Online Sales Tax: A Bird’s Eye View
Back in 1992, during the infancy of online shopping, a Supreme Court ruling relieved eCommerce businesses from paying sales tax for states where they didn’t have a physical presence, i.e. physical nexus.
For decades, based on this ruling, online businesses were given a free pass when it came to paying taxes in states other than their own, which means that they didn’t pay taxes in states where the end customer lived.
However, a much more recent Supreme Court ruling in 2018 has changed that and allowed states to impose taxes for online businesses that deliver products or services to their jurisdiction, even without the business’ physical nexus within. This is meant to increase the revenue for states, and at the same time even out the playing field for brick-and-mortar businesses, which have been subjected to taxes that never touched the world of online sales.
Let’s take a more in-depth look at what these recent legal changes entail, what they mean for your business, and how you can make sure your online business complies with the changing legal infrastructure of eCommerce.
The Precedent: Economic Nexus Laws
The 1992 ruling in the Quill Corporation v. North Dakota case was considered to be unfair by states and brick-and-mortar businesses, as it freed online retailers from paying taxes to states where they only delivered products without physical presence.
Increasing numbers of online shoppers – transfixed by the convenience of ordering products online and having them delivered to their doorstep, as well as the affordable prices of items bought over the internet – greatly increased the profit earned by online businesses. However, there’s a good reason the prices were so favorable, and it’s largely due to the fact that a lot of those sales were tax-free.
So, some states passed laws that practically went against this Supreme Court ruling, requiring online sellers to pay taxes in those states if they earn a certain profit in dollars, or make a certain number of transactions in that state. Basically, online businesses were required to collect a sales tax from the buyers in that state, for that state. This sort of taxation is called economic nexus laws.
This started when Ohio passed a “Commercial Activity Tax” (CAT) law in 2005, which required any remote retailer who earns more than $500,000 from sales in the state of Ohio to comply with Ohio’s sales tax laws and pay taxes. This sort of law is a precedent to the most recent Supreme Court ruling, as it bases taxation on the profit earned from buyers within the state, rather than the company’s physical presence in the state.
Following the example of Ohio, other states soon started imposing their own economic nexus laws. This brings us to the most recent internet sales tax regulation that was introduced by the Supreme Court. Finally, states could impose online taxes in accordance with the federal government.
An Overview of the New Online Sales Tax
A lot has changed since 1992. Online sales have grown more drastically than anyone could have predicted at the time. For instance, Amazon alone hit 280.5 billion $US in 2019, and in 2021, eCommerce revenue is expected to hit 4.48 trillion $US. In view of the revenue generated by eCommerce businesses, the 1992 Supreme Court decision that freed online businesses from paying taxes in the states of the end customer (unless it’s the same as their business address), no longer makes sense.
This brings us to the new Supreme Court ruling targeting internet merchants. On June 21, 2018, a decision as a part of South Dakota v. Wayfair Inc. was made which allowed states to charge taxes to online sellers that deliver goods to their state, even without having a physical nexus within it.
In other words, even if eCommerce businesses don’t have a physical presence in a state, but deliver goods or services to it, they’re still viable to pay taxes in that state. Of course, this law hasn’t been instituted in all states yet, but a rapidly growing number of states and countries worldwide are beginning to impose various online sales taxes.
So, as we’ve covered, the 1992 decision, ruled as a part of the Quill Corporation v. North Dakota case, limited states to only collecting online sales taxes from businesses with a physical presence within. Initially, this helped the growth and development of online retailers. Today, however, the gigantic revenue of eCommerce has put brick-and-mortar businesses at a disadvantage.
According to the research director at the Institute on Taxation and Economic Policy, Carl Davis, this ruling will help create a “more level playing field” for local businesses. And this is true not only for brick-and-mortars but for small-scale, local eCommerce shops as well. A small startup may not have the resources to offer its products to folks in other states and overseas, and on top of that they’ll end up paying more taxes than someone who can afford to deliver outside their state.
Additionally, the online sales tax is a win for states, which have missed out on yearly revenues of tens of billions of dollars from hereto tax-free online sales.
So, to recap:
Who Do the New Internet Sales Tax Laws Target?
The new internet sales tax laws mean that online retailers will have to pay taxes for states where the end customer lives, and not only states where they have physical presence (nexus), office, distribution centers, headquarters, and so on. This means that even if a business only has a selling connection to that state, i.e. delivers products to it, it’s still meant to pay taxes to that state for remote commerce.
The law was meant to especially target giants like Amazon, which until the new ruling wasn’t paying taxes in a bunch of states. Now, they pay taxes in all US states. Still, the law also applies to smaller online retailers.
Which States Have Instituted the Internet Sales Tax?
It’s not very surprising that states immediately jumped to the opportunity to make the internet sales tax a part of their legal infrastructure.
Local sales taxes were already enforced in 45 states (with the exception of the 5 NOMAD states – New Hampshire, Oregon, Montana, Alaska, and Delaware). Very quickly after the new Supreme Court ruling, 43 of those 45 states instituted taxes for internet and remote sellers. In January of 2020, Missouri also joined the ranks of internet sales tax- states. Florida remains the last of these 45 states to institute the internet sales tax.
Of course, there are stipulations based on how much profit an online seller is to make before paying taxes to that state. For instance, most states, including South Dakota, use the $100,000 mark to start charging taxes. So, if a business sells $100,000 worth of products, or completes over 200 transactions in a given year, in a given state, the company is obliged to pay taxes to that state. Other thresholds vary between $10,000, $550,000, while some states don’t have any stipulations and charge taxes at the very start.
What Does the Internet Sales Tax Mean for Your Business?
The sudden shift in legal infrastructure concerning internet sales has had online businesses scrambling to work out the details of new taxation rates across other states and countries. In the US alone, for instance, various states have different rules, regulations, and stipulations which dictate when you are required to pay tax, and how much.
Forty-four states with different internet taxation laws may seem a bit intimidating to manage. What’s more, while most states impose tax regulations on a state-wide level (and you only have to deal with one taxing entity), some states have a “home rule” system – which means that the state has granted smaller localities (like cities) the right to regulate and manage their own taxation systems.
Colorado is a great example of a taxation nightmare, as it currently has 70 cities given the home rule privilege, which can set up and administer their own sales tax rates and rules. On top of the base sales tax of 2.9% that’s statewide in Colorado, online sellers would also have to take into consideration the additional taxes charged by counties, cities, specific districts, and so on.
So, how can you manage interstate and international online sales while complying with the right set of taxation laws?
While you can get a tax expert and go through the process of assessing your nexus, pursuing tax compliance with individual states and localities, and so on, one of the easiest ways to handle the varying internet taxes is by using taxation software. See, in a way, the internet fixes (some) of the problems it creates by itself.
There’s a good deal of free and affordable tax calculation software you can use to manage everything from one place. Some popular and affordable software solutions include Avalara, TaxCloud, and TaxJar. These options can help you comply with the tax laws of different states and countries with minimal effort on your part.
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