Online travel agencies face complex tax regulations
Almost every business has state and local tax obligations. Online travel agencies just tend to have more.
There are basically three reasons tax obligations for online travel agencies (OTAs) are so complicated:
- The U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc. allows states to tax sales by online travel agencies
- Marketplace facilitator laws make OTAs responsible for many lodging taxes
- The regulatory complexity of state, county, and city tax requirements makes it hard for OTAs to identify and comply with all tax obligations
1. The U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc. allows states to tax sales by online travel agencies
The U.S. Supreme Court’s ruling on South Dakota v. Wayfair, Inc. (June 21, 2018) was a game changer for states and businesses. Prior to the Wayfair decision, a state could generally require a business to collect and remit sales tax only if the business had a physical presence in the state. The Wayfair ruling overturned the physical presence rule, thereby freeing states to tax remote sales (i.e., sales by businesses with no physical tie to the state) as well as in-state sales.
To be fair, South Dakota v. Wayfair, Inc. didn’t start the tax troubles for OTAs. By 2016, two years before the Wayfair ruling, online travel agencies had been embroiled in 92 lawsuits across more than 34 states as state and local governments sought to tax OTA services.
By removing the physical presence requirement, Wayfair exacerbated tax complexity for OTAs. One question raised in several of the lawsuits was whether state and local governments could/should tax out-of-state businesses, and Wayfair gave states the green light to do so. Within a few years of the 2018 decision, every state had an economic nexus law requiring businesses with a certain level of sales activity in the state to collect and remit sales tax.
The Wayfair decision revolutionized sales tax, but it was merely the tipping point for the online travel agency industry. To a certain extent, marketplace facilitator laws have proven much more impactful.
2. Marketplace facilitator laws make OTAs responsible for many lodging taxes
A marketplace facilitator or provider owns, operates, or otherwise controls a physical or electronic marketplace and facilitates sales on behalf of third-party sellers. Amazon and eBay are online marketplaces; so are Airbnb and Expedia.
Marketplace facilitator laws make the marketplace facilitator responsible for collecting and remitting applicable taxes for all sales made through the platform. This simplifies sales tax compliance for the third-party or marketplace sellers, but it complicates tax compliance for marketplace facilitators.
While just about every online marketplace is affected by marketplace facilitator laws, they’re particularly hard on accommodations platforms and online travel agencies responsible for collecting and remitting state and local lodging taxes.
3. The regulatory complexity of state, county, and city tax requirements makes it hard for OTAs to identify and comply with all tax obligations
State and local sales taxes are administered by a state tax agency like the California Department of Tax and Fee Administration or the Florida Department of Revenue in most states, with the exception of a handful of home-rule states. As a result, in most states, out-of-state businesses generally don’t need to register for sales tax with local governments or file sales tax returns with local tax authorities.
That’s not the case with accommodations taxes, which are typically the purview of local governments. There are thousands of locally administered accommodations taxes.
Thanks to economic nexus and marketplace facilitator laws, an online travel agency that facilitates bookings for lodging providers nationwide may need to register with and remit taxes to dozens of states (for state taxes) and potentially thousands of different local tax authorities (for county and city taxes).
For the most part, states take one of five different approaches to taxing accommodations. The simplest, for businesses, is a single statewide tax on lodging; the most complex is a state accommodations tax plus one or more local accommodations taxes. Since requirements vary from state to state, the first thing an online travel agency needs to do is figure out which taxes apply to each hotel, motel, short-term rental, etc. for which they facilitate bookings.
Finding all that information can be hard, and it’s the tip of the proverbial iceberg. Online travel agencies also need to:
- Register with all applicable tax authorities
- Collect and remit all applicable state and/or local tax obligations
- Ensure all transactions are sourced correctly
- File all state and local returns with the proper tax authority on time
Unique challenges with county and city taxes
Online travel agencies that deal with hundreds or thousands of different jurisdictions also face an additional compliance challenge: The marketplace platform may lack the information needed to remit certain excise taxes.
Local governments usually send tax information notices to businesses located in the jurisdiction: It’s in their best interest to ensure local businesses are aware of local tax requirements. However, they may not send the same information to accommodations platforms or online travel agencies based in other states. They don’t need to go the extra mile because the onus to understand and comply with tax obligations ultimately falls on businesses.
Because a tax authority may only share tax information with the actual accommodation provider (e.g., the hotel or short-term rental owner), it can be difficult for a third-party platform like Airbnb to identify every tax obligation imposed on each property in their network. Nonetheless, they may still be held liable for all applicable taxes.
Local accommodations taxes create “significant tax compliance challenges” for businesses, according to a report by the State Tax Research Institute, “particularly in states that do not provide centralized collection and remittance of local taxes.” The report urges states and localities to reduce the burden of compliance by adopting one or more of the following strategies:
- Consolidate state and local sales and accommodations taxes into a single, statewide uniform rate
- Establish a central, state-level point of administration
- Improve the availability of information
- Improve uniformity among localities within a state
- Limit additional information reporting requirements for accommodation platforms
- Set local-level economic nexus thresholds
Setting clear tax expectations and obligations is in the best interest of businesses, localities, and states. It’s good for businesses because it helps them comply with state and local tax requirements. It’s good for state and local governments because the easier it is for businesses to comply with tax requirements, the more tax revenue state and local governments will receive.
Local and state governments from coast to coast are working to clarify the tax requirements for online travel agencies, but change takes time. And to be honest, their focus is increasing tax revenue, not making life easier for businesses.
How can OTAs keep up with tax obligations and get tax right?
Given the current environment, automating lodging tax collection and remittance is a good idea. It improves compliance by tracking and updating city, county, and state tax rates for you. It streamlines reporting and improves efficiency by consolidating data and preparing, filing, and remitting reports for city, county, and state jurisdictions. In short, it lets online travel agencies stay on top of locally administered accommodations tax requirements.
If you’re an OTA and struggling to understand and maintain lodging tax compliance, contact us to learn how Avalara can help.
Stay up to date
Sign up for our free newsletter and stay up to date with the latest tax news.