Having an online presence instead of a physical storefront can save you from additional expenses like rent and utilities. But, there are certain taxes that online businesses can’t escape. As the owner of a U.S.-based ecommerce store, you need to understand your tax liabilities.
Follow internet business tax laws to stay compliant with applicable government agencies, like the IRS and your state. If you don’t pay taxes, you could end up with penalties, fees, or even a shut business. Understanding your tax responsibilities can free you up to focus on all the other pieces of running your business, so avoid getting bogged down with stress and unnecessary headaches about taxes.
Types of taxes for online businesses
When you start an ecommerce business, you must follow the same rules as any new small business owner. It can be helpful to have a conversation with a tax or accounting professional to help you make sure that you understand your full tax obligations, but here are the different business taxes you might need to know about:
- Estimated taxes
- Employment taxes
- Sales tax
You must pay estimated taxes and employment taxes the same way as a business with a physical storefront. Estimated taxes cover taxes like income and self-employment. As a business owner, you will probably be required to pay estimated taxes, unless you receive a salary and have taxes withheld on your behalf.
You can use the estimated tax worksheet from the Form 1040-ES instructions to determine your tax liability and to see if estimated payments are required. Estimated taxes are separate from sales tax and employment taxes. You pay estimated taxes from your income.
Employment taxes include federal income taxes, FICA (Social Security and Medicare) tax, and state and local taxes (if applicable). These are the taxes you withhold from an employee’s gross wages, and you make FICA contributions based on employee wages. You are also responsible for paying federal and state unemployment taxes (FUTA and SUTA) when you have employees.
Unlike estimated taxes and employment taxes, sales tax for online business does not work the same way as brick-and-mortar stores. You need to be familiar with rules for sales tax on internet sales and penalties for not collecting it. Learning about all your business tax obligations is important, but the rest of this article will focus on sales tax.
What is sales tax?
Before we break down the nuances of online sales tax, let’s get clear on sales tax basics. Sales tax is a pass-through tax imposed on customers in most states. That means a percentage of a sale is added onto the customer’s total bill. The customer pays the sales tax, but you need to collect, deposit, and report the tax.
Basically, your business is the middle-man between consumers and the government. You must tax consumers at the point of sale. The end user (i.e., the person who purchases the good or service and is not involved in its development) is responsible for paying the tax.
Retailers who buy and resell goods generally buy them wholesale. Wholesalers supply large quantities of products to retailers. Retail businesses then sell the products at a higher price than they paid. Because retailers register resale certificates, they do not pay sales tax when they buy products from the wholesalers. The retailer charges their customer sales tax when they sell the products. That way, the product is not taxed twice. It is taxed once when it reaches its end user, i.e., the retailer’s customer.
For example, Laura’s Little Table Shop buys wood wholesale to make their furniture. They have a resale certificate, so they don’t pay sales tax on the raw wood, but they do charge customers sales tax when they sell a finished table.
States can specify which items are taxable. For example, Pennsylvania taxes food and beverages at establishments like restaurants, but not at grocery stores.
States can also determine whether there is sales tax and what the rate is. Using Pennsylvania as an example again, its sales tax rate is 6 percent (there is an additional local tax in Allegheny County and Philadelphia).
There are five states that do not charge sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Hawaii also does not charge sales tax, but they have a General Excise Tax (GET) that is applied to all sales.
Both brick-and-mortar and online businesses could have a sales tax responsibility. But, internet business tax laws can be more complicated.
Sales tax on internet sales
Operating an online store gives you freedom—you can sell products to anyone across the nation. But, with that freedom might come confusion about sales tax. Many internet retailers are unsure about when they need to collect sales tax from customers since they conduct business in multiple states.
To determine online sales tax, you must ask yourself two questions:
- In which state(s) do I have nexus?
- If a customer makes a purchase from a state where I have nexus, which rate do I collect at (my locality or theirs)?
Read on to learn about nexus and origin versus destination sales tax.
Online businesses depend on nexus to determine when and how much to collect for sales tax. Nexus is an ecommerce store’s presence. Where is your business present? Your home state (where you conduct business) has nexus when conducting sales online.
Despite the fact that you don’t have a brick-and-mortar store, you might still have nexus in other states if:
- You have an office in the state
- An employee is located in the state
- You store your inventory or assets in the state
- You use a third-party provider to ship orders to customers, and they are located in the state
- You or an employee attended a trade show in the state within the last 12 months
For example: Let’s say your home office is in Ohio, your inventory is in New Jersey, and you have an employee in California (talk about having a presence from coast to coast!). You have nexus in Ohio, New Jersey, and California.
You will collect sales tax from customers in Ohio, New Jersey, and California.
You sell to a customer who lives in Ohio, which is the same state as your home office. You would collect sales tax from them. And, you have a buyer who lives in Texas. Since you have no nexus in Texas, you do not need to collect sales tax from the customer.
Origin versus destination sales tax
For the states you have nexus in, you then need to find out whether you must collect destination or origin sales tax. First, find out the sales tax rate you need to collect for your home state.
Origin sales tax
Origin sales tax is when you collect based on the seller’s location. However, you still remit the tax to your home locality or state.
There are fewer states that use origin sales tax than destination. These are the states that use the origin-based method.
Let’s say your home office is in Phoenix, Arizona. You have a buyer in Tucson, Arizona. You would collect the Phoenix, Arizona sales tax rate of 8.6 percent instead of the Tucson rate of 8.1 percent because your home state is origin-based.
Destination sales tax
Destination sales tax is when you collect based on the buyer’s location.
Destination-based sales tax is more popular than origin-based. These are the states (and Washington D.C.) that use the destination-based method:
Let’s say your home office is in Buffalo, New York. You sell to a customer from New York, New York. Use New York, New York’s sales tax rate of 8.875 percent instead of Buffalo’s sales tax rate of 8.75 percent since New York is a destination state.
Origin and destination sales tax rules don’t stop there. Next, you need to think about the nexus you have in other states aside from your home state.
For example, if you have nexus as a result of employees or warehouses in other states, you need to know the origin versus destination sales tax rules for remote sales made from state to state.
You are a remote seller if you have nexus in a state, but your home office is not based there (i.e., a warehouse).
The states that are destination- and origin-based are a little different for remote sellers. Most states use destination sales tax for remote sellers.
Let’s say you have a home office in Utah and a warehouse in Ohio. Your customer lives in Ohio. Ohio considers you a remote seller, so it would go off the destination method. You would collect at the Ohio rate and send the sales tax to Ohio.
Sales tax permit
Make sure you have a sales tax permit for the states in which you have nexus. To obtain the permit, contact your state tax agency.
You will need to provide your Employer Identification Number (EIN) and business information. Keep in mind that the information you need to obtain a sales tax permit varies by state.
Once you have a sales tax permit, you can begin collecting the tax from applicable customers.
Sales tax exemptions
Sometimes, states have sales tax holidays. These are days where customers can make purchases without having to pay sales tax.
If you are required to collect sales tax for a state that is having a sales tax holiday, do not collect during that time.
How to report and pay sales tax
Keep track of the sales tax liability that you remit to your state. Your state will determine your due date and give you directions on how to file sales tax.
You must collect the sales tax at the point of sale. But, you do not immediately send payment to your state or local government.
Typically, your filing frequency depends on the number of sales you make. If you have a high volume of sales, you will pay more frequently than a business with a lower volume of sales. Filing frequency can be monthly, quarterly, or yearly.
You are also responsible for reporting sales tax to the applicable agency. This lets the government know how much they should receive from you. Reporting can range from monthly to yearly.
Check with your state for your sales tax responsibilities and frequencies.
Consequences of not paying sales tax
As an online business owner, you need to be diligent about sales taxes. Failure to collect and remit sales tax to the appropriate government agency can result in audits, penalties, fees, or even criminal charges.
Again, sales tax is a pass-through tax. You just need to know and understand the laws of nexus and origin- vs. destination-based sales tax, as well as your state and local rules.
If you don’t collect sales tax from customers, you will be responsible for paying the amount owed. Say you were supposed to collect a total of $10,000 in sales tax from all your customers. You can’t go back and charge each customer their portion of sales charge—the total amount falls on you.
There are ways to make sales tax collection easier. A shopping cart solution will automatically calculate and collect sales tax. Many of these solutions even run reports so you know how much you have collected in sales tax.
Examples of sales tax omission
Not collecting and remitting sales tax can be detrimental for businesses. Since rules are extra confusing for online businesses, you need to be diligent.
Physical business example:
You might have heard about the recent controversies with Uber surrounding repayment to its New York drivers. In case you aren’t familiar with Uber, it is essentially a taxi-service company.
Though not an online retailer, Uber wasn’t charging customers (aka, the passengers) the New York rate of 9 percent sales tax on their rides. Instead of adding sales tax to the total bill, the controversy is that Uber had been taking the sales tax rate out of driver commissions.
Now, Uber may be forced to pay millions to its drivers to cover the cost of the sales tax that was taken out of their commissions.
Online retailer example:
According to one source, a couple wanted to sell their Amazon Store, but they had never collected sales tax while being in business (18 months).
Before they could sell their store, they needed to settle their sales tax liability, as the potential buyer did not want to be held responsible once the store was his. The sellers and buyer calculated that the business owed about $70,000 in uncollected sales tax.
As a result, the couple paid $70,000 out of pocket. This substantial payment could have been avoided had they followed sales tax laws.
Navigating sales tax can seem overwhelming; there are so many rules to follow and obligations to meet. Contact your state with any questions, and research shopping cart solutions that can calculate and collect sales tax for you.
In a nutshell, here’s what you need to do:
- Set up your online business
- Determine your business’s nexus, whether applicable states are origin- or destination-based, and the sales tax rate(s)
- Get a sales tax permit
- Collect sales tax from customers each time they make a purchase
- Pay attention to sales tax holidays
- Report and pay sales tax
As a business owner, you need to stay organized. Keep track of your sales tax deadlines by using a calendar and setting reminders.
Many states have tax filing deadlines on their state websites. And, you can even sign up to receive tax alerts like filing reminders (via email or text message) in some states, such as Ohio and Virginia.
Once you understand state laws on sales tax, as well as the rules on nexus, collecting and remitting sales tax won’t seem so stressful.