There's a heated debate over internet tax happening in the United States Senate this month. Whether or not to collect sales tax from e-commerce websites has been argued for several years along with a proposed federal law, called the Marketplace Fairness Act of 2013.
According to the new reports from today's Google search on the topic, it's unlikely that further debate about internet tax will yield any results before the end of December 2014.
Now that we are in the heat of the busy holiday season, where online shopping is at its peak, this topic deserves a review.
It doesn't matter if you like it or not, e-commerce is slowly creeping into every industry. E-commerce isn't simply about selling physical items online, it also include paying for classes, buying movie tickets, paying your utility bill, and ordering airline tickets.
Any financial transactions you allow through your website fall under the auspices of e-commerce and the all the security and tax requirements that come along with it. Naturally there are certain transactions that are not taxed, while others are. Some states provide exclusions of tax for an item that other states mandate tax collection for.
You really need to know your local tax laws because they are different from state to state.
You are also required to follow the state laws for all the states within which you operate. As a general rule, you are required to collect sales tax from online sales for any state where you have a physical presence.
Back in 1992, the United States Supreme Court presided over a mail-order case known as Quill Corp vs. North Dakota. In that ruling the mail-order business, Quill Corp, was told they needed to collect sales tax for any state where they had a physical presence.
That case set the general physical presence rules that were later extended to all online businesses.
Here's how the physical presence was defined:
- if you have an office in the state
- if you have a retail store in the state
- if you have a warehouse in the state
- if you have a sales representative in the state
Other than these general rules for a physical presence, some states have additional rules which define a presence. Some will even require you to collect e-commerce sales tax if your website is hosted in their state.
Think about that for a moment. Most people never think about the physical location of the computer systems their website is hosted on. Generally speaking a website lives "in the cloud," but in reality it's in a secure server room with frigid air conditioning, multiple hard drives, battery backups, and maybe even its own generator.
GoDaddy has a huge server farm in Arizona somewhere, while BlueHost has server locations in Utah. My own server rooms are in New Jersey and Arizona.
The interesting thing about websites is that your hosting company doesn't usually provide any guarantee as to where your website will be located. Furthermore, that could change on any day due to server maintenance. You could easily be breaking a state's tax law without ever even knowing about it!
It should be obvious that you need to comply with state sales tax collection laws wherever you have an office or a retail store.
On the other hand, it's not easy to understand the definition of a warehouse. Some states view a warehouse as a product storage facility that you own, manage, and directly control, while other states hold you accountable if you drop ship from your vendors.
Do you even know where all the warehouse locations are for your vendors? This is where the real mess comes into play. Back in the mid/late 90s, I sold computer equipment online and I drop shipped from my distributors. Because one of my distributors has a warehouse in California I was forced to register with, and collect sales tax for all items shipped into that state.
The goal of the Marketplace Fairness Act of 2013 is to create a way for all e-commerce sites to collect and pay their fair share of sales tax. Right now, there are millions of e-commerce sites selling tax-free online. Many of these businesses directly drop ship from multiple suppliers without ever physically touching a single product and they believe they are free from tax collection responsibilities. In actuality, they already fall within the old 1992 Quill Corp vs. North Dakota ruling.
With regard to sales representatives, you might need to collect tax for a state even if the sales rep is a freelance contractor, or only paid on commission. Most likely you'd have to consult with a tax professional in that state.
I really don't want to frighten you away from e-commerce just because of this. Eventually we all have to deal with it.
There are ways to get around some of these issues, for example:
You could always ship from your own store/office and avoid the warehouse rule. Certainly this will always increase costs a little for your customer, but they might be willing to pay a few extra dollars in shipping instead of hundreds of dollars in sales tax. There's an extra benefit here because you'll be able to physically see, touch, experience, and photograph all the products you sell.
You could host your website in your own state, in Canada, or in Europe. Simply ask your hosting company if they have those options and how much extra it will cost. There's a tiny downside to this because the speed of your website will be a little slower for US customers because it's further away from them. But again, what's a few extra milliseconds when you are able to save hundreds in sales tax.
Certainly, I'm not telling you that you should be evading sales tax, but I am sensitive to the difficulties of managing the paperwork required to register with the states and remit the taxes every month. If you operate within the United States, you will be required to collect sales tax for, at minimum, your home state. As a small business with limited labor resources, it's just better to keep your tax responsibilities limited to a single state.
For those of you who are jewelry designers selling wholesale to retail stores: you should be collecting the appropriate reseller tax certificates from the stores you sell to. You may never have to do anything with these, but with them in hand you are transferring the tax collection burden to those retail stores.
Eventually this will all change, but for now the strategy of constraining yourself to a single state is the best course of action.