While some states like Oregon do not have sales tax requirements, other states, like Washington, double down with both statewide and local sales taxes. Washington’s state sales tax of 6.5% combined with local taxes can total as much as 10.4% depending on the municipality, creating a sizable figure for businesses selling in these areas to manage.
As an e-commerce owner, you need to understand what your sales tax obligations are, determine how shipping costs factor into the mix, and practice crucial oversight.
A 1992 Supreme Court ruling dictated that states could not require online retailers to collect sales tax unless they had a physical presence in the state. A physical presence (also known as a “nexus”) was defined as having a storefront, office, or warehouse within a state.
However, a 2018 ruling (South Dakota v Wayfair) overturned that precedent. As a result, states are now allowed to require e-commerce businesses to collect and pay sales tax regardless of their connection to a state if they are selling to customers there. In 2017, even before the legal landscape changed, Amazon became one of the first major online retailers to adopt this practice to circumvent possible legal issues.
Unlike use tax, the burden of reporting and remitting sales tax falls on the retailer, which adds significant complexity to their online operations. Some states have exemption provisions for micro retailers (for example, those with fewer than 200 transactions annually) because they are not capable of handling this kind of tax compliance burden. All other businesses, however, must either familiarize themselves with the tax law for everywhere they sell to, or use a tax software like TaxJar to manage it on their behalf.
E-commerce businesses that automate their sales tax collection can (and should) use a sales tax calculator to spot check their calculated rates. Letting tax rate calculation errors linger opens a business up to fines and penalties and makes the eventual resolution of these errors more costly.
Even e-commerce businesses that have a good handle on how to charge sales tax correctly across various states can still get tripped up by how shipping affects sales tax calculations.
Should you charge sales tax on shipping costs?
The answer, like everything else about calculating e-commerce sales tax, is complicated. The short answer is maybe. Shipping charges are taxable in some states and not taxable in other states.
In states that have tax-exempt products, what you are shipping may be the deciding factor. But what if you are shipping some taxable products and some tax-exempt products (also known as a “mixed shipment”)? Sales tax is usually applied on top of shipping fees for mixed shipments, but some states further muddle the issue by requiring that sales tax only be applied to the shipping fees related to taxable products. This requirement necessitates a complicated method of dividing up the shipment by weight or price to isolate shipping costs for taxable items and calculate tax on them.
Furthermore, taxes on shipping costs are typically only applicable when the products are being shipped by carriers, not the sellers themselves in private vehicles. Additionally, if customers are given the option to pick up products (even if they do not take advantage of this option) the shipping cost is typically considered extricable from the cost of the product itself, which means sales tax may not need to be charged on it.
While “shipping” and “shipping and handling” may seem to be used interchangeably by e-commerce business, some states perceive the difference as more than just semantics. In some states, “shipping” costs are viewed differently than “shipping and handling” costs, with one being tax-exempt and the other being taxable.
Nuanced tax requirements related to shipping add a layer of complexity, further necessitating the use of a reliable tax software that ties into your accounting and e-commerce software platforms. Businesses with high volume sales or those with more complicated ongoing operations benefit most from outsourcing their accounting requirements altogether to offer a scalable solution to these tax intricacies.
Much of the confusion around e-commerce sales tax obligations stems from the fact that sales tax law was passed before the advent of online selling. Trying to take something meant for mail order purchases with freight delivery and applying it to online ordering is complicated. The earlier e-commerce precedent that required a nexus within a state to necessitate sales tax compliance was more limited in its reach than the 2018 verdict. This change has significantly broadened the scope of sales tax requirements, which is further complicated by the rise of selling through online distributors like FBA (Fulfillment By Amazon).
Some online retailers are so overwhelmed by sales tax rules that they just charge higher sales tax rates across the board for fear that they will undercharge customers and be on the hook for remitting more money than they collected. These businesses typically just hand over reporting and remittance responsibilities at the end of the year to a tax preparation professional to let an expert sort it out. However, this is not a best practice. While state tax authorities will certainly get involved if they discover that a business is selling taxable products and not collecting tax, they also have recourse if businesses are benefitting from charging sales tax incorrectly (either knowingly or unknowingly).
Tax law is constantly changing, which is why sales tax calculations, reporting, and remittance should be overseen by a professional that can verify accuracy and help anticipate tax challenges to mitigate business risk. Some business owners indicate that they do not want to pay for a bookkeeper or accountant to oversee this process. However, it will almost certainly be less expensive to do so than it will to pay back-owed taxes and the subsequent fines and penalties that can result when tax mistakes occur.
Find out more about other unique accounting considerations and complexities in our ongoing e-commerce bookkeeping blog series!
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