Online business owners face unique challenges and opportunities when it comes to sales tax compliance. Unlike brick-and-mortar businesses, online businesses can sell to customers across the country and even the world without having a physical presence in those locations. However, this also means that they may have to deal with multiple sales tax jurisdictions and rules, which can be confusing and complex.
By the end of this blog post, you will have a better understanding of what sales tax compliance is, its requirements for online business owners, and how to manage it to avoid audits, penalties, and complications. You will also learn what tools and resources are available to help you with sales tax compliance.
What is sales tax
A sales tax is a tax that is imposed on the sale of goods and services by state and local governments. It is usually collected by the seller from the buyer at the point of sale and then remitted to the tax authorities. Sales tax rates and rules vary by jurisdiction and by the type of product or service being sold
How is sales tax determined
Sales tax is determined by two factors:
- The tax rate: This is the percentage of the sale price that is charged as tax.
- The tax base: The tax base is the amount of the sale price that is subject to tax.
For example, if the tax rate is 5% and the tax base is $100, the sales tax is 5% x $100 = $5. The tax rate and the tax base can vary depending on the jurisdiction and the product or service category.
For example, some states have a single statewide tax rate, while others have different rates for different counties, cities, and special districts. Some states have a uniform tax base, while others have exemptions or exclusions for certain products or services, such as clothing, food, digital goods, or software. Some states also have reduced or increased rates for certain products or services, such as luxury items, tobacco, or alcohol.
To determine the sales tax for a transaction, you need to know the following information:
- The location of the seller and the buyer
- The type of product or service being sold
- The sales price of the product or service
- The applicable tax rate and tax base for the jurisdiction and the product or service category
What is sales tax compliance
Sales tax compliance is the process of preparing and filing sales and use tax returns and paying the tax due to the relevant jurisdictions. Sales and use tax returns are periodic reports that show the amount of sales tax collected and paid by a business. They must be filed and paid on a timely basis, according to the filing frequency and due date assigned by each jurisdiction.
Why is sales tax compliance important
Sales tax compliance is important for online business owners for several reasons.
- First, sales tax compliance is a legal obligation that must be fulfilled to avoid audits, penalties, interest charges, and legal consequences.
- Second, sales tax compliance is a customer service issue that can affect your reputation and trustworthiness.
- Third, sales tax compliance is a financial management issue that can affect your cash flow and profitability.
Sales tax compliance requirements, processes and checklist
Below are the requirements, processes, and checklist you need to fulfil to become sales tax compliant
- Register for sales tax with the tax authority and obtain a sales tax permit or license
- Collect and validate sales tax from your customers at the point of sale
- Report and file sales tax returns on a timely basis
- Pay the tax due to the tax authorities
- Maintain and organize your sales tax records
- Monitor and update your sales tax compliance status
The sales tax compliance requirements can vary depending on the jurisdiction and the type of product or service being sold, so you must constantly keep an eye on possible changes and updates in each state where you have a nexus
How to do sales tax compliantly (detailed step by step approach involved)
1. Determine your sales tax nexus
Nexus can be established by physical factors, such as having a location, inventory, employees, or agents in a state, or by economic factors, such as having a certain amount of sales or transactions in a state. Nexus rules vary by state and by tax type, so it is important to research and monitor your nexus status in each jurisdiction where you do business.
What you need to know if you have a sales tax nexus
To determine your sales tax nexus, you need to:
- Identify the states and countries where you have physical presence, such as a warehouse, an office, a store, or a staff member
- Identify the states and countries where you have economic presence, such as a threshold of sales revenue or number of transactions
- Check the nexus rules and criteria for each state and country where you have physical or economic presence
- Keep track of any changes or updates in the nexus rules and criteria that may affect your nexus status
2. Register for sales tax
If you have nexus in a jurisdiction, you need to register for sales tax with the tax authority and obtain a sales tax permit or license. This will allow you to collect and remit sales tax legally and avoid penalties for non-registration. You should also keep track of your registration information, such as your account number, filing frequency, and due date, and update it as needed.
What you need to register for sales tax
To register for sales tax, you need to:
- Find the registration form or website for each jurisdiction where you have nexus
- Fill out the registration form or website with your business information, such as your name, address, contact details, entity type, and products or services
- Submit the registration form or website and pay any registration fees, if applicable
- Receive your sales tax permit or license and your account number from the tax authority
- Display your sales tax permit or license at your place of business, if required
- Update your registration information if your business changes, such as your name, address, contact details, entity type, or products or services
3. Collect and validate sales tax
Once you are registered for sales tax, you need to collect the correct amount of sales tax from your customers at the point of sale. This requires you to know the sales tax rate and rules for each jurisdiction where you have nexus and where your customers are located. Sales tax rates can vary by state, county, city, and special district, and can change over time.
Sales tax rules can also vary by product or service category, such as clothing, food, digital goods, or software. Some products or services may be exempt from sales tax, or subject to reduced or increased rates, depending on the jurisdiction.
What you need to collect and validate sales tax
To collect and validate sales tax accurately, you need to:
- Verify your customers’ addresses and apply the correct tax jurisdiction and rate based on their location
- Apply the correct tax base and tax rate for each product or service category, based on the jurisdiction’s rules and exemptions
- Calculate the sales tax amount for each transaction, based on the sales price, the tax base, and the tax rate
- Add the sales tax amount to the total amount of the transaction and collect it from the customer
- Issue a receipt or an invoice to the customer that shows the sales tax amount and rate
- Collect and store any exemption or resale certificates from your customers who are eligible for sales tax exemptions, such as nonprofits, government entities, or resellers
4. Report and file sales tax returns
After you collect sales tax from your customers, you need to report and file sales tax returns to the tax authorities on a regular basis. Sales tax returns are periodic reports that show the amount of sales tax collected and paid by a business. They must be filed and paid on a timely basis, according to the filing frequency and due date assigned by each jurisdiction.
What you need to report and file sales tax returns
To report and file sales tax returns efficiently, you need to:
- Gather and reconcile your sales and tax data from various sources, such as your e-commerce platform, payment processor, accounting software, and more
- Populate and format your sales tax returns according to the requirements and layout of each jurisdiction
- Submit your sales tax returns online or by mail, depending on the jurisdiction’s preference
- Pay the tax due to the tax authorities, either by check, electronic funds transfer, or online payment
- File and pay your sales tax returns by the due date, or request an extension if necessary
- Keep a copy of your sales tax returns and payments for your records
5. Maintain and organize your sales tax records
Keeping accurate and complete sales tax records is essential for sales tax compliance. Sales tax records include your sales and purchase invoices, receipts, tax returns, payments, exemption and resale certificates, and any correspondence with the tax authorities. You need to maintain and organize your sales tax records for audit purposes and for future reference. You also need to comply with the record retention policies and rules of each jurisdiction where you file sales tax returns.
To maintain and organize your sales tax records effectively, you need to:
- Have a system for storing and retrieving your records, either electronically or physically
- Label and categorize your records by date, jurisdiction, tax type, and transaction type
- Secure and back up your records to prevent loss or damage
- Retain your records for the required period of time, depending on the jurisdiction’s rules
- Dispose of your records safely and securely when they are no longer needed
6. Monitor and update your sales tax compliance status
Sales tax compliance is not a one-time event, but an ongoing process that requires constant monitoring and updating. Sales tax laws and regulations can change frequently and affect your sales tax obligations and rates. You need to stay informed and updated on the latest sales tax developments and changes in each jurisdiction where you have nexus and where your customers are located. You also need to review and adjust your sales tax compliance processes and procedures as your business grows and changes.
To monitor and update your sales tax compliance status effectively, you need to:
- Have a reliable source of sales tax information and guidance, such as a tax research database, a tax newsletter, or a tax consultant
- Stay alert and aware of any changes or updates in the sales tax laws and regulations that may affect your sales tax obligations and rates
- Implement and communicate any changes or updates in your sales tax compliance processes and procedures to your staff and customers
- Perform regular audits and checks on your sales tax compliance performance and identify any errors or gaps that need to be corrected or improved
- Seek professional help or advice if you encounter any sales tax compliance issues or challenges
5 Commonly encountered sales tax compliance complications
Sales tax compliance can be complicated and challenging for online business owners, especially if they have sales in multiple states or countries. Some of the commonly encountered sales tax compliance complications are:
1. Nexus determination
A lot of business owners have difficulty determining their sales tax nexus in each jurisdiction, especially if they have complex business operations such as drop shipping, third-party fulfillment, or marketplace facilitation. They may also have to deal with changing nexus rules and criteria, such as the economic nexus thresholds that were introduced after the South Dakota v. Wayfair Supreme Court case in 2018.
2. Tax rate and rule variation
Many also face the difficulty of finding and applying the correct sales tax rate and rules for each jurisdiction and product or service category, especially if they sell a variety of products or services that have different tax treatments, such as clothing, food, digital goods, or software. They may also have to deal with changing tax rates and rules, such as the sales tax holidays or exemptions that are offered by some jurisdictions.
3. Tax calculation and collection
Some experience difficulty calculating and collecting the correct amount of sales tax from their customers at the point of sale, especially if they sell through multiple channels, such as their own website, a marketplace, or a social media platform. They may also have to deal with customer requests or complaints, such as refunds, returns, or exemptions.
4. Tax reporting and filing
Most online business owners have difficulty reporting and filing their sales tax returns on a timely basis, especially if they have to file in multiple jurisdictions with different filing frequencies and due dates. They may also have to deal with technical issues or errors, such as system glitches, data discrepancies, or format mismatches.
5. Tax payment and remittance
Difficulty paying and remitting the tax due to the tax authorities is also another common challenge, especially if they have to pay in multiple currencies or methods. They may also have to deal with cash flow issues or penalties, such as late payment fees, interest charges, or bank charges.
How to manage multi-state sales tax compliance
Multi-state sales tax compliance means that online business owners have to comply with the sales tax laws and regulations of multiple states where they have a nexus and where their customers are located.
This can be overwhelming and time-consuming, as online business owners have to deal with different sales tax rates, rules, exemptions, filing frequencies, due dates, and forms for each state.
To manage multi-state sales tax compliance effectively, as an online business owner, you need to follow these steps
- Identify the states where you have nexus and where your customers are located
- Register for sales tax with each state where you have nexus and obtain a sales tax permit or license
- Collect, calculate and validate sales tax from your customers based on their location and the type of product or service being sold
- Prepare and submit the sales tax returns with each state and pay the tax due
- Store and manage their sales tax records for each state
- Stay alert and aware of any changes or updates in the sales tax laws and regulations for each state
Common sales tax compliance services offered by sales tax softwares or solution providers
Common sales tax compliance services offered by sales tax software or solution providers
Sales tax software or solution providers are companies that offer various services and tools to help online business owners with their sales tax compliance tasks. Some of the common sales tax compliance services offered by these providers are:
1. Sales tax calculation
This service helps in calculating the correct amount of sales tax to charge their customers based on their location, product type, and other factors. The service also updates the tax rates and rules automatically to reflect the latest changes in the sales tax laws and regulations.
2. Sales tax collection
This service helps online business owners collect and validate sales tax from their customers at the point of sale. The service also handles tax exemptions and certificates for eligible customers and products.
3. Sales tax filing and remittance
This service helps in preparing and submit their sales tax returns to the relevant tax authorities on a timely basis. The service also pays the tax due to the tax authorities on behalf of the online business owners.
4. Sales tax audit support
This service helps online business owners deal with sales tax audits and inquiries from the tax authorities. The service provides assistance and guidance on how to respond to audit notices, requests, and questions and how to resolve any issues or disputes.
5. Sales tax reporting and analytics
This service helps online business owners monitor and analyze their sales tax performance and compliance status. The service provides reports and dashboards that show the sales tax collected, paid, and due, as well as the sales tax nexus, liability, and risk.
Top 3 sales tax compliance software solutions
There are many sales tax compliance software solutions available in the market, but some of the most popular and reputable ones are:
AtomicTax sales tax compliance software
AtomicTax is a cloud-based sales tax compliance software solution that offers a robust and reliable way for online business owners to comply with their sales tax requirements. AtomicTax integrates with various e-commerce platforms, marketplaces, payment processors, accounting systems, and other business applications and helps to
- calculate sales tax collected from customers,
- file and pay sales tax returns to the tax authorities,
- Analyze and monitor sales tax nexus and
- update the sales tax compliance status.
Avalara
Avalara sales tax compliance software solution that offers a comprehensive suite of services and tools for online business owners. Avalara integrates with hundreds of e-commerce platforms, marketplaces, payment processors, accounting systems, and other business applications to automate and streamline the sales tax compliance process.
TaxJar
TaxJar is a cloud-based sales tax compliance software solution that offers a simple and affordable way for online business owners to manage their sales tax obligations. TaxJar connects with various e-commerce platforms, marketplaces, payment processors, and other business applications to calculate and collect sales tax from customers, file and pay sales tax returns to the tax authorities, and track and report sales tax data and performance.
Sales tax compliance documentation
Sales tax compliance documentation is the collection of records and documents that you need to keep and maintain to prove your sales tax compliance. Sales tax compliance documentation includes:
- Sales and purchase invoices, receipts, and statements that show the sales price, tax rate, and tax amount for each transaction
- Sales and use tax returns and payments that show the sales tax collected, paid, and due for each filing period
- Sales tax permits or licenses that show the registration and authorization to collect and remit sales tax in each jurisdiction
- Exemption and resale certificates that show the eligibility and verification of sales tax exemptions for certain customers and products
- Correspondence and communication with the tax authorities that show the response and resolution of any sales tax audits, inquiries, or issues
Conclusion
Sales tax compliance is a vital and challenging task that requires attention and diligence from businesses of all sizes and industries.. By following these sales tax compliance basics and tips, you can simplify your tax reporting and filing process and reduce your risk of audits, penalties, and complications.