Internet sales tax

Internet sales tax: Definition, types, and examples

If you’ve ever sold an item in a store in the United States, we’re willing to bet you’ve managed the collection and payment of sales tax. Of the 50 United States, 43 states and Washington, D.C. charge some amount of sales tax on in-person purchases.

When it comes to e-commerce, however, the rules are a bit different, and remote sellers need to keep an eye on regulations. For years, online retailers weren’t required to charge sales tax for states in which they were not located. Savvy shoppers flocked to online sellers to purchase items sales tax-free. However, as online sales continue to grow exponentially and in-person sales dwindle in the face of the COVID-19 pandemic, sales tax laws have changed.

What are sales tax and internet sales tax?

Sales tax vs. internet sales tax

In a way, you can think of these two taxes as siblings. Are they related? Yes. But do they have some differences? Definitely. Let’s look at both definitions and when they’re used. 

Sales tax definition

Sales tax is a type of tax known as a consumption tax, meaning a tax on the purchase of goods or services. As a small business owner, you already know that sales tax collection doesn’t go into your pocket. Instead, you must pay the sales tax collected from your customers to the government.

Internet sales tax definition

Internet sales tax is a type of tax known as a sales and use tax. This type of tax takes place when sales are done online or from a remote location. Again, these taxes are not pocketed. Instead, they are paid back to the government. Now let’s find out how much internet sales tax will cost you.

What is a sales tax nexus?

A nexus is a physical presence. Wherever your business’s physical presence is, you are considered to have a sales tax nexus. However, a nexus does not only refer to your business’s physical location, like an office or a storefront. It can also be applicable in the following situations:

  • An employee selling your goods in another state
  • An affiliate selling goods on your behalf in another state
  • Sales at a trade show or other event in another state
  • A state in which you store your inventory, even if you have no employees there
  • A state in which your drop shipper is located
Economic nexus is determined when a business surpasses a threshold of revenue and/or transactions generated in the state.

Sales tax nexus example

If you’re a Colorado business owner who is selling goods physically in Massachusetts, then you have a sales tax nexus in Massachusetts, whether or not you have a brick-and-mortar in that state. That means you’ll need to charge customers who purchase goods from you in Massachusetts the Massachusetts state sales tax and pay it to the government.

When do you collect sales tax? 

Sales taxes are collected at the point of sale. Some services, like QuickBooks, even track sales tax whenever you make the sale. In fact, QuickBooks performs several functions:

  • Determines taxable items
  • Calculates how much sales tax you owe
  • Helps you pay down your sales tax

The 3 types of sales tax

The three types of sales tax are seller privileges, consumer excise, and retail transaction tax. Sales tax isn’t one-size-fits-all and different types embody different privileges. There are three types that you should know about:

  1. Seller privilege taxes: For retail sales within the state, these are for the privilege of retail sales within state lines by the seller. 
  2. Consumer excise taxes: For retail purchases in the state, these are for the privilege of retail sales by the buyer.
  3. Retail transaction taxes: For both the seller and buyer on the main retail transaction. Sellers collect the tax, while consumers pay however they are passed onto the state by the seller.

The evolution of internet sales tax law

The evolution of internet sales tax law.

Now that we understand the basics of sales tax, let’s get into the nitty-gritty. According to the rules of a sales tax nexus, there needs to be at least some sort of physical presence in a state to charge sales tax in that state. As an online retailer, you likely sell goods in states across the U.S., where you have no physical presence whatsoever. This begs the question: Do you have to charge sales tax for e-commerce sales?

To answer this question, we’ll look at two U.S. Supreme Court cases: Quill Corp. v. North Dakota and South Dakota v. Wayfair Inc.

Quill Corp. v. North Dakota

For decades, the application of state tax to online sales was prohibited by a 1992 ruling known as Quill Corp. v. North Dakota. Here was the outcome:

  1. The Supreme Court ruled that a state could not require a business to charge sales tax unless that business had a physical presence in the state. 
  2. Instead, customers were expected to pay taxes to their state on any purchases they made from businesses outside of their state. This is what’s known as “use tax.”
  3. However, the use tax is not closely monitored. In response, states argued that they were losing significant amounts of money, especially as online sales overtook in-person purchases. Many felt it was unfair that online giants such as Amazon were not required to charge their customer’s sales tax.

South Dakota v. Wayfair Inc.

These issues intensified in a 2018 case between Wayfair Inc. and the state of South Dakota, with the introduction of a concept known as an economic nexus. An economic nexus is determined when a business surpasses a threshold of revenue and/or transactions generated in a state.

As a result of the Wayfair decision, states can now require businesses to charge and pay sales tax to states in which they don’t have a physical presence, as long as they have an economic nexus. If they generate an amount of revenue or number of transactions that exceed a limit determined by the state, they are considered to have an economic nexus. This means they’ll need to charge and pay state sales tax.

This can get quite tricky, however, as each state has the ability to determine its own threshold for an economic nexus.

How to stay sales tax compliant

To ensure that your online business is sales tax compliant, you’ll need to understand the rules of every state in which you sell goods.

For most states, you can simply consult their websites to confirm their economic nexus laws, if any. As of 2019, 43 states and Washington, D.C. have economic nexus laws.

43 states and Washington, D.C. have economic nexus laws.

State-specific considerations

There are a handful of states that have different standards around tax compliance laws.

States that do not have economic nexus laws are:

  • Florida
  • Missouri

States that do not have sales tax or economic nexus laws are:

  • Alaska 
  • Delaware 
  • Montana 
  • New Hampshire 
  • Oregon
States with no economic nexus laws

Other states where economic nexus varies

Some other states’ economic nexus laws vary. For instance:

  • Minnesota, Wisconsin, Maine, Vermont, and Indiana’s economic nexus threshold is either $100,000 in sales or 200 or more retail transactions.
  • New York has one of the highest economic nexus thresholds. To be considered an economic nexus, a company must have both $500,000 in revenue and 100 transactions in the state.
  • Tennessee and Pennsylvania consider the previous 12 months to determine an economic nexus, rather than the calendar year.
  • Kansas is the only state in which all out-of-state sellers who have a transaction in the state are considered to have an economic nexus.

As a seller, the assessment of sales tax rules and states in which you have an economic nexus is your responsibility.

As a seller, the assessment of sales state tax n which you have an economic nexus is your responsibility.

You must cross-reference your sales by state with each state’s economic nexus requirements to determine where you meet the threshold. In states in which you have an economic nexus, you must register as a seller by applying for a tax permit. Finally, it is your responsibility to charge online sales tax according to the state’s requirements and pay it to each state’s department of revenue on a regular basis.

If you want to ensure you’re doing everything right, let us do the hard work. QuickBooks now automatically calculates sales tax so you don’t have to. We’ll spare you the headache, and save you time that you can instead spend on running your business.

What to do if you get audited

If your small business is audited for sales tax compliance, it doesn’t necessarily mean you’ve done something wrong. It may simply be your turn to be examined.

Nonetheless, an audit is a process that should be taken seriously. See the basic steps of the process below:

1.Record request: You’ll need to show thorough business records, including:

  • Sales and purchase records
  • Bank statements
  • Sales tax returns

2.Review and report: An auditor will review all of your information. They’ll return a report to you with any issues they may have found in your documentation. 

3.Respond and update: You’ll then be able to respond to that report and provide additional information as needed. This process will continue until the auditor is satisfied with your answers.

4.The final report delivery: The auditor will deliver a final report, known as the proposed assessment. This report details their final findings and any additional state tax payment you may owe. 

5.Pay or object (if needed): You can either object to the findings or choose to pay.

It’s best not to go through a tax audit alone. If your small business is notified that it’s being audited, consider reaching out to a tax professional for advice and oversight. They can help you get all the necessary documentation together to prove that you’ve been following tax policy law.

Covering your internet sales tax bases

Whether you’re just starting out or are an established small business, sales tax is something you need to take into account. That’s where QuickBooks comes in—we automate the sales tax process and take the burden of collection and calculation off your plate. 

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