Sales tax laws in the United States can give even the most financially astute small business owner a headache. A 2018 Supreme Court ruling only served to further complicate tax law compliance.
In June of 2018, the U.S. Supreme Court ruled that states can require the collection of sales taxes for online purchases, regardless of where in the United States the business is physically located. The South Dakota vs. Wayfair ruling is a reversal from previous rulings and legislation that said retailers must have a physical presence in a state in order to pay sales taxes there.
The ruling has been somewhat of a blow to small businesses with e-commerce shops selling to out-of-state customers.
Mike Trabold, Director of Compliance Risk at Paychex, writes that small e-commerce businesses are facing “significant incremental compliance obligation” because they will have to manage tax compliance in every state in which they make sales. As Trabold notes, 50 states means 50 different tax obligations.
That’s the frustrating aspect of the ruling for many businesses.
A Ruling Both ‘Sweeping and Vague’
The Wayfair ruling did not create one federal standard for the collection or remittance of sales taxes in the U.S. Instead, it was a “sweeping and vague” ruling that left a vast gray area that states, businesses, and policy experts are left to define, explains Andrew Moylan, Executive Vice President of the National Taxpayers Union Foundation.
With individual states — and sometimes cities — defining their own thresholds and standards for what constitutes a taxable e-commerce business, small businesses are struggling to manage their new obligations and regulations.
"What freaks online retailers out is less having to pay the taxes, and more having to manage the new burdens of thousands of tax jurisdictions, myriad filings, and compliance at a scale they cannot administer," says Stephen Culp, the Founder and Chairman of Chattanooga-based online furniture retailer Smart Furniture.
5 Steps Business Owners Can Take to Navigate Compliance
Many small businesses haven’t previously had to manage sales taxes for online sales at all. For those businesses, there simply aren’t processes in place to handle compliance. Here are some key steps you can take to help ensure you are meeting your online sales tax obligations.
1. Understand Where You Are Selling
Start by identifying into which states you are currently shipping products. Then, research what your tax obligations would be in each of those states (see below for more information). With varying thresholds across the states, be sure to track how much you must sell in goods and money before you’re obligated to pay state sales taxes.
2. Rank States in Order of Priority
Going state by state in your audit could be overwhelming. Break the work up into manageable pieces by prioritizing where you make the most sales. Learn your tax obligations in those states first, then move down your list.
3. Register in the States Where You Have Obligations
You will have to register your business in states that now require you to pay sales taxes. In most states, this will be done through the state’s department of revenue, or whatever entity is responsible for collecting sales taxes.
One piece of advice to save yourself some time when filling out your registrations: Memorize your NAICS codes and Sales Tax ID number, advises San Diego-based accountant Thomas Huckabee.
4. Collect Sales Taxes on Each Purchase
Check to see whether a state you are doing business in has origin- or destination-based taxation:
- Origin-based means the tax rate you apply to the sale must be the local rate where your business is located. Destination-based means the tax rate you apply to the sale must be the local rate where the product is being shipped.
- Once you start collecting those taxes, you will need to hold on to them until it is time to remit them to the state. You don’t need to remit after every purchase. It will be monthly, quarterly, or annually, depending on the state.
Consider setting up a separate bank account to hold that money safely until you have to send it in. Ryan Smith, Managing Editor at Bench Accounting, says this is the best way to keep that money safe and to avoid the temptation to use it for regular operating expenses.
5. File and Remit Taxes on Time
The most important thing you can do is file and remit your sales taxes on time. You do not want to be in trouble with a state over uncollected taxes. Failure to pay on time could result in penalties or interest charges for late payments.
How Businesses Are Ensuring Tax Compliance
To stay on top of their tax obligations, many small businesses are turning to technology and tax experts for guidance.
“Businesses operating in more than a handful of states must seriously consider automating the calculation and collection of sales tax as much as possible,” Donna Neilsen and April Meade at the accounting firm Katz, Sapper & Miller write. This reduces the pressure of trying to manually manage compliance.
Tax experts can also relieve some of the burden of compliance. Seeking a professional’s advice as you establish your state sales tax obligations is a worthy investment.
The worst thing you can do for your business is fall behind on state sales tax compliance. The Wayfair ruling certainly complicates things, but by proactively taking the proper steps to ensure you correctly collect and remit state sales taxes, you will help save yourself from even bigger headaches like financial penalties and IRS audits.
How States Have Responded to the Wayfair Ruling
The Wayfair ruling opened the door for states to collect tax revenue from businesses that participate in e-commerce. Now, business owners are all left wondering how that ruling impacts their businesses.
To get the answer to that question, you will have to dive into the sales tax laws of each state.
The first thing to know is that the ruling applies to any and all remote sellers, not just online retailers and domestic companies. Robert Peters, Mary Alice Cashin and Dustin Jensen at the corporate advisory firm Duff & Phelps note that “remote sellers cover a wide spectrum of business concerns outside the realm of the internet.” Some of those concerns, they explain, include drop shipments, international sellers, software as a service (SaaS), and wholesales.
The other key part of the ruling was the establishment of new economic nexus (or presence) thresholds. These are standards that the states can set to determine whether a business’ transactions in the state qualify for sales tax collection. The standard in the Wayfair case was $100,000 in annual sales or 200 annual transactions in the state.
Some states, like Colorado, Hawaii, and Illinois, have adopted the same economic nexus thresholds as South Dakota. Others have taken different approaches.
- In Georgia, sales thresholds are $250,000 or 200-plus retail sales to residents.
- In Washington, the sales thresholds are $100,000 or 200 transactions in the current or prior year. If a company doesn’t meet those, but its sales still exceed $10,000, the company has the choice to register and collect the sales tax or follow certain tax notice and reporting requirements.
- In Alabama, sales to residents of more than $250,000 qualify a company for sales tax collection.
In all, according to a map by financial advisory firm BDO, 43 states have enacted economic nexus thresholds as of September 1, 2019. Of the seven states that have not, five of those don’t have state sales tax: Alaska, Oregon, Montana, New Hampshire, Delaware. The two remaining states, Missouri and Floria, have not yet enacted thresholds.
Could a Single Federal Law Could Change All of This?
The ruling from the Supreme Court did not call for a federal standard, but Congress still could potentially create one. Congress has traditionally shied away from getting in the way of states collecting sales tax, however. At this point, says the team at corporate financial services advisory firm CBIZ, “there doesn’t appear to be much traction at a federal level around uniform sales tax rules.”
If and until that day comes, businesses must maintain compliance in all states where they have online sales that meet the economic thresholds.