This article was published in the Winter 2021 issue
by Brittany Brown, Founder and CEO, LedgerGurus
There is nothing more annoying than taxes, and no business tax is more annoying than sales tax. No founder starts their business so they can spend time calculating and paying taxes. The burden of sales tax increased significantly in 2018 with a Supreme Court ruling, and the compliance risks are greater than ever with the COVID recession. Painful as it is, every business selling online needs to understand the growing risks and act accordingly.
Our Reluctant Journey to Sales Tax
LedgerGurus has been an outsourced accounting service provider since our founding in 2014. Like so many doing business online, we wanted nothing to do with tax. In 2017, we decided to specialize in businesses selling online, in particular those doing ecommerce. Avoiding income tax was easy, as there are thousands of CPA firms doing that. Sales tax was less easy to avoid, but not as big a deal at the time thanks to the laws exempting sellers from sales tax. That all changed in 2018 with South Dakota v. Wayfair.
South Dakota v. Wayfair was a 2018 Supreme Court Ruling that opened the doors for states to require sales tax on business based on economic activity alone which affected online sellers significantly. States were relatively nice about the compliance requirements initially, but we are seeing a shift with the COVID recession.
Sales Tax and the COVID Recession
Many states have seen tax revenue declines with higher unemployment and lower economic activity. One way they are attempting to increase revenue is through targeting out-of-state online sellers. If you’ve been avoiding online sales tax, we get it. Sales tax compliance is messy, it’s complicated, it’s annoying. But it’s been devastating for us to see businesses pay sales tax owed from previous years and associated penalties, and pay it all out of pocket. We want to help by outlining some of the basics you should be aware of when it comes to sales tax compliance in 2021.
What you Need to Know About Sales Tax in 2021
The three most common questions we see from businesses selling online fall within the following:
- In what states do you need to register for a sales tax permit?
- When do you need to collect sales tax for online sales?
- What do you do with the collected sales tax?
In What States do you Need to Register for a Sales Tax Permit?
Before collecting sales tax from customers, you must have a sales tax permit from the state in order to do so. You can register for a sales tax permit at the Department of Revenue website for each state. So, in what states do you need to register?
The short answer is that you are required to register in any state where you have sales tax “nexus”. Sales tax nexus is just a fancy way of saying you have some sort of business activity in that state, so they require you to register for sales tax.
The most common forms of sales tax nexus are “physical presence” and “economic nexus” (the result of South Dakota v. Wayfair):
- Physical presence – States where your business is registered, owners/employees live, inventory is stored, etc.
- Economic nexus – States where you have a lot of sales or transaction. The economic thresholds vary, but a common level is when you reach $100K in annual sales or 200 annual transactions into a particular state. You’ll definitely want to check a state’s specific economic nexus thresholds when you approach those levels, as they differ by state.
There are other sales tax nexus laws, but these are the main ones that you should worry about. Once you have sales tax nexus and have a sales tax permit, now you need to know when to collect sales tax for online sales.
When do you Need to Collect Sales Tax for Online Sales in 2021?
You only need to look at collecting sales tax in the states where you have nexus. In those states, you need to determine (1) if your product is taxable and (2) if you or the site you sell on is responsible to collect sales tax from customers.
Product Taxability
The taxability of your product will differ by state. For example, any clothing sold and shipped to New York with a price tag under $110 is exempt from sales tax. So, if you have sales tax nexus in New York and you sell clothing, you’ll only need to collect sales tax if the clothing is priced over $110. But in other states where you have sales tax nexus, you may need to collect sales tax for clothing sold under $110. At the end of the day, you’ll want to check the taxability of your products in any state where you have sales tax nexus.
Who collects the sales tax?
In states where you have sales tax nexus, you likely only need to worry about collecting sales tax on your own site (Shopify, WooCommerce, Wix, etc.). If you sell on a third-party marketplace (Amazon, Etsy, Ebay, etc.), those sites are required to collect and remit sales tax for its sellers in all but three states as of 2021. Those states are KS, MO, and FL. So, you’ll still need to collect and remit sales tax for sales into those three states on marketplaces.
To sum this section up, you need to collect sales tax for sales in states where (1) you have sales tax nexus, (2) your product is taxable, and (3) your sales are on your site or a third-party marketplace site in KS, MO, or FL. Then you can setup sales tax collection on all your necessary sales channels and products.
What do you do with the Collected Sales Tax?
The sales tax you collect from customers is not your money! We recommend holding these funds in a separate bank account so you don’t spend it. Make sure you are tracking those sales tax liabilities correctly on your balance sheet.
Each state has different deadlines for filing and remitting your sales tax. In general, the more sales tax you collect, the more frequently you’ll need to file and remit sales tax. Your sales tax filing will include your total sales in that state, how much of those sales were taxable, and the final sales tax amount being paid.
Fearmongering versus Risk Management
Let’s agree that the sales tax environment is a mess. The cost of compliance is unreasonable: especially for smaller businesses. It needs modernization to reflect the ever-increase of online sales. Those of us supporting businesses with sales tax can be seen as doomsayers only seeking an opportunity to increase our services. There is definitely some of that, but there is also a lot of increased risk for businesses who don’t play by the rules.
With state tax revenues down, we see some concerning behaviors including:
- Increased sales tax audits by state tax commissions
- Information sharing between states to identify businesses who aren’t registered in their state
- Information sharing from marketplaces like Amazon to identify sellers in their state
- States buying business lists of online sellers to question if they have economic nexus (including Utah)
With these risks, we end with some key recommendations for any business selling online:
- Understand your nexus and when you need to register
- Never collect sales tax unless you intend to register and remit
- Register wisely balancing the cost of compliance with the risk of non-compliance
- Use tools to automate as much of the sales tax process as possible
- Work with sales tax experts to help you navigate these issues
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