I talk to small-business online sellers every day about how they handle sales tax. It’s an incredibly diverse group. However, one quality they share is that many of these e-commerce operations start with absolutely no sales tax automation in place. Oh I’ve seen an endless array of intricate spreadsheets - and some very impressive pivot tables. I’ve also seen sellers who pay far too much to bookkeepers – and some who simply roll the dice and rely on estimation and luck.
As a result of the many discussions I’ve had with such e-commerce entrepreneurs, I thought it might be beneficial to outline the typical process that these small (no-automation) sellers face as they try to comply with sales tax laws. This information could help to educate new sellers regarding the challenges of sales tax compliance. It could also help business and political leaders, as they consider sales tax legislation, to more fully understand the challenges of sales tax compliance for small businesses.
In general, an on-line seller’s sales tax set-up and compliance process involves (at least) 5 key steps:
Step 1: Determine Where a Seller Has Sales Tax Nexus:
Nexus is a term which means “physical presence” and it is what (generally) triggers a seller’s obligation to collect sales tax in a particular tax jurisdiction. Once nexus is determined in a jurisdiction, the seller must apply for a sales tax license within that state or face penalties -or even criminal charges.
This used to be a straight-forward process. Traditionally, you’d have sales tax nexus wherever you had an office, warehouse or employee. However, states are constantly expanding their definition of nexus to include a broader range of activities (i.e. trade shows, deliveries, service calls, etc.) as well as business relationships (i.e. internet affiliates, third-party installation services, etc.)
Additionally (and increasingly common) e-commerce realities like 3rd party fulfillment (or drop-ship) can make determining nexus even more painful. Amazon FBA sellers, for example, currently have sales tax nexus wherever their goods are stored in Amazon fulfillment centers.
Step 2: Set up Sales Channels to Charge the Correct Amount of Sales Tax:
Every e-commerce platform (such as eBay, Amazon, Etsy, etc.) is different when it comes to setting up sales tax. Some automatically charge sales tax in a seller’s home state but make them jump through hoops to charge sales tax in other states where that seller might also have nexus. This process is further complicated if the seller sells a variety of goods, as various states often have different rates and rules depending upon the type of product. Food items, as just one example, are taxed in some states but not taxed in others.
This process is complicated for someone selling on a single sales channel. However, as barriers to entry for an e-commerce business get lower, more and more small-business sellers are selling goods on multiple online platforms - or creating their own online store powered by a shopping cart system like Shopify or BigCommerce. But with more channels and more sales comes more complexity.
Multi-channel sellers must be sure they are complying with all state sales tax rulings on all channels on which they sell.
Step 3: Pulling Monthly Tax Reports:
Then comes tax time, when sellers must calculate how much they owe to the various states. What many new sellers don’t realize is that even very small (single channel) operations can have (literally) dozens of sales tax filing due dates per year.
Multi-channel sellers must pull reports from all channels on which they sell, and then manually (or via spreadsheet) calculate how much they must remit to each state (or sometimes local) tax jurisdiction. This is a compliance nightmare that can eat up hours each filing period, especially as sales volume increases. Additional levels of complexity can be added when the seller suddenly finds him or herself responsible for nexus in a new state (such as when Amazon FBA decides to ship their inventory to a new warehouse.)
Step 4: Analyze Sales (Line-by-Line):
The next issue is ensuring that the seller has collected the correct amount of state and local sales tax. This involves going through sales in states in which they have nexus, line-by-line, using lookup tables at individual state websites to ensure compliance. If the seller did not collect the correct amount of sales tax at the point of sale, they could also find themselves paying out of pocket. With over 11,000 sales tax jurisdictions in the U.S. alone, a seller might find that they are spending more time analyzing sales tax issues than actually making sales.
Step 5: Subtotal Sales By Jurisdiction:
The majority of states are “destination-based” sales tax states, meaning that the seller is responsible for collecting sales tax at the buyer’s local rate. As you can imagine, this makes calculation at the point of sale painful, but it also places yet another burden on the seller when it comes time to file taxes. Many destination-based states require the seller to subtotal their tax filings by jurisdiction. In states (such as Kansas) which has over 1,000 local sales tax jurisdictions (including cities and counties), just figuring out how to fill out the sales tax filing can be an accounting puzzle in itself.
Should a Seller Consider Sales Tax Automation?
While a manual sales tax process is labor intensive, there are thousands of online sellers who do just that. It is possible – assuming a seller has the skills and is able to invest the time and effort. However there are also risks. What if one of the formulas in the seller’s spreadsheet is broken? States don’t like it if you collect too much sales tax from their citizens - or remit too little sales tax to their coffers. An error in either direction can lead to a comprehensive audit.
It’s also important to realize that the effort (and risk) multiplies if sellers are active on multiple sales channels. Sales tax automation can help you take sales from multiple channels into account, and help to keep you compliant with each state’s requirements. Not to mention, time spent calculating sales tax by hand is time that could be spent in much more inspiring ways – like making a profit.
Other recent “Small Business E-Commerce” posts by Mark Faggiano:
- POS Devices and Sales Tax: What Multi-Location Sellers Need to Know
- E-Commerce Sales Tax Compliance: 5 Step “No Automation” Approach