Making returns easy for shoppers is good for business, but hard on businesspeople

Merchandise returns are an ever-increasing fact of life for retailers, in large part because of the growing realization by online retailers that an easy return policy can actually drive sales. That’s because shoppers are more willing to buy an item when they know they can send it back if they don’t like it in person as much as they did online.

As a result, anywhere from 15% to 40% of items bought online are returned, different studies have found. That accounted for $428 billion worth of merchandise in 2020, according to the National Retail Federation.

Yet while easy returns may be good for business, they’re yet another aspect of running a business that can be hard.

Returns create a bookkeeping challenge, as that $50 payment from the blouse you thought you sold moves suddenly out of the booked revenue column. Returns can create an inventory problem, when about 20% of the items you shipped from your warehouse come back.

Returns also can create any number of tax liability problems, depending on how you sold the item, how you shipped the item, and where it was stored before it was sold.

All of these have the potential to create a really bad experience for your customers, if they’ve got to stand in a line at a register, or sit on hold on the phone, for several minutes while your customer-facing staff tries to figure all this out on their own, or perhaps with a manager.

Returns also can create bottom-line problems for your business. If you process the sales tax wrong and return too much, you’re giving away money that should be adding to your profits. If you don’t return enough sales tax, you’re opening yourself up to a class-action lawsuit.

Timing can affect tax remittance requirements

Your customers aren’t the only ones looking to ensure you’ve properly refunded the right amount of tax. Tax authorities, if anything, will be looking even closer.

Online sellers with customers and tax obligations in multiple states need to understand each state’s policies regarding sales tax, refunds, and exchanges.

Depending on the state, if a product is returned soon enough — after the tax was collected but before your business was required to remit it to the authorities — you may simply be able to refund the tax.

However, things get much more complex if you’ve already remitted the collected taxes and filed the required sales tax returns. Some states (like Connecticut) say that customers aren’t entitled to a sales tax refund more than 90 days after the original purchase date.

Each state has its own requirements, which merchants are responsible for following.

Brick-and-mortar returns are easier for tax compliance, except when they’re not

If you’re fulfilling orders and processing returns at one brick-and-mortar location, that’s a pretty straightforward process for tax compliance. You know the amount of tax you charged originally and you know your local tax rate.

(As long as there aren’t state-imposed deadlines on sales tax refunds, or you’re dealing with items sold during a sales tax holiday, or a situation where the tax rate has changed in your state or local jurisdiction since the time the customer bought the item.)

If you’re an ecommerce merchant, things can quickly get (even) more complicated, starting with whether or not you should have charged sales tax on shipping for the initial order. Each state has different rules on this, depending on how you got the product to the customer from your warehouse and (sometimes) how you invoiced the transaction.

If you’re using a central location for order fulfillment and returns processing, you almost certainly will have a record on-site of how much tax you collected on the original sale. When the item comes back, you’ll know what you collected and what you can refund.

However, many retailers have moved away from centralized order fulfillment and returns processing.

Major retail chains often fulfill orders from the closest brick-and-mortar location they have to the buyer’s address. This does two things for retailers: It cuts down on transport time and costs, making it easier and cheaper to get product quicker to the buyer; and it helps retail locations cycle through inventory faster so there is less in the store to mark down at the end of a season.

On the other hand, fulfilling orders from a brick-and-mortar location can affect taxability as you process returns, especially if the returned item goes back to a different place than from where it was shipped. Customers like being able to order online but take returns to a physical store — and merchants offer the service because once a buyer is in the store as many as 83% of them will buy something.

Yet that also creates complications if you’ve shipped from a central order fulfillment location but allow returns at a physical store where the sales tax rate may be different.  

Something similar happens if a customer buys from one brick-and-mortar location and returns the item to another one. Your staff will need ready access to sale tax rate data for the location where the original sale was made. They can’t just look at the other store’s ZIP code and guess.

Third-party fulfillment: You can outsource shipping, but not tax compliance

And what happens if you sell an item to a customer during a sales tax holiday, only to have them return it weeks later? Will your staff know what to do in that scenario?

Many smaller retailers subcontract their order fulfillment and returns functions to a third-party logistics company (a “3PL” in industry jargon). Fulfillment by Amazon is a well-known one, but there are others.

Outsourcing your order fulfillment doesn’t mean you’ve outsourced your sales tax obligations too.

If your 3PL provider stores your inventory in another state, you’ve likely created a taxable physical nexus in that state, meaning your company is obligated to register to collect and remit sales taxes. Some states will require sellers to pay taxes on the inventory, even if the 3PL owns it. It’s also possible, if the 3PL has your inventory stored in warehouses in multiple states, for you to have a physical nexus in each one. (Check out our state-by-state guide here.)

This is significant: If a retailer has a low volume of sales into a state it might not be enough to trigger a requirement to register and collect sales taxes under that state’s economic nexus laws.

But there is no corresponding threshold for physical nexus; if you — on your own or via your 3PL — have a physical nexus in a state, you have sales tax obligations.   

So, if your business in Kansas makes one sale of $20,000 worth of merchandise in Arkansas, shipped from your own Kansas warehouse, that’s not likely going to trigger a sales tax requirement under laws governing remote sellers. But if your 3PL stores that merchandise in Arkansas with the intention of shipping it to buyers from there, then you’ve probably got a sales tax obligation in Arkansas because your 3PL has physical nexus in The Natural State.

What can stores do to reduce the tax complexity of returns?

There are a couple of things merchants can do to address these issues.

No. 1 is purely an operational issue for your order fulfillment team: About 80% of returns are driven by damage in shipping. If you can improve your packaging to better protect your merchandise, that will reduce your overall returns.

No. 2 is another operational issue: Establish clear, customer-friendly policies for returns and exchanges and drill your staff on them for quick processing.

And, No. 3 is automation. Automated tax compliance software can keep track of the various rates at the places where you’re processing returns, and how those differ from the rates in the places where the original transaction occurred. It also can help keep track of changes in tax deadlines, rates, and rules that you otherwise might miss.

To learn more, read our report on Tax compliance for ecommerce sellers.

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