How Do I Calculate Sales Tax When Offering Free Shipping?
- Jul 11, 2016 | Michael Ansaldo
Few things give ecommerce sellers fits quite like sales tax. The questions of when, where, and what to charge are complicated by intricate requirements that vary from state to state. And the rules only get murkier when you factor shipping charges into the equation.
But what if you offer your customers free shipping? Surely you don’t need to collect tax on something you're not charging for? That's true, but it's important to know that depending on how you’re handling free shipping, you may be upping your customers' sales-tax bills by bringing down their shipping costs.
How does it all work?
Check for Nexus
Sales tax questions always start with nexus -- the legal concept that determines whether or not you are required to collect sales tax in a given state.
If you have a significant physical presence in a state -- an employee, office, warehouse, or distribution center, for instance -- you may have to charge sales tax on purchases made by customers there.
If you participate in Amazon’s FBA program, there’s a good chance you have nexus in multiple states. And in some states you can trigger nexus merely by advertising online or crossing state lines to sell at events.
If you don’t already know where you have nexus, finding out should be your first step.
Tax Rules for Shipping Vary by State
If determining where you have nexus isn’t challenging enough, states also differ on how they handle sales tax on shipping. A majority of states say that if you charge shipping as part of an order -- whether it is added to the price of the item or listed separately -- it’s taxable. But some states tie their sales-tax rules to how you list the shipping charges on your invoice.
Certain states' rules are particularly byzantine. In California, shipping may be non-taxable, partially taxable, or fully taxable depending on any number of factors, including your method of shipment, how you itemize charges on your invoice, and whether or not the charge is more than the cost of delivery. In Maryland and Virginia, shipping is taxable when it’s combined with handling charges, but exempt when stated separately.
Is your head spinning yet?
So What About Free Shipping?
The short answer to whether or not you must collect sales tax on free shipping is "no," since you can't tax a charge you don't make.
However, if you advertise free shipping but increase your prices to compensate because you can’t afford to absorb the shipping costs, your customers must pay sales tax on the higher amount. This means that in states where separately listed shipping charges are tax-exempt, they'll be paying more sales tax than they would if you charged them shipping costs.
Chances are that doing so will still result in a smaller final bill, so customers may not mind, but no one likes paying more taxes than they have to. And free shipping tends to make your customers happier (studies show that shipping costs are a determining factor in shopping cart abandonment). And not dealing with the sales-tax implications of shipping charges will simplify the tax collection process for you.
As with all things sales-tax related, it’s advisable to check the Department of Revenue for the state in question to clarify your obligations.