What you need to know about destination and origin sourcing of sales tax
One of the first things you need to determine when making a taxable sale into another jurisdiction is which sales tax rules rule: those in effect where you’re located, those in effect where your customer is located, or a bit of both. The answer comes down to sales tax sourcing.
There are basically three options:
- Destination sourcing
- Origin sourcing
- Mixed sourcing
Destination sourcing rules apply to most sales in most states. Destination sourcing is when the sale is sourced to the location where the customer takes possession of the product or service sold.
Origin sourcing is when the sale is sourced to the seller’s location — either where an order was taken or fulfilled. Pennsylvania is an origin-sourcing state: Local taxes only apply to sales originating within the boundaries of the local tax jurisdiction, so businesses with no physical presence in a local tax jurisdiction aren’t required to collect them. Businesses with a physical presence in Pennsylvania follow origin-sourcing rules.
Several states, including Colorado, New Mexico, and Tennessee, have transitioned from origin sourcing to destination or mixed sourcing (more details below).
Mixed sourcing is when destination sourcing applies to some transactions or taxes, while origin sourcing applies to others. States with mixed sourcing rules include California, Illinois, Ohio, Tennessee, Texas, Utah, and Virginia.
Sourcing intrastate vs. interstate sales
An intrastate sale is when a vendor and a customer are located in the same state. When the vendor and customer are in different states, it’s an interstate sale. Some states source interstate and intrastate sales differently.
Most states use destination sourcing for both interstate and intrastate sales
Most states now use destination sourcing for interstate sales, so if you have nexus with another state (i.e., an obligation to collect sales and use tax in that state), you likely need to collect the rate in effect at the ship-to address. There are a few exceptions, detailed below.
States won the right to tax interstate sales in 2018, when the Supreme Court of the United States ruled in favor of the state in South Dakota v. Wayfair, Inc. Prior to the Wayfair decision, states could require a business to collect and remit sales tax only if the business had a physical presence in the state (aka, intrastate sales). Physical presence still establishes a sales tax obligation, but all states with a general sales tax now also have economic nexus laws that enable them to tax remote sales.
Some states have amended sourcing rules for interstate sales since adopting economic nexus. For example, Tennessee switched to destination sourcing for interstate sales on October 1, 2019, a few months after it began enforcing economic nexus. New Mexico began requiring remote internet sellers to pay state and applicable local taxes (based on the destination of the sale) starting July 1, 2021, the same day its economic nexus law took effect.
Illinois began enforcing economic nexus on October 1, 2018, initially requiring remote retailers to collect the state use tax only. As of January 1, 2021, remote retailers must collect state and local retailers’ occupation tax at the rate in effect at the point of delivery (aka, destination sourcing). However, as noted below, Illinois has different sourcing rules for intrastate sales and for out-of-state retailers holding inventory in Illinois.
Most states use destination sourcing for intrastate sales as well. However, origin sourcing or mixed sourcing rules do govern intrastate delivery sales in some states. The tricky states.
States with complex sourcing rules
California. Out-of-state retailers that are “engaged in business” in California are responsible for collecting, reporting, and paying state, local, and district taxes at the rate in effect at the delivery address (destination sourcing). That’s the easy bit.
In-state businesses must collect applicable state and local sales taxes on all sales in the state, and local sales tax is allocated to the place of business (origin sourcing).
In-state businesses are liable for California district taxes if California sales exceed the state’s economic nexus threshold of $500,000. Businesses selling beneath the $500,000 threshold are responsible for collecting district taxes only in districts where they have a physical presence, which includes holding inventory or making deliveries in company vehicles.
Colorado. In Colorado, businesses with over $100,000 in sales should already be using destination sourcing, but in-state businesses selling beneath that threshold may continue to use origin sourcing for delivery sales until October 1, 2022. At that point, “all businesses located within Colorado, regardless of their sales volume, must begin complying with the destination sourcing rules.”
New Mexico. New Mexico transitioned from origin sourcing to destination sourcing on July 1, 2021, at least for most transactions; sourcing rules for professional services that require an advanced degree or license from the state continue to be sourced to the seller’s place of business.
Ohio. Internet, mail order, or telephone sales by Ohio vendors to Ohio consumers are generally sourced to the location where the order is received (not the location where the order is processed or shipped). If the order is received at a location outside of Ohio, whether by an out-of-state seller or an Ohio business with locations in other states, destination sourcing rules apply. See this sourcing chart for vendors and sellers for more details.
Tennessee. Though destination sourcing rules apply to remote sales, as of October 1, 2019, “tax is imposed in the locality of the seller’s location in Tennessee from which the sale is made” when a seller has a physical presence in the state. In other words, origin sourcing applies to in-state sales.
Texas. Origin sourcing governs certain city, county, special purpose, and transit sales taxes in Texas, but destination sourcing rules state sales and use tax and local use tax. Whether an order is fulfilled in Texas or outside of Texas can also affect how sales are sourced in the state. It's a complicated dance that the Lone Star State is working to simplify; the Texas Comptroller offers more information in Local Sales and Use Tax Collection — A Guide for Sellers (publication number 94-105).
The Texas Comptroller would like to change the way some sales are sourced. Currently, businesses located in Texas source internet orders to the location where the order was received. If the Comptroller gets their way, internet orders fulfilled in Texas will be sourced to the location where the order is fulfilled; if the order is fulfilled out of state, destination sourcing rules will apply. The proposed change is on hold because localities benefitting from the original sourcing rules are challenging it.
Utah. Sales in Utah are sourced by transaction type. In-state sales are generally sourced to the seller’s fixed place of business, even if delivered. Remote retailers with no physical presence in Utah should collect the use tax rate in effect at the point of delivery.
Virginia. In-state businesses should collect the sales tax rate at the business location or point of sale (origin sourcing). Out-of-state businesses should use destination sourcing, collecting the rate in effect at the point of delivery. However, according to the Virginia Department of Taxation, “In-state marketplace facilitators that are unable to associate an order with a physical place of business in Virginia may use destination-based sourcing to determine sales tax rates.”
Sourcing marketplace sales
Some of the most complicated sourcing rules pertain to sales made through a marketplace facilitator (marketplace sales) with inventory in the state.
Arizona and Illinois use origin sourcing for marketplace sales fulfilled in the state but destination sourcing for marketplace sales fulfilled in another state. Sourcing rules in Illinois are so complex that the Illinois Department of Revenue created FAQs and this nifty flowchart to help retailers and marketplace facilitators navigate to the proper rule.
How to sidestep complicated sourcing rules
Alabama and Texas both allow remote sellers to collect and remit a single rate for all sales into their respective state. Businesses that opt to use the single rate don’t need to worry about origin or destination sourcing because they use one rate for all sales.
However, the single rate usually isn’t available to in-state sellers. Texas doesn’t allow marketplace providers to use the single local use tax rate.
What small businesses need to know about sales tax sourcing
If you’re a small business with few resources to devote to sales tax, sourcing can be particularly troublesome. If you have nexus in destination sourcing states, you need to be able to make sure you apply the proper sales or use tax rate to each transaction. If you’re doing business in a state with mixed sourcing rules, you need to be sure you source every sale correctly.
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