10 Things Online Retailers Get Wrong About Sales Tax
Managing sales tax can be a minefield for online retailers. With an ever-changing array of state regulations, determining where and how to collect sales tax is complex, especially for businesses expanding beyond their home state. Missteps in this area can lead to hefty fines, audits, and reputational risks. To help e-commerce business owners navigate the murky waters of sales tax, here are the top 10 mistakes they commonly make and how to avoid them.
1. Assuming sales tax only applies in your state
A common mistake online retailers make is assuming they only need to collect sales tax in their home state. In reality, you’re often responsible for collecting sales tax in any state where you have "nexus." Nexus is a legal term that defines the connection between a business and a state. Traditionally, having a physical location—such as an office, warehouse, or employees in a state—created a nexus. However, thanks to recent legislation, nexus can also be established through sales volume or revenue.
Pro tip: Use nexus-checking software or consult a tax advisor to understand where you may have a tax obligation, as this can vary significantly by state.
2. Misunderstanding economic nexus rules
With the 2018 Wayfair ruling, the Supreme Court changed the game by allowing states to impose sales tax obligations on out-of-state sellers if they meet certain thresholds. Known as "economic nexus," these rules vary by state. For example, some states require sales tax collection once annual sales exceed $100,000 or 200 transactions within the state. Each state has its own thresholds, so businesses need to stay informed on where they qualify for economic nexus.
Pro tip: If you’re scaling up or already have significant sales across multiple states, consider automating sales tax tracking and reporting. Some e-commerce sales tax software solutions can track state thresholds and notify you if you reach economic nexus in a new state.
3. Thinking all products are taxed the same
Sales tax isn’t universally applied to all goods and services in the same way. Each state can dictate which products are taxable and which are not. Some states don’t tax certain items—like clothing, groceries, or prescription drugs—while others do. Additionally, some states apply different tax rates for specific categories of goods or services, which can be confusing for sellers handling diverse product inventories.
Pro tip: Identify product-specific tax rates in each state where you operate. Tax compliance software can often assign the correct tax rates based on product categories, ensuring that you’re collecting accurately.
4. Believing that digital products don’t need sales tax
Digital goods are an increasingly important part of online sales, and sellers frequently believe they’re exempt from sales tax. However, many states now impose tax on digital products like ebooks, online subscriptions, and even streaming services. For example, Texas and Washington state tax digital goods, while others may impose partial or conditional taxes.
Pro tip: Check the sales tax rules on digital products for each state where you have nexus. It’s essential to understand the specifics because some states only tax certain types of digital content while others apply taxes more broadly.
5. Neglecting to update tax software regularly
Sales tax rules, rates, and exemptions are constantly changing as states modify their laws to capture tax revenue from e-commerce. Using outdated sales tax software can lead to inaccurate tax calculations, potentially costing you thousands in fines and penalties. Many states adjust their tax rates each year, and some implement mid-year changes that can be easy to miss.
Pro tip: Ensure your sales tax software or e-commerce platform is set to auto-update tax rates. This can save you from unexpected tax errors and reduce the need to monitor changes manually.
6. Assuming online sales tax is automatically collected by platforms
A common misconception is that e-commerce platforms, like Shopify or Amazon, automatically collect all necessary sales tax on your behalf. While these platforms may offer sales tax tools, they often require you to enable and configure them correctly. Moreover, some platforms might only cover certain states or require separate registrations, leaving you responsible for setup.
Pro tip: Verify your platform’s tax settings for each state where you have nexus and manually check that all relevant states and rates are enabled. This helps ensure full compliance across your sales channels.
7. Confusing sales tax with VAT
For businesses that sell internationally, VAT (Value-Added Tax) and sales tax can create additional confusion. Unlike sales tax, which is collected at the point of sale, VAT is added to a product's price throughout the supply chain and often requires different registration and reporting requirements. For example, if you sell to EU customers, you’ll need to know how VAT applies to your goods and register for VAT in each country where you exceed sales thresholds.
Pro tip: Use VAT software with international tax settings or consult a tax professional to help distinguish VAT from sales tax in cross-border transactions. This is especially important if you plan to scale into global markets.
8. Failing to register for a sales tax permit in new states
When you establish a new nexus in a state, whether through physical or economic presence, you’re required to register for a sales tax permit in that state before you start collecting sales tax. This is an important step because collecting sales tax without a permit is illegal and can lead to penalties. Simply crossing an economic nexus threshold doesn’t automatically authorize you to collect tax; registration is a separate and essential process.
Pro tip: Plan for potential registration needs in states where you’re approaching economic thresholds. This proactive approach can prevent delays and help you avoid non-compliance issues.
9. Thinking sales tax is a set-it-and-forget-it task
Sales tax is a moving target for online sellers. As your business grows, your tax obligations change too. States continually adjust nexus rules, introduce new tax laws, and modify tax rates. An e-commerce business that starts by shipping only locally may eventually reach nexus thresholds in multiple states as it grows.
Pro tip: Perform regular nexus and tax obligation assessments, ideally every quarter. If your e-commerce software tracks nexus thresholds, review its reports and adjust your processes as needed to ensure that you’re collecting tax wherever required.
10. Neglecting to remit sales tax collected
It’s not enough just to collect sales tax from customers—you also need to remit it to the appropriate state tax authorities by specified deadlines. Each state has different filing requirements, and failure to remit on time can result in costly penalties and interest. Late payments or missing tax returns can also lead to audits, which can create a cascade of problems for your business.
Pro tip: Set up calendar reminders or use software to track remittance deadlines for each state where you collect tax. Some e-commerce platforms offer automated remittance services, simplifying the process.
Conclusion
For e-commerce businesses, understanding the ins and outs of sales tax is crucial for avoiding costly mistakes. From knowing where you have nexus to staying on top of ever-changing tax rules, taking proactive steps will ensure your business remains compliant and positioned for growth. By avoiding these common errors and utilizing available resources, online retailers can navigate the complexities of sales tax with greater confidence and efficiency.
With a proactive approach, reliable software, and ongoing education, you can set your e-commerce business up for a smoother path toward sales tax compliance and a more predictable financial future.
Do you need help with your sales tax compliance? Book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.
