I speak to thousands of eCommerce or online sellers every year. Sometimes in large groups, sometimes in small groups and sometimes one on one. The single biggest question that comes up time and again is, “Do I need to collect sales tax?” This question is a great question and is posed by both small sellers and large sellers. It is posed by those selling through a marketplace like Amazon or eBay and those just selling on their own website. And the question is not only posed by those selling products but also by those selling services. My answer is, as many of my answers to broad sales tax questions are, “it depends.”
The 5 Key Factors to Consider:
Sales tax collection depends on several factors including:
- Where the sale is sourced. When it comes to products we generally look at where a product is delivered and when it comes to services, we generally look at where the benefit of the service is received.
- Do you have any link or connection with the state where the product is delivered or where the benefit of the service is received? This link is called nexus.
- Is what you sell taxable where the product is delivered or where the benefit of the service is received?
- Does the state, where the product is delivered or where the benefit of the service is received, have remote seller use tax nexus and reporting requirements.
- Are your revenues and/or exposure material in the state where the product is delivered - or where the benefit of the service is received?
Each one of these factors deserves its own blog post, which we will do over the coming weeks, but let's quickly look at the part they play in determining whether you should collect and remit sales tax or not.
Factor 1 - Sourcing: Under current law, a seller is generally not required to collect tax based on where they are located, but rather where the customer is located. So, if you live in Texas and your customer is in Florida and you ship a product to that customer in Florida, you would not be responsible for collecting the Texas Tax. However, depending on the rest of the factors you may be responsible for collecting the Florida tax and remitting that tax to the to Florida. If you perform services, the same would be true. If the customer is in FL, the benefit of the service is generally going to be in Florida.
Factor 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. There are many activities that you do that can create nexus for you in another state, but what many sellers don’t realize is that even the activities of third-parties can create this link. Where we live or operate our business creates a link, so if we are in Texas and our customer is in Texas 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 and 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 Texas and a customer residing in Florida, if there is no link present it we are one step closer to not having to collect tax. If there is a link present we are one step closer to having to collect a tax.
Factor 3 - Taxability: Taxability of products and services can vary greatly from state to state. In this post, I assume products are generally going to be tangible personal property (TPP) rather than real property, intangible property, or more recently digital goods. 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 named as so, but many 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, you have no further responsibilities. If it is taxable you are one step closer to having to collect tax.
Factor 4 - Notice and Reporting Requirements: This factor will only come into play if a seller does not have nexus in the state where the sale is sourced, 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 statutes. The statutes are designed to make life so miserable for sellers, by imposing extra accounting and customer communication notices, that sellers “voluntarily register to collect sales tax. Failure to comply with these requirements can subject the seller to draconian fines. These fines make Tony the loan shark in NY look like a sweet guy. If you are subject to these requirements we strongly suggest you register.
Factor 5 - Materiality: Just because a state says you should do something does not necessarily mean that it is a good idea to comply. Especially if the cost of compliance is going to be greater than any back taxes, plus penalty and interest. In general, I cannot make the math work if a seller’s sales into a state in question are less than $3,000 annually. In this case, it is my belief that it is better to wait for a state to find you and if they do, pay the state out of your pocket at that time. That does not mean that at $3,001 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 - and the lower your threshold should be.
In summary, we do not need to collect sales tax on all sales. We only need to worry when we have nexus in the state where the sale is sourced, what we sell is taxable in that state, and overall exposure is a material in that state. If the answer to any one of those questions is negative there is a good chance you don’t need to collect taxes. The exception being, if you are subject to a remote seller use tax notice and reporting statute. In that case, I strongly suggest you voluntarily register. Once you do you will no longer be required to comply with the requirements nor be subject to the penalties.
Please let me know if you have any questions and look for the next post in about two weeks. See below for contact options.
Other recent “Small Business E-Commerce” posts by Michael Fleming:
- With Quill Dead You Could Now Have Sales Tax Nexus Everywhere
- Do Online Sellers Need to Collect Sales Tax? 5 Key Factors!