The complete guide to ecommerce and online selling
Learn about tax compliance challenges for online selling and how to solve them, whether you sell on a website, through a marketplace, or you are the marketplace.
Online selling overview
The worldwide growth of ecommerce has made it easier than ever to find new customers and break into new markets. This news should be exciting for everyone doing business online. However, the more places you sell into, the more tax obligations you’ll have. That’s where things start to get tricky for online sellers and the marketplaces they sell on.
In the following guide, we’ll break down the ins and outs of online selling, the risks associated, and the keys to success. You’ll learn about potential tax compliance challenges of online selling and how to solve them, whether you sell on a website or ecommerce store, through a marketplace — or you are the marketplace.
Do I need to collect sales tax for selling online and what are the risks?
You may wonder if you need to collect sales tax for online sales. It depends.
This question can be answered with another question: Do you have sales tax nexus in states where your products are being delivered?
If the answer is yes — you do have nexus in a state — you’ll have to register to collect and remit sales tax in that state. If you’re selling on a marketplace, the marketplace usually collects and remits sales tax for you — but that’s not always the case. If the marketplace doesn’t have nexus, but you do, you’re responsible for the tax owed.
Outside of sales tax, marketplaces are also required to collect, verify, and provide certain information about high-volume sellers on their platform. Making this information available to customers is mandated by the INFORM Consumers Act that went into effect in June 2023 due to the rise of stolen and counterfeit goods on major online marketplaces.
Online sales tax risks
The business risk of not collecting sales tax online is great enough that we have decided to speak to it directly. Other than property and income tax, sales tax is the largest source of state tax revenue, and one frequently leveraged to fill budget gaps. In short, state governments want their sales tax dollars.
When it comes to selling online, it’s the online business or seller that’s frequently responsible for sales tax. Marketplace facilitators are obligated to collect and remit sales tax on behalf of all the online sellers on their platform. Yes, businesses typically pass this responsibility to buyers by charging sales tax for online sales, but if the online seller fails to do that, the business will be the party held accountable by state and local tax authorities.
Every dollar of ecommerce sales tax you fail to collect is a dollar you’ll be held accountable for by state and local tax authorities. Additionally, late payment penalties, interest, and collection fees may also be assessed. At the extreme, criminal charges may be brought if it’s determined tax evasion has taken place.
Late filing and payment penalties
Businesses making taxable internet sales will be required to file ongoing sales tax returns. If you miss your filing deadline or payment deadline, you may be assessed a penalty of up to $50 in some states. This penalty may even apply if you’ve collected no online sales tax during the filing period. Once you commit to collecting sales tax for online sales, you need to be organized. We recommend you set several calendar alerts the week your sales tax return is due to help you remember to file. For marketplace facilitators, filing sales tax returns for potentially dozens to hundreds or even thousands of sellers, automation can be a lifeline to avoiding late filings.
Collection fees
If a state auditor determines you have outstanding taxes for online sales, they may outsource the collection to an agency. This action will come at a cost to you and may impact your personal credit rating.
Interest
Outstanding online sales tax liability isn’t a free loan. State and local tax authorities charge interest. Depending on how much online sales tax you owe, this interest can add up fast. Moreover, if you haven’t collected any online sales tax, you’re dealing with a double-edged sword. First, you’re responsible for paying your buyers’ online sales tax out of your own pocket. Second, you’re responsible for the interest on those late payments.
When do you collect sales tax when selling online?
The most common question we hear from online sellers and marketplace facilitators is, “When do I need to collect sales tax for selling online?” The answer is complicated.
If you’re running your business by the letter of the law, you need to begin collecting ecommerce sales tax on your first taxable sale. The same goes for marketplace facilitators. If vendors are selling on your platform, then you should be collecting sales tax from the start. State and local tax authorities don’t offer a grace period wherein online sales tax can be ignored. We understand, however, that most small business owners are looking for a magic number. For that, consider the following statement from Michael Fleming of Peisner Johnson:
“A number we have seen some companies use is $250 a month in taxable sales. This equates to $3,000 a year or $12,000 over a 4-year period. The tax on $12,000 in sales would be approximately $960 and you may have an additional 50% or so in fines and penalties which bring your risk into the $1,500 range.”
Beware sales tax myths
As mentioned above, managing sales tax on online purchases is complicated. That shouldn’t come as a surprise. All taxes are complicated. Why should ecommerce sales tax be any different?
There are online sellers who would have you believe they’re tax experts simply because they too are wrestling with online sales tax compliance — and they may be very knowledgeable. But, it’s very difficult to discern the experts from the charlatans, and consequently, when the advice you’re getting is sound versus wrong.
We encourage the online businesses we speak with to strike a balance between online research and professional advice. Always consult an accounting professional or government websites when you have questions that go beyond the fundamentals of online sales tax compliance.
Sales tax nexus determines where your business owes sales tax for online sales
Once you’ve decided to get started collecting sales tax for online sales, you’ll need to know in which states you’re required to collect sales tax because you’ve established nexus.
To trigger economic nexus means that you’ve exceeded a U.S. state’s sales or transactions threshold — and now you must collect, remit, and report sales tax there.
But these aren’t the only ways to trigger nexus. You may unknowingly have tax obligations in a state via several different types of business activities.
Nexus is broadly defined as “a physical connection to a state or local taxing jurisdiction.” However, nexus isn’t limited to a physical presence in the plain English sense of the words.
It used to be that businesses needed a physical presence in a U.S. state to have tax obligations there. But since the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc. in 2018, even online sales into a state can trigger nexus, aka tax obligations.
What to know for nexus when selling online
Home state
A business will always have nexus in the state in which it’s headquartered — its home state. A home state is more than just the state in which the business is located. It’s defined as “the state where your company exists, either in physical form or by virtual existence based on business registration, d/b/a name registration, or banking activity.”
The home state is the most common nexus trigger for nearly every business. We recommend online sellers use their home state as an opportunity to determine a plan, get the right tools, and learn to be efficient with your online sales tax filing. That way, when you’re ready to begin filing in other states, the task will not appear as daunting.
Visited states
Should you be traveling to other states for business (such as conferences, meetings, or sales calls), you’ll likely be on the hook for nexus. Be sure to manage your travel accordingly so you don’t unwittingly trigger nexus and fail to collect sales tax.
Fulfillment services
If you’re utilizing a fulfillment service with warehouse locations throughout the United States, you’ve likely triggered nexus in those states, which is very common for Amazon sellers participating in the Fulfillment by Amazon (FBA) program or other third-party fulfillment services. If that includes you, be sure to learn how to monitor where your inventory is being stored.
The FBA network is large and growing. Moreover, this service utilizes data to determine the optimal warehouses for your products to be stored in. This means the states where you have inventory could change frequently as Amazon reshuffles that inventory to improve shipping efficiency and reduce costs. You’ll want to check which warehouses your goods are being stored in periodically to stay up to date on your overall sales tax nexus profile.
Remote employees
Communications services like Zoom, Slack, and Teams make it incredibly easy for companies to leverage a remote workforce. However, it also makes it incredibly easy for companies to trigger nexus across the country. Sometimes companies work around this obstacle by only hiring remote workers in their state. However, that’s not always the most practical way to hire the right employees. It’s important for businesses to know that hiring remote workers in other states is likely to trigger nexus. Being aware of this possibility is helpful in staying ahead of sales tax collection requirements and avoiding penalties.
Affiliate marketing
A common way for online sellers to leverage the marketing power of the internet is through affiliate marketing. Affiliate marketing typically involves working with individuals or companies who have an internet presence like a blog or online store. Advertisements for your business are set up by the affiliate to drive relevant traffic and, in turn, product sales. The affiliate marketer gets a small cut of the revenue as compensation for their advertising efforts.
Amazon Associates and Google AdSense are the most widely used examples of affiliate marketing programs. In fact, the Amazon Associates program is most responsible for creating what is widely known as click-through nexus or “The Amazon Law.”
Exemptions add more complexity to ecommerce and online sales tax
It’s highly likely that an online seller will make a tax-exempt sale sooner or later. Taxable goods may be eligible for sales tax exemption depending on the type of buyer or the manner in which the goods will be used.
It’s on the seller to collect and file a valid exemption certificate for each business, organization, or individual making an exempt purchase.
It’s also up to the online seller to ensure that exemption certificates are valid for each sales transaction. This requires your business to keep a copy of each exemption certificate and ensure that they’re renewed when they expire.
Because marketplace facilitators are responsible for sales tax, they can also find themselves responsible for validating these exempt sales. Depending on the marketplace, you could be dealing with a huge amount of certificates, so having a system to collect and store your exemption certificates can be crucial to maintaining tax compliance.
Common sales tax exemption challenges for businesses selling online
Sales tax holidays
Many states offer limited periods where purchases can be made tax-free. These are commonly referred to as sales tax holidays. They typically coincide with two events: back to school and disaster preparedness.
As an online seller, you may be presented with a request for tax exemption during these periods by residents of participating states.
Resellers
If a buyer isn’t the end consumer of a taxable good, they may make the purchase tax-free. It’s up to the buyer to provide the necessary paperwork to verify they’re a reseller. As an online seller, you’re expected to get this documentation and keep it on file. This information will need to be produced upon request in the unfortunate case of a sales tax audit.
Manufacturers
There are also unique sales tax considerations for manufacturers. The purchase of raw materials to be incorporated into an end product prior to resale may qualify for tax-exempt status. In some cases, the tools and machinery used in the manufacturing process may also be tax-exempt.
Nonprofits
It’s common for people to think nonprofit organizations are exempt from sales tax on all purchases. Not true. What is true is that for certain sales, sales tax is waived for transactions relating to the charity’s “charitable mission.” Again, the nonprofit organization must provide the necessary paperwork verifying their status. It’s up to the seller to manage this paperwork.
Online sellers must identify the taxability of what they sell
Sales tax rates and regulations vary depending on what and where you’re selling, who you’re selling to, and the channels you sell through.
The type of product being sold — physical, digital, or service — has a huge impact on the way it will be taxed. As usual, how products are taxed varies from state to state.
If you sell digital products, the type of product may determine if it’s taxed at all. For example, digital games are exempt in Arkansas while other digital goods are taxable. Digital games are taxable in North Dakota while other products are exempt. Even the definition of what a digital product is can vary by state.
Similar nuances apply to physical goods and on-demand services.
It gets more complicated when a business starts bundling products together — such as selling a product alongside a service. Even something as simple as including disposable utensils with a food delivery can impact taxability.
Product taxability also depends on who you’re doing business with. Are you or your vendors selling to other businesses or directly to consumers? The kind of online store or marketplace you’re running has big implications on your tax obligations, so it’s important to get it right.
Marketplaces and vendors selling directly to consumers need to identify their items’ taxability and apply the correct tax at the point of sale.
Marketplaces and vendors selling to other businesses (B2B) may find that some transactions are exempt from sales tax. If so, it’s vital to verify and store exemption certificates for those sales in case of an audit.
Steps to sales tax compliance
The steps necessary to manage sales tax properly are as follows: determination, registration, collection, filing, and remittance. We’ll walk through each of these steps recognizing that the details specific to your situation are unique.
Crucial online sales tax compliance considerations
Sales tax determination
A sales tax object may be a good, a service, a digital asset, or a combination of each. Understanding the taxability of objects is critical, as undercollection can result in audit assessments and overcollection can result in potential class action suits (or unhappy customers).
It’s important to remember that each state may view the same object differently. As such, the taxability answer in state A may or may not be applicable in state B.
Business licenses and sales tax registration
The first step toward establishing sales tax compliance involves registering your business in the states where you have nexus. It’s also important to understand the business license requirements in your area to ensure you’re operating legally. Depending on the size of your business, registering may involve a brief review of your operations or a professional nexus study. Furthermore, the type of registration can vary based on the facts and circumstances of your business. Applying for a state’s sales tax registration accurately is important because it will determine compliance for the life of your business, so take your time, do the necessary research, and get it right.
Registration gets your business an official sales tax license. All states require a business selling taxable goods in their state to register at least one to two weeks prior to selling.
Once registered, the state taxing authority will assign you a filing frequency, which can be monthly, quarterly, or annual.
Collecting, filing, and remitting sales tax online
Once you’ve registered for sales tax and received your business licenses in the states where you have nexus, you can begin collecting sales tax for online sales — and all sales. Every major ecommerce selling platform offers this functionality natively. It’s up to you to set things up from your dashboard.
Once you’ve started collecting sales tax for online sales, you’ll need to file a sales tax return based on the filing frequency assigned during registration. Filing a sales tax return involves breaking down the sales tax you’ve collected by jurisdiction (such as state, county, city, or special) and submitting this information to state and local taxing authorities.
Contrary to what many think, the process of filing sales tax returns doesn’t involve remitting sales tax. Think of the filing step as reporting your numbers. You’re completing the paperwork necessary to report to state and local authorities exactly how much sales tax you’ve collected.
Online marketplaces have their own sales tax considerations just like sellers
Just as online sellers have to consider sales tax, so do marketplace facilitators. If you’ve ever sold on Etsy, eBay, or Poshmark, you may have noticed (or been blissfully unaware) that you didn’t have to calculate or collect sales tax from the buyer. That’s because marketplace facilitators are generally responsible — thanks to marketplace facilitator laws — for collecting the online sales tax on behalf of the retailers who sell through their marketplace.
Marketplaces must provide W-9s and 1099s and sellers must complete them
Marketplace facilitators are also required to provide and distribute W-9s and 1099s to their sellers for tax reporting purposes. This task will become even more of a burden when the threshold for this requirement drops from $20,000 in marketplace sales to $600, thus increasing the number of forms you have to deliver. For reference, the number of 1099-K forms submitted to the IRS is expected to jump from 14 million to 44 million once the threshold is lowered.
While some marketplaces plan to handle this manually, automated tax compliance solutions can be a huge help in complying with the additional requirements that result from the lower threshold.
How do I know if I’m a platform or a marketplace, and what do I do?
As the ecommerce universe expands, the lines between marketplace seller and marketplace facilitator are becoming blurred due the fact that many online sellers are now operating as both. From a customer perspective, it might be hard to tell whether you purchased something directly from an ecommerce business or from an online marketplace. But for the sellers themselves, the requirements are distinct.
What makes a marketplace facilitator?
Just like sales tax, the exact definition of a marketplace facilitator varies from state to state. But generally speaking, a marketplace facilitator is a person who:
- Owns, operates, or controls a physical or electronic marketplace
- Contracts with marketplace sellers to facilitate the sale of their products or services
- Directly or indirectly collects the payment from the purchaser and transmits all or part of the payment to the marketplace seller
In other words, the marketplace facilitator connects vendors with their customers and handles the transactions, including tax collection.
An ecommerce platform, like Shopify or Magento, is a tool that helps businesses display and sell their products or services. They can help track inventory, fulfill orders, and indicate customer preferences.
With an ecommerce platform, the online seller is still responsible for the look and feel of their online shopping experience as well as the taxes owed on the products they sell.
You’ll know if you’re selling through a marketplace if you have no control over the look and feel of the website — and you don’t have to collect sales tax.
Amazon, eBay, Etsy, and Walmart are all examples of marketplace facilitators.
There are also different types of marketplaces, each with different taxability requirements on the products they sell.
What are the types of online marketplaces?
Physical goods marketplaces
Physical goods marketplaces primarily sell tangible physical products. Unlike digital marketplaces or service marketplaces, physical goods marketplaces often have to warehouse or drop ship items to customers. This can create unexpected sales tax obligations.
Digital goods marketplaces
Digital goods marketplaces specialize in the sale of digital products and digital content. As we noted before, take extra special care regarding your taxability if you sell on or run a digital goods marketplace.
On-demand services marketplaces
On-demand services marketplaces, also known as service marketplaces, provide and sell services to customers rather than actual goods in physical or digital form. There is a range of services, from delivery to rideshares, childcare, education, and more. Understanding the taxability for your type of service is key to maintaining tax compliance.
Marketplaces and online sellers benefit from sales tax software and automation
Regardless of whether you’re an online seller or a marketplace facilitator, staying tax compliant in the ever-expanding ecommerce universe is a never-ending challenge.
Tax compliance is complicated no matter what kind of business you are — and everyone doing business online, from ecommerce sellers to marketplaces, can benefit from tax compliance software. Automating your tax calculations and reporting can drastically increase efficiency, saving you time and money that would otherwise be spent on complex processes and constant tracking.
Letting a tax compliance software, like Avalara, bear the weight of these processes can shift your focus from swimming against the current of tax compliance to riding the wave of business expansion. Contact Avalara today to learn how we can help you streamline sales tax compliance for how your business sells online, no matter where and how you’re selling.
