The state of internet sales tax in a post-Wayfair world
Ecommerce sales tax is the new normal
As federal and state governments turn their attention to capturing more revenue from Internet sales tax, many ecommerce businesses are finding themselves under increasing scrutiny, and they need to look at the impact sales tax may have on their business as they expand into more states.
On a national basis, according to a US Census Bureau survey in 2012, as much as a third or more of state budgets are derived from sales tax, which helps state and local governments fund taxpayer services. Internet merchants should understand their responsibilities and liabilities as they do business not just in their own state, but other states or countries. We may very well be seeing the beginning of a “new normal.” This paper will help you understand and be prepared for some of the basic requirements around sales and transactional taxes in the ecommerce world.
State sales tax nexus requirements
Every state has the right to define who has to collect sales tax, what those taxes are, and any exemptions that may be allowed. However, there are limits to how states can define “nexus.” Nexus means a “connection.” Ecommerce merchants must have a connection to a state in which a customer resides for the merchant to be liable for sales tax. But states define nexus in different ways, and this makes it confusing. Nexus triggering events can include:
- Traveling salespeople
- Agents or distributors
- Employees on payroll
- Trade show attendance
- Inventory / warehousing
- Servicing tangible personal property
Crossing your t’s and dotting your i's
Once you’ve figured out where your business has nexus, you need to ensure that you are properly set up to collect and remit sales tax within applicable states. To do that, you’ll need to register with the state(s) in which you have nexus by declaring your business. With each state you will need to:
- Get your ID number by setting up an account with a state, and visit their local .gov website to determine the exact steps. Usually they will have you file a form and register.
- Once that is complete, you will have a unique code applied to your business, and this code will show up along with your business name in all future sales tax filings.
- As soon as you have completed your paperwork, make sure to check that same regulatory department for up-to-date rates and tables, rules and boundaries. It is also critical to set up your ecommerce shopping cart with the appropriate rates in each of the states in which you have nexus.
- Set either mixed, destination or origin sourcing rules to make sure you are paying the tax in the right place.
- Research the taxability of your items, making sure to apply thresholds and tax holidays if they apply in your state.
- Make sure that you only have to file one sales tax form in one state, as many states require remittance to local jurisdictions (which can number in the hundreds), as well as the state.
- Consult a sales tax professional, as laws are complex, ever changing and not fun!
In taxation, accuracy is everything
Sales tax is calculated based on specific laws, regulations and rates defined for state, city, county, and in some cases special taxing jurisdictions and Regional Transit Districts. Sometimes, sales tax calculation is simple (certain states have no sales tax), or it’s a fixed percentage tax rate across a state. However, there are many states where sales tax calculation is more complex.
For example, a business in Arapahoe County, Colorado selling to a customer in the same county would need to know the following rates prior to charging sales tax:
- Colorado (State Tax) – 2.9%
- Arapahoe (County Tax) – .25%
- Aurora (City Tax) – 3.75%
- Scientific & Cultural Facility (Special Tax) - .10%
- RTD Greater Denver (Special Tax) – 1%
In 2012, the number of changes in these rates, rules and boundaries equaled or topped seven thousand across 46 states. Monitoring these changes using hard code, pushing rate tables or designing special processes to handle these changes, is critical. Businesses unable to ensure accurate application of rates and taxability face increased audit risk. It is extremely important for ecommerce businesses to ensure accuracy in rates and taxability.
Sales tax needs to be collected on numerous products and services across the country. The list of products and services may vary from state to state. For instance, in Florida, school items are not taxable during school holidays. In New York, clothing and apparel are only taxable when the cost meets certain dollar thresholds ($110). In California, digital software downloads are not taxable, but the same software bought in a box with a CD is taxable. Clothing and apparel, medical devices, digital media, software, and services are all examples of industries in which product taxability rules apply. These are just a few examples of the kinds of product taxability challenges that Internet merchants face. It is very important to make sure you know the relevant state product taxability rules. Once you know these rules, they should be kept up to date via hardcoding, rate tables that match product taxability, thresholds, holidays and sourcing requirements.
The Streamlined Sales Tax (SST) agreement
A number of states have worked together on an agreement called the Streamlined Sales and Use Tax Agreement. The purpose of the Agreement is to “simplify and modernize sales and use tax administration in order to substantially reduce the burden of tax compliance.” For companies with aggressive expansion plans, or affiliate relationships in a number of states, registering as an SST volunteer can save you a lot of time, effort and money. Signing up to SST requires only one form to register across all SST states. There is no cost for registration, and, if you qualify, filing is a free service across the SST states. SST volunteers have limited audit exposure (no negative audits possible). SST full member states include*:
- New Jersey
- North Carolina
- North Dakota
- Rhode Island
- South Dakota
- West Virginia
* Tennessee is recognized as an associate member state.
The Marketplace Fairness Act of 2013
On May 6, 2013 the U.S. Senate passed a bill known as the Marketplace Fairness Act of 2013 (MFA). This act grants federal permission for states to require collection of sales tax by remote sellers (such as Internet retailers, mail-order catalogs, or phone sales) if states adopt specific measures. The bill is currently before the House of Representatives, and a vote could come at any time. The White House has already indicated strong support and a willingness to sign it. If passed by the House and signed by the President, the bill will become law. For more information on this legislative activity, visit www.salestaxchanges.com.
The current version of the Marketplace Fairness Act sets a revenue threshold for remote sellers of $1M of remote sales revenue in the prior calendar year. Even if your business falls below $1M in revenue, it still is bound by standing state nexus laws, and their enforcement. Companies concerned with how their expansion might be impacted by federal legislation might look at SST as a means of building sales tax compliance into their business processes. Setting up on a sales tax infrastructure will make the transition to a post-MFA world easier. Even if federal legislation passes, sales tax rules will still vary widely from state to state, and from jurisdiction to jurisdiction. Some states may continue to have no sales tax, others will maintain complex jurisdictional and product taxability rules, and everything in between. As we’ve seen, taxes can apply to specific products, types of products, or thresholds for those products. Products or customers can be exempt from sales tax. Rates and locations change constantly, based on seasons, events, or holidays. Keeping current with the changes and getting filing done on time is time consuming and requires you to devote resources that could otherwise be generating more revenue for your business. And, if you’re audited, the cost to you in time, resources and money can be quite substantial.
Audits happen, protect your business
Audits can happen at any time, and over the last few years, state enforcement activities have risen dramatically. California and Washington have doubled the number of auditors in just three years. When you are audited, the auditor will want to see documentation of your sales, the sales tax you collected, and sales where you didn’t collect sales tax. Most ecommerce businesses do not have a sales tax professional on staff, and companies tell us they can spend weeks finding and preparing the information being asked for, and even more time in the audit review. The key areas auditors will focus on include tax rates on collections (jurisdiction and product taxability) as well as exemption certificates for ecommerce businesses that sell to end retailers.
Auditors often find errors in tax rates because rate calculations were based on ZIP codes. For the most part we find that these are responsible for the majority of errors and fines in sales tax audits of ecommerce businesses. Why? ZIP codes were designed for shipping, and not sales tax. You can learn more about complexity of state and jurisdictional boundaries at www.avataxrates.com.
Auditors also expect to see documentation including a copy of a sales tax exemption certificate for each sale exempted from sales tax. Many businesses being audited spend a great deal of time and effort to find or track down the exemption certificates they need to include.
During a review, the auditor may come back to you many times for more information or clarification, and the process can take weeks or months. After the review, any discrepancies and errors can be met with additional tax liabilities and fines, and it is more than likely that, once you’ve been audited, a state is likely to audit your business again in the following year or two.
The case for automating sales tax management
Not automated? Many small business owners either do their own sales tax remittance, or pay for bookkeeping or accounting help. There is a cost for doing it either way; in time, resources, accuracy and dollars. You may need to subscribe to tax content you can use on an invoice or line item level. You are responsible to know the changes that occur where you have to collect sales tax. Automate It! Technology services are available in the market to help businesses automate sales tax calculation. These range from on-premise servers to simple sales tax calculation using ZIP code downloads, to services that can integrate your systems and automate the whole process.
ZIP code-based solutions are based on US Postal ZIP codes, and while they may be adequate for simple tax states, they will leave you with compliance issues in states where sales tax is more complex. These solutions may require setting up your own server, administering, managing and updating subscription files on a monthly basis. They may also be provided as an add-on to payment or logistics systems. ZIP code-based solutions generally provide limited or no reporting or product taxability capabilities, and the providers of these solutions may not have adequate resources to support your systems or tax information. And when you have an issue, you may be charged per service call.
Cloud-based solutions eliminate the need for an on-premise sales tax server or infrastructure. With a cloud-based solution, you have no need to manage or update hardware, software or tax data. These solutions typically provide sub-second speed within the shopping cart (helping to avoid abandoned carts), and should provide out-of-box reporting with data accessibility and export capabilities. They should integrate with a business’s systems that generate quotes or invoices. Some services may use ZIP code tables or may not own their own tax data. This can make a difference in accuracy and support.
Periods of high growth, or upgrades or changes to your ecommerce site, provide good opportunities to explore how automating sales tax can help your business. Whether you are a small business selling in one state, a business expecting to be over the threshold for the MFA, or a company with nexus in multiple states, sales tax can be an opportunity for you. Automating sales tax transforms sales tax from a burden into a simple part of your business process, and a competitive differentiator. Automation results in far fewer resources devoted to sales tax and far less time devoted to sales tax compliance, and can substantially reduce your exposure in audits. Some Avalara customers even use sales tax as a promotional tool – with in-shopping cart tax free days or discounted tax days. Want more information on the best way to automate sales tax for ecommerce?