One of the topics I’ve been coming across lately is the impact on small businesses of a recent court decision regarding sales tax for online transactions. It appears many growing businesses find themselves in a tough spot as they strive to comply to varying laws in multiple jurisdictions.
Much has been said about the potentially outsized effect the recent tax-law changes might have on smaller companies relative to bigger e-commerce players, that may already have more sophisticated tax automation systems and can absorb any financial shocks more easily.
Here we’ll take a few minutes to provide a brief overview of the new e-commerce sales tax laws and discuss what small businesses should keep in mind in order to meet compliance obligations.
What was the ruling?
In June 2018, the U.S. Supreme Court found that states have the authority to require retailers to collect sales taxes on online sales even if the businesses do not have a physical presence in the state.
The 5-4 decision came via the South Dakota v. Wayfair case, overturning the 1992 decision in Quill v. North Dakota, which prohibited states from collecting sales tax from companies that had no in-state physical presence, such as a storefront, employees or inventory.
Now, companies are legally obligated to collect and remit sales tax to the state as long as they have an “economic presence” there. “Presence” is established by testing whether a company’s sales exceeds the state’s economic threshold for total revenue and/or number of transactions.
State laws vary on what defines economic presence, or “nexus.” For South Dakota and many other states, a business has economic presence when online sales exceed $100,000 or 200 or more transactions in the state within a current or previous year. Other states’ thresholds are set at $200,000 and higher upward to $500,000, such as California. Two states, Florida and Missouri, have proposed economic threshold legislations, yet to become law.
Understanding the ruling
This new sales-tax ruling was viewed as a milestone of sorts that marked the “treatment [of e-commerce] as a mature player in a marketplace no longer defined by trips to the corner store or the shopping mall.”[1]
As far as the growth and scale of e-commerce are concerned, that is a fair description. And while some, such as Daniel Castro of the Information Technology and Innovation Foundation, have said this feels like a step in the right direction, it seems the potential range of impact these changes could have on growing businesses is broad. Small- and medium-sized online retailers may be facing one of the biggest challenges as they try to meet the new tax collection mandates and comply with requirements in various jurisdictions. At the time of the ruling back in 2018, Small Business & Entrepreneurship Council CEO Karen Kerrigan said the new law would create “uncertainty, havoc, vast new costs and unknown exposure for small businesses.” Indeed, key among the challenges for small businesses appears to be the lack of uniform definition by state, as the burden is now on the sellers to act as tax collectors for separate state and local jurisdictions.
Other tax issues affecting online sellers…Marketplace Facilitator (MPF) Laws
As an online seller you may have decided to use online platforms, such as, Amazon, Walmart or Etsy. These online platforms are known as a marketplace facilitators or providers. There are at least two tax issues to consider when utilizing these platforms as your source for online selling: (1) inventory at a fulfillment warehouse location; (2) marketplace facilitators/providers’ sales tax collection and remittance requirements on your sales to consumers.
First, if you have inventory located at fulfillment centers for shipment of your online sales, some states such as California define this as having nexus in that state even if the thresholds, (as discussed earlier), have not been met.
Second, some states are requiring the MPFs to collect the tax on your behalf for remittance to the states. However, there are administrative tasks on your end that should be addressed, such as, (1) If you are using another sales channel, i.e., your own website or Shopify website and have met economic nexus, then you are still required to register, collect and remit the sales tax outside of your MPF sales. (2) your sales tax returns may still need to reflect the MPF sales as deductions, (3) Address proper setup within your tax engine, software or MPF online account. (4) Caution should be taken to avoid duplicate tax collection and remittance to the states where the MPF have already collected and paid. 2
What to keep in mind as you work toward compliance
There aren’t any simple 3-step methods to neatly achieve compliance with a state once and be done with it. A small business operating in three states or 30 will have vastly different sets of rules to follow and potentially complex and costly tax solutions to implement. It is crucial, in any case, for you as the business owner or manager to assess potential impact and evaluate where your revenues are coming from and determine where to focus compliance attention.
As obvious as this may sound, pursue compliance. Register with the states appropriately. Managing the complexity of these laws can be quite tricky, but it can be helped by having the right tax advisory solution and technology in place, as there are software programs dedicated to helping online retailers track and alert when the thresholds are met, collect state sales taxes, and certain e-commerce systems can be integrated with tax automation software to calculate taxes based on buyer location and order size.
If your online sales aren’t yet meeting the revenue threshold of a given state, don’t think that you are safe; it may be surprisingly easy to hit the transaction threshold, especially for sellers that have lower average order value. For example, a company whose average order is $10, selling 200 items would exceed the threshold in South Dakota (and other states that have the same threshold). That means the seller would become liable to collect sales taxes in those states after just $2,000 in revenue, even though the states’ sales threshold is $100,000. Also, check with the states’ nexus requirements if you have inventory located at fulfillment centers. This may present requirements to register and collect sales tax as well.
The new reality
New tax laws can certainly be a cause for headaches. However, they have become the new reality in this post-Wayfair world, and companies need to comply. There is a chance that Congress might pursue a standardized federal policy given the immense challenge of keeping track of all the different state laws. Though politically not likely to take place now, this may be worth keeping in mind. At present, it will be critical for businesses to keep track of revenues, inventory and laws in applicable states, stay vigilant, and proactively build the estimated resources and costs into planning for the states in which they anticipate having to become compliant.
[1] Wall Street Journal. Supreme Court Rules States Can Collect Sales Tax on Web Purchases. June 22, 2018.
[2] https://www.prospershow.com/media/prosper-blog/media/press-releases/the-two-most-important-sales-tax-laws-affecting-high-volume-amazon-sellers-today
