Do you sell online? 3 game changers that impact ecommerce sales tax obligations
Does your company sell online, or plan to do so soon? If you’re involved in ecommerce, understanding your sales tax obligations is critical. This article will explore three recent game-changing impacts on sales tax compliance for ecommerce merchants — along with options for managing sales tax compliance.
Sales tax compliance is a statutory requirement, so there’s no way around it. Your company is required to either collect and remit sales tax or prove you’re exempt from doing so. Unfortunately, sales tax compliance in the United States is extremely complex and difficult to get right. In fact, nearly half of accounting professionals surveyed believe that an auditor would find costly errors if they were audited.
Why? In part it’s because our country was founded on states’ rights. Each state has the right to enact tax rules and rates of its own choosing, and as a result, every state has different tax rates and rules. A business selling into all 50 states could have customers in more than 12,000 different tax jurisdictions. It has to know which customers, products, and services are exempt, and it must validate all exempt transactions. Trying to keep all this straight, especially if managed manually, is mind-bogglingly complex and error prone.
It also takes up a lot of time. According to a Wakefield Research study, handling compliance manually takes on average 460 hours annually. Though sales tax compliance is critical, it brings in no revenue. Instead, it takes valuable accounting staff away from projects more beneficial to the bottom line, such as tightening up accounts receivable or determining the risks and rewards of entering a new market.
In other words, handling compliance manually brings no reward but creates high risk.
Yet sales tax compliance cannot be overlooked. Ecommerce sellers should therefore consider automating sales tax compliance, which reduces audit risk and frees valuable resources for tasks that could help your company grow.
Below are three recent game changers affecting sales tax obligations for many firms that sell across state lines, especially ecommerce merchants.
Game changer #1: The rise of economic nexus
In June 2018, the Supreme Court of the United States delivered a landmark decision in South Dakota v. Wayfair, Inc. The ruling allowed for a new method of determining a company’s obligation to collect and remit sales tax, or “nexus.” Prior to the Wayfair decision, nexus was based almost entirely on physical presence. Wayfair enables states to base a sales tax obligation on an out-of-state seller’s annual revenue or sales in the state. This is known as economic nexus, and it’s a real game changer. The decision impacts many companies that sell across state lines, including tax-exempt sellers.
Since the Supreme Court’s decision, 43 states and Washington, D.C., have adopted economic nexus laws. Local governments in Alaska have done the same. Since economic nexus laws differ from state to state, compliance has become more challenging than ever for ecommerce sellers and other businesses that sell into multiple states.
The first challenge arises when trying to determine whether economic nexus has been established, as most states provide an exception for small sellers: A remote business is required to register to collect sales tax only if its sales into the state meet or exceed a certain economic nexus threshold. In Alabama, the threshold is $250,000 or more in retail sales of tangible personal property in the state in the prior 12 months. In Georgia, it’s $100,000 in retail sales or at least 200 retail transactions of tangible personal property delivered electronically or physically during the prior calendar year. In California, it’s $500,000 in retail sales of tangible personal property during the current or preceding calendar year, by the retailer and all persons related to the retailer. And so on.
There are other details to master as well. Does the transactions threshold apply on a per-invoice basis, or on a per-line-item basis? Do exempt sales count toward the threshold? Tax-exempt sellers aren’t always off the hook for economic nexus, as more than 30 states include gross sales in their economic nexus thresholds. This creates a whole new compliance headache for tax-exempt sellers.
This map shows how the ruling could impact a typical ecommerce merchant:
The impact is enormous, with a company’s nexus footprint increasing by an average of six to nine times.
This ecommerce merchant is currently registered and collecting sales tax in the dark gray states — likely where it had nexus prior to the Wayfair ruling, when nexus was determined primarily by physical presence (e.g., a headquarters in California, a warehouse in Texas, and offices in New York and Michigan).
Today, the company also has economic nexus in orange states, thanks to Wayfair and subsequent state action. Yellow represents where the company is approaching economic nexus thresholds.
The map shows how in just two years, a company’s nexus footprint can grow from four to 39 states, plus D.C., and be in danger of growing more.
Economic nexus makes the already burdensome process of tax compliance exponentially more difficult, especially for online sellers. Companies that struggled with sales tax compliance prior to Wayfair now face even more burdens and increased audit risk.
Game changer #2: COVID-19’s effect on ecommerce
The COVID-19 pandemic has created the second game changer. Online shopping has become the de facto choice for consumer shopping, so to stay solvent, many brick-and-mortar retailers are focusing on online operations. Ecommerce is brand new for some businesses, while others are expanding into new online channels to broaden their market reach. Since March 13, 2020, ecommerce sales have increased by more than 60%.
Marketplace facilitators such as Amazon and Etsy provide a valuable service, enabling small firms to sell online and reach a broad audience. Yet while they facilitate sales, marketplaces can also add to the complexity of compliance. Though many states require marketplace facilitators to collect and remit sales tax on behalf of their marketplace sellers, they may still require individual sellers to register. In states that don’t hold the marketplace liable for the tax on third-party sales, individual sellers may establish physical presence nexus through inventory stored in a facilitator’s warehouse.
To date, more than 40 states have marketplace facilitator laws. Expect more states to jump on the bandwagon this year.
Game changer #3: The impact of COVID-19 on states
The pandemic is breaking states’ piggy banks. States are spending millions to help constituents, while simultaneously losing millions in transaction taxes because the economy has ground to a halt. The situation is particularly dire in Florida. With no income tax, Florida is heavily reliant on tourism and sales tax. It’s also one of two states that doesn’t tax online sales by out-of-state sellers because it hasn’t enacted economic nexus.
Florida isn’t alone. Due to COVID-19, every state will likely soon be in the red, with budget shortfalls larger than during the Great Recession. By 2021, the total shortfall could be as much as $290 billion.
What can states do? They can tap a rainy day fund, if one exists. Or, they could cut services, which won’t go over well in a pandemic. Or, they can increase taxes and audits.
For the time being, many states have delayed sales tax filing and remittance deadlines due to COVID-19 — changes Avalara is tracking at our COVID-19 tax news and resources hub. Yet eventually, state and local tax authorities will need to collect the revenue that’s due to them. And when it isn’t enough, they could look to increase taxes: The Center on Budget and Policy Priorities notes that states may not be able “to avoid deep spending cuts, tax increases, or both as they deal with the costs of the COVID-19 response and a recession.” States could also have to amp up audit activity.
Compliance automation for ecommerce: How to get your ducks in a row
- Economic nexus laws are increasing online sellers’ nexus footprint — and compliance burden — exponentially.
- COVID-19’s effect on the economy is increasing ecommerce.
- COVID-19’s impact on state budgets could lead to increased audit risk.
Considering all this, now would be a good time for ecommerce businesses to get their proverbial ducks in a row and update tax compliance strategies if necessary:
Know your nexus. Learn where you have sales tax collection obligations. Avalara can help with a free, easy-to-use sales tax risk assessment tool. Simply answer three questions or upload your sales data into the tool to discover the states where you likely should be collecting sales tax now, as well as states where you’re nearing the economic nexus thresholds.
Address past compliance issues. For example, get an exposure analysis. Consider voluntary disclosure agreements, if needed. Look into registering in states where you should be registered. In other words, do what it takes to land on the right side of the law. The tax compliance experts behind Avalara's Professional Services can help.
Monitor sales across all channels. Selling through multiple channels (e.g., ERP, shopping cart, POS, marketplace) makes it difficult to know when nexus is triggered. Sales made through marketplaces often contribute to a retailer’s overall transaction volume, so it’s important to monitor sales across all channels to understand where you’re are at risk of triggering economic nexus. Consider implementing a technology that can track where all sales occur.
Provide a clear audit trail. Audits go more smoothly if the auditor can easily access all necessary documents. If or when an auditor shows up at the door, have your office in order. An automated sales tax solution helps.
Tax compliance technology should integrate with your existing ERP, POS, and ecommerce platforms, so you can maximize the technology investments you’ve already made. And it should be adaptable: Your tax tech shouldn’t hold you back as you expand sales into new channels and new markets.
Avalara has over 700 prebuilt integrations into today’s most widely used accounting, ERP, ecommerce, shopping cart, and other applications. Our integrations include ERP players such as Microsoft, Oracle, and Sage; accounting packages such as QuickBooks; and ecommerce offerings such as Magento, Shopify, and BigCommerce.
Avalara also partners with over 1,000 technology value-added resellers (VARs). And Avalara is a certified service provider in the Streamlined Sales Tax (SST) Program: The 24 member states will cover the cost of sales tax calculation, returns preparation, and filing for qualifying firms that partner with Avalara.
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