It is a fact of life that if you plan to run a business, then you must pay taxes. If you’re an online retailer, then you’re also responsible for charging sales tax to customers living in states where your business has a physical presence. This tax is then remitted to the relevant tax authority.
Filing taxes is a cumbersome process and online sellers will waste several hours trying to deal with compliance. If you’re new to the e-commerce business, let’s take a moment to understand what exactly a sales tax is.
Sales tax, by definition, is a ‘consumption tax’. It is charged when you buy goods or services. State and local authorities use this tax for things like roads, schools, and public safety. It is controlled at the state level. This means that each individual state can set down its rules and laws about administering sales tax. The only prerequisite is that they fall within the framework defined by the US Constitution.
Sales tax can vary in terms of the list of items that are taxable, the amount of sales tax charged, and the frequency and dates on which online sellers need to file these returns.
Some steps that can guide you through the process are as follows:
1. Determining Sales Tax Nexus
The word nexus means to tie or to bind. Having a sales tax nexus means your business is tied to the state under consideration and your requirement as a business owner is to charge this specific tax to buyers present in these states.
In the US, the following activities can create a sales tax nexus for your business:
- Location: Having an office, store, warehouse, etc., for your business in that state.
- Personnel: Having an employee, salesperson, contractor, or installer who is doing work on behalf of the business in that state.
- Inventory: Some states will consider inventory storage to cause nexus.
- Sales: The amount of revenue you generate in sales also determines the sales tax nexus in some states. The threshold for this is usually 100,000 US dollars annually. It can also be according to the number of transactions recorded, for example, 200.
- Affiliates: If a business affiliate advertises your products and shares in the profit made, this can create a sales tax nexus in some states.
- Shipping Relationship: If a third party ships products to your buyers, a nexus can be created.
- Sales at Trade Shows or Other Events: If you sell products on a temporary basis in a trade show or any other event, then this may create a nexus as well.
2. Verification of Taxable Products
The next step is verifying which products are taxable. Most tangible products are taxable in the US. This can include everything from furniture to toothbrushes and coffee mugs. However, items that are in the category of necessities may not be subject to taxes in all states. This can include:
- Groceries items
- Books, particularly textbooks or religious books
- Digital products (Music, movies, E-books)
Some states may exempt other items as well. For example, Ohio exempts the tax amount on precious metal coins. The price of the item can also determine whether it is taxable or not. In New York, clothing items with a price higher than $110 are not exempt from this tax.
3. Registration for a Sales Tax Permit
After determining how a sales tax nexus works and which products are liable for taxation, the next step is to register for a permit so that you can legally collect sales tax. Sales Tax Registration is managed by a state’s taxing authority. It is usually the State Department of Revenue.
You can register on your own or hire a professional to complete your sales tax permit registration for you. Registration for a sales tax permit will require the following information:
- Personal contact information
- Business contact information
- Federal Employer Identification Number (FEIN or Social security number (SSN)
- The entity of your business (Partnership, Sole proprietorship, LLC, etc.)
- Your NAICS Code
You may get your sales tax permit number instantly (when filing online) or might take at least 10 business days.
Note: Do NOT skip this step. Sales tax collection is considered illegal if you don’t have a valid permit. It may be a mistake in some cases, but some states consider this to be tax fraud and take serious action.
Other aspects of sales tax permit registration include:
- Due Dates: When you receive your sales tax permit, you will also receive a filing frequency as well as due dates for tax filing. The filing frequency can vary from a monthly, quarterly or an annual/semi-annual basis. The filing frequency can depend upon the amount of sales tax collected by the seller in a state. The due dates for tax filing will be different for each state. In most states, the due date falls on the 20th day of any given month.
- Resale Certificates: Your sales tax permit can also serve as a resale certificate in most states. This means that you can buy retail items and resell them without paying tax.
4. Setting up Sales Tax Collection from Buyers
Now that you’ve understood the various technicalities involved in sales tax collection, we can move to the main task – collecting the money from buyers.
In online retail, the shopping cart and marketplace lets you set up a sales tax collection feature. Some of the aspects involved in setting up sales tax collection include:
- Origin-Based and Destination-Based Sales Tax Collection: You will generally be required to collect sales tax from buyers through:
- Origin-Based Collection: Depending on the state, this requires you to collect sales tax at your business location. For example, if your business is based in Texas (an origin-based state), then the rate is determined in accordance with your location. Buyers in Texas are then charged that particular sales tax rate. This is a relatively simple form of tax collection.
- Destination-Based Collection: In this form of tax collection, you charge sales tax according to the location the product is being shipped to. As compared to origin-based tax collection, this is a little complex and requires you to calculate it according to the state, county and city where the buyer is located.
- Shipping taxability: Most online retailers will charge for shipping, and some states consider shipping to be a mandatory part of an online transaction. This is subsequently followed by a sales tax charge on the shipping amount. Other states consider shipping to be a separate charge and do not consider it to be taxable.
- Drop Shipping and Sales Tax: Drop shipping is when your vendor ships an item directly to a customer. This can be a profitable business model, but it can cause complications in sales tax collection. An example of drop shipping is if your website sells phone cases but uses a third-party company for design printing and shipping the product to the customer. If you notice there are several transactions happening here – your customer purchases an item from you, you purchase an item from your vendor, and finally your vendor ships that item to the customer– and if the vendor has a sales tax nexus in your state, they will have to charge you the required amount on the purchase, unless you provide them with a resale certificate. Additionally, if your customer is located in a state where you have sales tax nexus, then you will have to charge sales tax to the customer as well.
5. Sales Tax Reporting
After sales tax collection comes filing on the due date decided. This type of filing can be time-consuming. When filing a return, you don’t just need to determine the amount of sales tax collected from buyers in an entire state. Instead, you will have to calculate the amount collected in each county, city, and any other taxing district. This is important because states use these dollars to make payments for budget items like infrastructure and public safety.
However, they need to know which city or area to allot these funds to, and that’s where the additional breakdown of your transactions comes in. For some states, for example, origin-based states or those that have a single sales tax rate, the breakdown is not very difficult. This is limiting to only a few states, however, and breaking down transactions is extremely time-consuming, especially if you sell items through multiple channels and in high volumes.
6. File your sales tax returns
Most states allow you to file your sales tax online. Some may even make this mandatory. If you want to file manually, you will have to log in to the website of your state’s taxing authority. We recommend that you file your taxes a few days before the due date. This can help avoid problems that may occur with your filing and also give you time to deal with unexpected state idiosyncrasies.
For example, in Florida, the due date is the 20th of a given month after the taxable period. Florida, however, requires a seller to pay via an electronic funds transfer (EFT), and their payment should reach by the due date. Therefore, if you want to file on time, you will need to know the sales tax amount you owe and transfer the money to the Florida Department of Revenue a few days before the given due date. If you fail to file on time, there will be a fine of $50 with interest on the amount of sales tax you owe.
Other states operate under similar mechanisms and require sellers to file with interest if they are late. If you know you will be late in filing your taxes, some states allow a filing extension. However, this is not the case for most and a seller can still be fined in spite of being granted an extension.
If you’re late by accident and receive a penalty, then you can contact the taxing authority of that particular state and request for the penalty to be waived. This works if it’s the first time you’ve been late.
Outsourcing Your Tax Management:
Complying with the various rules and regulations attached to sales tax filing can be a resource-draining activity for any e-commerce business. If you feel like managing this is taking up too much time and energy and are still not sure that your reporting will be error-free, then you can consider outsourcing this activity and reduce the risk of errors and late filing penalties. Outsourcing also reduces the cost that comes with hiring a full-time employee for your accounting and tax filings.
Life after Taxes in an E-Commerce Business
Besides managing your sales tax, there are numerous other benefits of having an outsourced accounting team for your eCommerce business. After all, accounting is no longer just about completing tax returns and balancing the checkbook. The reality is that a growing eCommerce and digital business needs a monthly accounting department. Hiring a full outsourced accounting team with a modern outlook offers you proactive and real-time thinking that will increase the efficiency of your business and give you more time to focus on expanding and improving upon your core operation. With a team of experts working to bring your accounting division up to mark, turnover and disruption will no longer be your issue.
Finally, our services allow for the improvement of your cost structure and can help reduce your customer acquisition costs, costs of goods sold, and labor costs. All of these will ultimately result in greater profitability. You can lower the costs of your finance and accounting operations, gain faster access to reports and useful data, make better decisions, and improve the KPIs for your eCommerce business. Also, get tax advice and planning that will save you thousands of dollars each year.
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