Taxjar, and Hubdocs are usually the most preferred tax management and compliance software today. When hiring bookkeepers or accountants, ensure this will be an essential part of your discussion.
Sales Tax For E-Commerce Sellers: Tax Solutions With Unloop
With Unloop's e-commerce sales tax services, you can ensure seamless tax management and compliance for your business. We partner with accounting firms and Taxjar, a tax compliance company, to ensure accurate internet sales taxes on time.
We accommodate you in every step you need to take for sales tax compliance. Our action plans are as follows:
- We identify where you have a sales tax nexus.
- We determine if you're able to abide by the tax laws of your state(s).
- We help register your business for tax permits.
- We take charge of setting up your e-commerce platforms for automated tax rate adjustments.
- We help manage your tax filings. While we don't file tax returns (we're not a CPA firm), we work with CPAs who can file them for you instead.
- Monitor sales rates and tax compliance to help you stay on top of things.
Whether you're a U.S. seller on Amazon or Shopify, we have all the bookkeeping solutions ready. If you're serious about growing your business in the online marketplace, take this step with great courage and let us help you out from start to finish!
E-commerce is rapidly developing, and so are the states adapting to the Wayfair rule. In the constantly changing chain of tax systems, you must keep pace with the changes to achieve proper tax compliance.
Once you understand how things work, implement solutions that help you make the work manageable and eliminate the mess. Hire the right people, use effective tools, and stay on top of your growing e-commerce sales.