What would you do if you lost a significant percentage of income? You got a pay cut but had to do the same amount of work. Year over year, you earn less, run up debt, and you’re out of ideas to balance your budget.
This is what happened to state governments as online sales became ever more popular.
The Internet changed how we shop. It’s great if you’re a consumer. I love it! It’s convenient. I can compare prices and find things I never knew I wanted. Plus, my order arrives in a couple of days. Even if I wanted to go to a store, I rarely have time to run errands and pick up the item before it could arrive.
Yet online shopping hurts state and local governments (and local businesses). The states collect less in sales tax revenues. Citizens expect them to provide the same services. With a growing population, their budget deficits rise. The tax laws lag behind leaps in technology.
Now that is no longer the case.
Why? The Supreme Court decision last year on South Dakota vs. Wayfair. Let’s refer to this case as Wayfair.
Side Effects of Online Shopping
When you buy from an out-of-state business, you may save a little money by not paying sales tax. This was common for online sales.
A business with a physical tie to a state must charge sales tax (if the item is taxable). The tie could be a warehouse, office, or even a remote employee living there. If they don’t have any physical presence in the state, they aren’t required to collect sales tax.
As online shopping became more popular and states could not tax the sales, their sales tax revenues declined.
If your state is in a budget crisis (I’m looking at you Connecticut), these untaxed online sales add to the deficit. The Government Accountability Offices estimates that states miss out on $13 billion (Billion) in sales tax revenues every year.
E-commerce sites have an unfair advantage over traditional brick and mortar stores too. In part, their prices are lower because they don’t have to charge sales tax. This makes physical stores less competitive. Even big companies, like the bankrupt Toys 'R Us, struggle to survive.
South Dakota vs. Wayfair and Economic Nexus
Several times states tried to tax online sales, but they were unsuccessful --- until Wayfair. The Supreme Court upheld a South Dakota law forcing online retailers to charge sales tax. The online retailers include both direct sellers, like Amazon, and marketplaces, like Etsy.
The South Dakota law created a new type of nexus: economic nexus.
Nexus means you must pay or collect and remit a tax.
Economic nexus depends on where the customer is. The business no longer needs an office, store, or employees (all which create physical nexus) in a state. Companies that make above a set amount of sales now must collect and remit sales tax. Either the sales volume or dollar amount can create economic nexus.
In Wayfair, the Court acknowledged that e-commerce changed how businesses operate. A company doesn’t need a physical location to do lots of business in a state. Thus, if they have significant economic activity, they have nexus and must charge sales tax.
New Sales Tax Laws Post-Wayfair
Since the June 2018 Wayfair decision, almost all states have updated their tax laws. As of October 1, 2019, 43 of the 45 states that collect sales tax can now tax based upon economic nexus.
Each state determines when economic nexus applies. In most states, a company must do more than 100-200 transactions or $100k-500k of sales. You need to check with your state for the exact rules.
How to Manage Sales Taxes in 2019
If you sell anything online or in a digital format, you need to reassess if you need to charge sales tax liability. Check with each state where you do business. Learn what products and services are taxable and at what threshold you have nexus.
Here are two resources with an overview by state:
You have three ways to manage your sales taxes: do it yourself, hire a professional, or use a software service.
If you do it yourself, you’ll need to watch for changes. Every state publishes their rules online. You can check their website for updates and pay attention to your local news.
Consulting a professional, like a CPA, helps if you are unsure of your obligations. We can review your products and services, clarify your responsibilities, prepare returns, and assist in audits.
You may want to invest in sales tax compliance software if you do a lot of e-commerce business in several states. Avalara and TaxJar are two examples. If you sell in several states, it's a cost-effective solution.
Sales tax laws change at a dizzying pace. There are over 12,000 jurisdictions, each with their own set of rules. Be wary of doing it yourself. The last thing you want is a sales tax audit – it’s exhausting, expensive, and incredibly nitpicky. A professional or compliance software can help you file your returns right the first time and keep the proper proof.
Because sales tax compliance is so challenging, many businesses want one federal law. They are pushing for Congress to create a nation-wide internet sales tax policy.
Sales tax compliance is cumbersome – in particular for small- and medium-sized businesses. If you agree, reach out to your state representatives and senators.
As a result of Wayfair, you will pay more taxes for online shopping. Keep in mind that you are helping local businesses and your state government.
You may have already noticed that you are paying sales tax online. If not, you won’t fall out of your chair when you do.
On the bright side, maybe states (Hey Connecticut!) can balance their budgets without raising other taxes.