Origin and Destination Taxation: Beyond the Basics
- April 22, 2016 | Mark Berens
For most of us, when we ship a package, our biggest concern is usually just deciding which kind and how much tape we should use. Gray duct or clear packing? Double (or triple?) tape just on the top and bottom flaps or all of the sides, too? Once our cold sweat has dried, we just make sure the address is correct, take it to the local post office, pay at the counter, and we’re done. Whew.
When a business ships a product to its customers however, their considerations can be stickier than anything put out by 3M. That's because they have to worry about taxes. While a package sitting on a porch is one of life’s more benign images, the seller’s considerations in delivering it there -- their tax responsibilities based on where it’s coming from or going to, where/if they have nexus, and which jurisdiction collects the tax (called sales tax sourcing) -- can get very complicated. Throw in the Internet, and it gets nearly impossible (we’ll touch briefly on that).
Today, we’re going to build on the basics of origin-based and destination-based taxation, then go a little deeper.
NOTE: If you’re a brick-and-mortar storefront retail shop or a restaurant -- meaning you neither ship nor deliver -- you can stop reading. Nothing changes about the way you handle sales tax. When a buyer receives merchandise at your shop, sales tax is based on that location -- the “origin” of the sale.
The Standard Definition of Origin- and Destination-Based Taxation
Search online for “origin- and destination-based sales tax,” and you’ll likely find this definition (or some slight variation):
“Origin-based” means sales tax is based on the location from which the shipment departs rather than the location where the customer receives it. Just 11 states are origin-based: Arizona, Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Virginia.
“Destination-based” is the opposite, meaning sales tax is charged based on the product’s destination, not its origin. Thirty-four states are destination-based.
While not at all incorrect, these definitions don’t give the complete picture, particularly regarding interstate sales -- sales betwixt and between origin- and destination-based states -- which can be more complicated. To clear up confusion, I spoke with people at the Federation of Tax Administrators in Washington, DC, who graciously clarified and greatly simplified the issue (examples below are simplified to demonstrate the concepts).
Basic Principles of Interstate Taxation
Whether you’re a seller in a destination- or origin-based state, a few things apply across the board:
- Sales tax is paid by the buyer and collected by the seller.
- By law, a sale can only be taxed once. As a result, states choose to only tax sales on goods delivered to their state. Shipments going out are typically exempted.
- A business has to have nexus with the receiving state in order to have to collect the sales tax. No nexus, no tax collection by the seller (the buyer still has to pay a tax, but that’s another story).
For in-state businesses, nexus is a given -- you have it -- so there’s no confusion whether or not you have to collect taxes (you do, if you’re in a state that charges a sales tax*).
- If you’re shipping within an origin-based state, you charge the rate from where the shipment departs -- the seller’s location -- rather than the rate where the customer receives it. Because many states allow counties and cities to add sales tax above the state base rate, the tax rate typically varies from one city to the next (so, if you’re in Dayton, Ohio, selling to Cleveland, Ohio, you charge Dayton’s tax rate, which may be different than Cleveland's).
- If you’re shipping within a destination-based state, you charge the sales tax based on the rate of the location to which an item is shipped (so, if you’re in Seattle, Washington, selling to Spokane, Washington, you charge Spokane’s rate, which may be different than Seattle’s).
Out-of-state sellers may have to collect sales tax and remit to those states in which you have nexus. If you don’t have nexus in the state you’re selling to, you don’t need to collect sales tax. Therefore:
- If you have nexus in the buyer’s state and that state is destination-based, you’ll charge sales tax based on the total sales tax rate (the total of the state sales tax and any local county, city, or other taxing authority’s rate) where the item will be received.
- If you have nexus in the buyer’s state and that state is an origin-based state, you’ll likely need to charge only the state’s portion of the sales tax rate, regardless of any increment of local tax that may apply. This may be different in each origin-based state, so you will want to consult that state’s rules.
Interstate Selling Online
Far too complex to outline here, it’s enough to say that the online marketplace has thrown a wrench in traditional notions of “nexus,” forcing economists to debate “economic nexus theory,” lawmakers to attempt to enact a uniform remote seller sales tax law (while a drone drops off the newest tablet to work from), and leaving states and businesses to essentially make their own rules as they go and ask forgiveness later. The main thing to know is that sales tax sourcing without the Internet is tricky enough; throw in the Web, and it’s giving people fits.
Long ago, we were all pretty satisfied with some-day shipping. Now we want it same-day. As if staying in business wasn’t hard enough for traditional retailers, in addition to keeping on top of traditional sales tax sourcing rules, now they have to compete with online sellers who seem to make it up as they go.
As recipients, we’ve got it easy. The next time a package lands at your front door, take a minute to look at the sender’s address. Then thank the stars that all you have to do is open it.
*While 34 states and the District of Columbia follow destination sourcing rules and 11 states apply origin sourcing rules, we left out a few quirks: Delaware, Montana, Oregon, and New Hampshire don’t have sales tax at all. California is a modified origin state, meaning state, county, and city taxes are based on origin while district taxes are based on destination. Alaska does not have a statewide sales tax, but as a “Home Rule” state, it allows local jurisdictions to charge sales tax, which are all destination-based.