When speaking with eCommerce sellers, the single biggest question that comes up time and again is, “Do I need to collect sales tax?”
This question is quickly followed by, if so then where and when? These are great questions and they are being asked by everyone. They are asked by eCommerce sellers their CPAs and other tax professionals.
It doesn’t matter if they are large or small; if they are selling through a marketplace like Amazon or eBay, or just selling on their own website. And the question is not only asked by those selling tangible products but also by those selling digital goods, software and even services. The answer is ‘maybe.’
How to Determine if Collection is Needed
Figuring out sales tax collection for your eCommerce clients depends on five core elements. These are:
1. Sourcing: Currently, a seller is generally not required to collect tax based on where they are physically located, but instead where the customer receives the product or in the case of digital goods and software it could be the billing address. So, if you live in California and your customer is in Pennsylvania and you ship a product to the customer in Pennsylvania, you are not responsible for collecting the California tax.
However, depending on the rest of the elements you may be responsible for collecting the Pennsylvania tax. For service providers, the benefit of the service will generally be where the customer is located, and the same concept applies.
2. Nexus: Nexus is the term that we use to mean link or connection. You must have some sort of link or connection with a state before a state can require you to collect its tax. Contrary to popular belief it is actually pretty easy to create nexus.
Even third-parties, those with no connection to a seller other than providing a service can create nexus if they are helping the seller establish or maintain a market. (Tyler Pipe v. Wash. Dept. of Rev., 483 U.S. 232 (1987)) There are many activities that can create nexus, but the biggest link is where we live or operate our business.
So, if we are in California and our customer is in California we are one step closer to having to collect the tax. Other activities that can create nexus are having inventory in a warehouse whether it’s our own or someone’s like Amazon or having third parties perform services on our behalf like installations, implementations, training, sales, etc. So, going back to our example of a seller located in California and a customer located in Pennsylvania, if there is no nexus, we are one step closer to not having to collect tax. If there is nexus we are one step closer to having to collect a tax.
3. Taxability: Taxability of products and services can vary greatly from state to state. Let’s assume the products in our example are tangible personal property (TPP). Tangible property is something that can be seen, felt, smelled or otherwise perceived by the senses.
It is generally something that can sit on a warehouse shelf. TPP by default is generally taxable unless there is some sort of exemption and there are many. In contrast, services are generally not taxable unless enumerated as taxable. However, many are surprised by what services are taxable, and more states are taxing more services all the time.
If what you sell is not taxable in the state where the sale is sourced, whether you have nexus or not you have no further responsibilities. If what you sell is taxable, you are one step closer to having to collect tax.
4. Remote Seller Notice and Reporting Requirements: This will only come into play if an eCommerce seller does not have nexus, the seller’s products are taxable, the state has passed a remote seller nexus and reporting requirement, and the seller exceeds the thresholds imposed by the statute. There are about ten states so far that have passed these types of statutes.
The statutes are designed to make life so miserable for sellers, hat sellers “voluntarily register to collect sales tax. They make life miserable by imposing extra communications burdens and usurious penalties for failure to comply.
Personally, I am aghast that a state can virtually extort you to collect their sales tax when under current law you do not even have nexus. However, Colorado introduced this concept back in 2010. The Direct Marketing Association (DMA) tied it up in the courts for seven years and it went to the US Supreme Court twice.
The first time the Court heard the case they said it was not a tax and sent it back to the lower court who decided for CO. It was appealed back to the Court who refused to hear it in December 2016. Colorado implemented their statute in July of 2017 and many states have jumped on board since then.
Some of the more recent states make CO look very generous. States like OK, PA, RI, and WA have extremely low thresholds and minimum penalties that start at $10,000-$20,000. If you register to collect sales tax, the requirements and potential penalties go away. Legal extortion if you ask me.
5. Materiality: Just because a state says you should do something does not necessarily mean that it makes good business sense to do so. Especially if it costs more to comply, then the total of any back taxes penalty and interest if the state finds you.
In general, I cannot make the math work if a seller’s taxable sales in the state are less than $3000 annually. That does not mean that at $3001 a seller should start collecting taxes. Each seller needs to set their own threshold.
Three things to keep in mind when determining your threshold are your risk tolerance, your profit margins and your cash reserves. It is counter-intuitive but the smaller your profit margin, the smaller your cash reserves the lower your threshold should be.
Sales tax does not need to be collected on every sale made by an eCommerce seller. Sellers only need to worry when they have nexus where the product was delivered (benefit received), the sale is taxable in that state, and overall exposure is a material in that state.
If the answer to any of those questions is no you would generally not have to collect sales tax. A major exception would be if you are subject to a remote seller use tax notice and reporting statute. In that case, I strongly suggest you voluntarily register.
States are becoming more aggressive in finding sellers and new ways to force them to collect tax. We believe it is easier and cheaper to comply today, then to fight the state when they find you down the road. While there is a cost of complying, technology has advanced to the point where pricing has come way down and the process is a relatively simple one.