Colorado delays sales tax sourcing requirement for small businesses

Sourcing rules dictate which sales tax rates and rules govern a transaction. There are basically three options:

• Destination sourcing bases sales tax on the location of the buyer (i.e., where the order is delivered or picked up)

• Origin sourcing bases sales tax on the location of the seller (i.e., where an order is taken)

• Mixed sourcing uses a combination of destination and origin sourcing rules

Most states use destination sourcing for remote sales, which occur when an out-of-state seller has no physical nexus in the state where the consumer is located. Not all remote sellers have an obligation to register for sales tax, but if they do, they typically need to collect and remit the tax rate in effect at the delivery address.

Origin sourcing and mixed sourcing usually come into play only when the seller has some sort of physical location in the state where the consumer is located. This can be a brick-and-mortar retail store, an office, a warehouse, or even inventory held in a third-party warehouse.

Sales tax compliance is trickiest in states with mixed sourcing rules because some transactions are governed by destination sourcing while others follow origin sourcing rules. Illinois illustrates the complexity perfectly.

In-state sellers in Illinois are required to collect and remit state and local retailer’s occupation tax at the origin rate. Similarly, out-of-state sellers must collect state and local retailers’ occupation tax based on the origin of the sale when selling activity occurs in Illinois (i.e., if an order is taken or fulfilled in Illinois). However, registered remote retailers need to collect and remit use tax when selling activities occur outside Illinois.

The situation is so complicated the Illinois Department of Revenue has developed three flowcharts to help remote retailers and marketplace sellers figure it out:

• Illinois (In-state) Retailer’s Sales Tax Responsibilities Flowchart

• Leveling the Playing Field for Illinois Retail Act Flowchart

• Out-of-State Seller and Remote Retailer Registration Flowchart

Illinois has been working to simplify sales tax sourcing and compliance for retailers, albeit with mixed results. Texas is another state known for notoriously complex sourcing rules, and it, too, is striving for simplicity.

But back to Colorado.

Colorado began transitioning to destination sourcing in 2019, shortly after the state began enforcing economic nexus. Economic nexus laws base a sales tax collection obligation on an out-of-state company’s economic activity in the state rather than physical presence in the state, thereby allowing states to tax remote sales.

Because Colorado is a home rule state where local governments can administer local sales tax independently of the Colorado Department of Revenue, small businesses in the state were given more time to comply when the state made the transition to destination sourcing. Instead of being required to collect and remit the rate in effect at the location of delivery, small businesses in the state could continue to adhere to origin sourcing rules.

“It’s not surprising Colorado is taking its time transitioning small in-state sellers to destination sourcing,” says Scott Peterson, VP of Government Relations at Avalara. “That process is more complicated than origin sourcing and impacts sellers who may be least capable of making the change.”

The small business exception applies only to Colorado businesses with less than $100,000 in retail sales (made in the current or previous calendar year) in the state. Remote businesses with less than $100,000 in Colorado sales are not required to register, while both in-state and out-of-state businesses whose sales exceed the $100,000 threshold should already be using destination sourcing.

The Colorado Department of Revenue has made it clear that it “is not authorized to grant exceptions to this statutory requirement.” Any exceptions to destination sourcing that were given to small businesses in 2019 “will no longer be available as of October 1, 2022.” 

October 1 will be here before you know it. Avalara’s Small Business FAQ can help you understand everything from registration requirements to returns and help put you on the path to sales tax compliance.

Cover photo by Canva