The e-commerce sector has grown significantly in the last few years, and both new businesses and established retailers have moved toward developing online businesses to sell their products and services. Recent research from Statista tells us the U.S. e-commerce market has already reached $4.9 trillion—and could grow to $7.4 trillion by 2025.
Image from statista.com
As the e-commerce market continues to grow, so does the complexity of the tax regulations surrounding online sales. Now, more than ever, small e-commerce business owners need to be aware of their obligations to avoid penalties and fines.
In this article, we'll give you an overview of e-commerce sales tax in the U.S. and the common factors that affect this. We'll also provide tips on how to stay compliant and some advice for those doing business in the UK.
What is e-commerce sales tax?
E-commerce sales tax is a tax that online retailers must collect (and remit) on sales made through their web-based platforms. This is similar to the sales tax that physical retailers pay to their respective states and local governments.
Yet e-commerce sales tax can be more complicated than its traditional counterparts. While it's similar to retail sales tax, it can involve multiple jurisdictions and tax rates, making it harder to keep accurate records. This is especially true for small and newly established businesses.
It works differently in the UK. The British government applies a fixed 20% VAT (value-added tax) to most goods and services sold. However, some products, such as children's car seats, are eligible for a reduced rate of 5% and others are classified as zero-rate products and are completely exempt.
If you're doing business in the UK, it's worth looking into this in more detail to see what VAT level applies to the products or services you sell.
Common factors that affect sales tax
When you run an e-commerce store, many factors may affect the tax you collect and pay across your business. Here are some of the most common:
Local sales taxes
Each state has a sales tax rate, and some cities and counties will also impose an additional tax. This means the sales tax rate can vary based on the customer's location.
For example, New York State's standard tax rate is 4% but can vary between 0-5% locally. So, a business that sells a product for $110 in New York City would need to collect $4 in sales tax. Meanwhile, the same product sold in Buffalo, New York, might cost $3.75 in sales tax.
Image from salestaxinstitute.com
This is not something that UK-based businesses have to deal with. The UK applies a standard rate on most goods and services regardless of where they're sold in the country.
The physical presence of your business
In the past, businesses were only required to collect sales tax in states where they had a physical presence, such as a store or warehouse. However, this changed with the Supreme Court's decision in South Dakota v. Wayfair, Inc. in 2018.
This ruling means states can now require businesses to collect sales tax even if they have no physical presence there. This kicks in anytime they sell a product above a defined threshold. In our example of New York above, the threshold is currently $110 per sale. It may also apply if you meet a certain overall revenue threshold from sales in the state.
A marketplace facilitator
Many e-commerce platforms, such as Amazon and Etsy, offer a "marketplace facilitator" program. Under this, the platform is responsible for collecting and remitting sales tax on behalf of sellers.
This means that if you sell products on a marketplace facilitator platform, they are considered the reseller for local tax purposes. So, you will not be responsible for collecting and remitting sales tax. Again, though, the rules can vary locally for marketplace facilitators.
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State economic threshold
Each state has its own threshold for when a business is required to collect sales tax. For example, in most states, businesses are required to collect sales tax if they have more than $100,000 in sales or 200 transactions in the state.
However, in some areas like Texas and California, the threshold is $500,000. Small business owners should be aware of the economic threshold in each state where they sell products.
Sales tax source point of origin or destination
As we said. The thing that makes it challenging for e-commerce businesses to stay on top of tax regulations is the fact that these laws can vary significantly by state. For example, some states have what's known as a "destination-based" sales tax. This means that the tax rate charged is based on the buyer's location rather than the seller's location.
Other states have an "origin-based" sales tax, meaning that the tax rate charged is based on the seller's location. To make things even more complicated, some states have both types of taxes.
It depends on the specific product or service being sold. Some states even have different tax rates for different types of goods, such as clothing, electronics and food. To explain this, let's return to our earlier example of New York's tax laws.
In 2010, New York's prepared food tax came to public attention when it affected New Yorkers' favorite snack, the bagel. That's because buying a whole bagel, or a bag of bagels wasn't subject to sales tax. Yet, purchasing a bagel with a schmear was.
Why? That's because "preparing" the bagel (in this case, adding the schmear) made it a different product for tax purposes. It goes from being unprepared food to prepared food. To cut a long story short, prepare your own bagels if you want to pay less in sales tax.
This can be incredibly confusing, especially when you're also trying to manage cash flow, inventory and marketing. This is why working with an experienced accountant or tax professional is important. They can help you determine which taxes apply to your business and ensure you collect and remit the appropriate sales tax amount for each transaction.
How to stay compliant with e-commerce sales tax
Now that you understand the factors that affect sales tax in e-commerce, here are some tips to help you stay compliant:
Be educated about where you have sales nexus
It's important to know which states you have a sales nexus– the thing that determines where you need to collect and remit sales tax. You can determine your sales nexus by reviewing the common factors that affect sales tax.
That means things like your physical presence in a state, your sales volume, and your use of a marketplace facilitator. You can also consult with a tax professional to help you identify your sales nexus.
Obtain selling permits for states you will be operating
Once you determine your sales nexus, you will need to obtain selling permits for those states. You can typically apply for a selling permit online or by mail, and you may need to provide certain information about your business and your sales activities.
Keep in mind that each state has its own requirements for selling permits, so it's important to research the specific requirements for each state where you have sales nexus.
Keep an organized record of your sales for tax purposes
Whether you're paying tax in the UK or in the U.S.it's going to be a lot easier to do so if your sales records are well-organized. Using the right software for accounting for retail business can make all the difference.
It can provide instant access to your records, along with real-time data on your tax liabilities. This means you can plan ahead, stay compliant and meet all tax deadlines.
You'll also be able to improve collaboration with your accountant or bookkeeper - big help when you're trying to navigate the complex world of sales tax.
Stay updated about new laws related to e-commerce
E-commerce sales tax laws are constantly changing, so it's important to stay up-to-date on new developments. This can include changes in sales tax rates, sales tax nexus rules, and changes in reporting requirements, like HMRC's scheme to digitalize tax.
It's up to you to stay informed of any changes that might affect your business. If you're based in the U.S.you can subscribe to IRS Tax Tips or state tax newsletters. For UK-based businesses looking into Making Tax Digital software can go a long way towards keeping your business compliant with all changes.
Image from sage.com
One final tip for e-commerce businesses is to be proactive in addressing any issues or concerns related to sales tax compliance. If you have questions or concerns about your obligations under state and local tax laws, reach out to a tax professional or government agency for guidance.
By taking a proactive approach to compliance, you can ensure that your business is in good standing and avoid potential penalties or legal issues down the road.
Understanding sales tax
Understanding the rules and regulations surrounding taxes for e-commerce can be overwhelming. Yet, for a small business owner, it's an essential part of running a successful e-commerce store.
Familiarize yourself with the common factors that affect sales tax and stay compliant with tax laws. That way, you can avoid business tax penalties and keep your business running smoothly. Remember to always consult with a tax professional if you have questions or concerns about your tax obligations.