Making Online Sales Tax Compliance Less Taxing

While many e-tailers may be fretting about the April 15 deadline for income tax filing, the real challenge for online business owners is navigating — and complying with — the confusing and complex laws governing day-to-day sales taxes. To help you, we spoke with Marshal Kushniruk, executive vice president of customer experience and strategic accounts for Avalara, a Web-hosted sales tax management services company, who provided us with tips and resources for tax topics related to e-commerce.

Sales taxes for Web shop owners are actually an everyday challenge, as online businesses are generally required to calculate this tax for every transaction, said Kushniruk. In fact, most e-store merchants are required to file and remit sales tax to states on either a monthly or a quarterly basis (depending on how much revenue your business generates).

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"The reality is that the pain of sales tax happens every day whether you know it or not. It really isn't a seasonal activity, and therefore has no correlation to 'tax season,'" he said.

To that end, he offers eight tips for e-tailers, covering your responsibility for sales tax, knowing where you are liable, or understanding nexus, recognizing exemptions, how to correctly calculate sales tax, accounting for use-tax, how to manage your tax calculations and prepare for an audit.

1. Understanding your Responsibility for Sales Tax
It's a myth that e-commerce companies are required to collect and remit sales tax in every state. "They're only required to pay sales tax if they have nexus in that state," said Kushniruk, "which leads us to understanding nexus."

2. Making the Nexus Connection: Know Where you are Liable
According to Avalara's nexus documentation, just simply making a sale in another state does not necessarily mean that you have a sales tax obligation. There are many rules involved that you need to consider first. These rules are created by the states and define when a business has a connection to that state. This "connection" is also called nexus.

When you have created nexus in a state, you are required to calculate, collect, report and remit that state's sales taxes every time you make a transaction there. This is why you pay sales taxes based on where your business is located. The building where your organization is located creates nexus. But besides a physical structure there are many other ways to create nexus.

"Nexus rules vary from state to state, but are typically based on a physical presence in a state, such as do you have property in a state, do sales representatives reside in a state, or do you participate in tradeshows within a state," said Kushniruk.

Kushniruk offered the following scenarios: If you have stores in multiple states, you have sales tax obligations in each location. You can also create nexus by employing sales people who work in other states. If you have employees or contractors do any work-installing products, for example, at a customer's out-of-state location, you may have developed nexus. In some states, you can even create nexus by regularly attending trade shows or regularly advertising in a jurisdiction.

He also said that one specific challenging tax scenario for e-tailers is drop shipment of products from a supplier directly to the customer. Owning or leasing property in another state or renting or owning out-of-state storage, warehousing or drop-shipping facilities may create nexus.

Because each business is unique, you may need a CPA or a tax lawyer to assist you in defining in which states you have nexus.

3. Take Care of Taxability and Exemptions
Not all products or services are taxable (have taxability) or taxed in the same way as other products or services. Additionally, taxability for some products-as well as for shipping or freight-differ from state to state.

For example, medical equipment may be taxable in some states, and exempt others (or partially exempt in others), said Kushniruk. Or children's clothing may have "tax holidays" prior to the school season in some states, which means you don't have to collect sales tax during that period of time. Additionally, there are exemptions based on how the product is used, (called use-based exemptions) as well as those based on the customers themselves. For example, schools and nonprofit organizations may not be required to pay sales tax. Exemptions typically require documentation.

4. Validate Addresses and Consider State Sourcing Rules
There are more than 12,500 tax regions across the United States, said Kushniruk. To make an accurate sales tax calculation, you need to validate and identify the "roof top address" and then apply the correct set of sales tax rates to that transaction. The sales tax rate applied to a sale can be made up of a state sales tax, a county sales tax, a city sales tax and several special taxing jurisdictions.

In terms of why the so-called roof top address is important, Kushniruk warns that one house in a neighborhood could have a different sales tax rate than its neighbor, if it is physically in a different zone. "If someone you sell to across the street is near a stadium or in a school zone, it may have a different tax applied," he said. "It shows how granular these tax jurisdictions get."

Additionally, some states base the sales tax on where the product is shipped from, while others base it on where it's shipped to, while still others base it on a combination of the ship-to and ship-from addresses (these rules are called origin and/or destination based sourcing rules).

Think of a furniture delivery company. If the state is origin-based, the tax rate is calculated based on the location of the retail store, but if destination-based, the sales tax rate is based on the delivery address. On top of all that, some states switch from one to the other. For instance, Washington state, starting July 1, said Kushniruk, is in the process of switching from origin based to destination based taxation.

5. Don't Forget About "Use Tax"
Supplemental to sales tax, consumer use tax is a tax on the storing, using, consuming and sometimes distribution of tangible personal property. It can also be applied to taxable services. In other words, you will be subject to the use tax in the state where that event occurs. For example, if you buy an item over the Internet and did not pay sales tax to the seller, but you stored, used, or consumed that item in your state, the purchase is now subject to your state's use tax.

"If you buy something for your business to 'consume internally,' say you buy a computer and your vendor didn't charge you sales tax on it, you have to figure out the use tax and pay it to your state." said Kushniruk, "While it's not feasible for taxing authorities to make sure individuals are paying their use tax, it is the first thing an auditor will look at."

(Continue to Page 2 for More Tips on Sales Tax Strategy)