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Understanding Internet Sales Tax
July 29, 2021

Internet sales tax, or sales tax on goods sold online, is a complex issue. Forty-five states and the District of Columbia require consumers to pay sales taxes on purchases; retailers must collect the sales tax and remit it to the state.

But the rules for online purchases are different from those made in brick-and-mortar stores.

In Quill Corp. v. North Dakota (1992), the U.S. Supreme Court upheld a law that states cannot require a business to collect state sales taxes unless it has a physical presence (or “nexus”) in that state. In other words, if you own a retail store in California and also sell products online, you have to collect sales taxes from online customers who live in California, but not from online customers who live in Pennsylvania.

Although this Supreme Court decision was made before ecommerce became part of our lives (Quill Corp. sold products across state lines by mail order), the ruling has been used as the basis for maintaining current Internet sales tax laws. Largely to protect small businesses, the federal government has continued to limit states' abilities to collect sales tax on products that are sold across state lines.

While this is good news for online retailers, brick-and-mortar retailers often feel that it puts them at a competitive disadvantage. For example, if your store sells a product that retails for $1,000, and you have to collect 10 percent sales tax on it, you’re competing with online retailers who sell the same product for $1,000 with no sales tax.

Meanwhile, states aren’t happy about losing potential tax revenues from products their residents buy from out-of-state. A report earlier this year from the National Conference of State Legislatures and the International Council of Shopping Centers estimates the total uncollected sales and use tax from Internet sales at nearly $26 billion annually.

Technically, even if an online retailer doesn’t collect sales taxes, taxpayers are supposed to pay “use taxes” on those online purchases anyway. However, few if any individuals are even aware of this law exists, much less taking the time to track their online purchases, calculate the use tax owed, and remit it to their state tax authority.

Over the years, federal legislators have battled over internet sales tax laws. Some states have passed laws requiring large internet sellers to collect sales tax even if they don't have a physical store in that state. In April 2017, for example, Amazon began collecting sales tax from customers in states with sales taxes.

What if you’re a third-party retailer selling products on a larger marketplace, such as Amazon? If you are a "Fulfillment by Amazon" (FBA) seller, you can sign up and pay to have Amazon collect the sales taxes for you. While many FBA sellers don’t do so for states where they don’t have a physical location, several states have proposed laws that would require third-party sellers (such as FBA sellers) to collect sales taxes regardless of nexus.

At the time of this writing, a South Dakota law requiring some online retailers to collect South Dakota sales taxes is before the South Dakota Supreme Court, it and has a good chance of going all the way to the U.S. Supreme Court. However, even if the Supreme Court overturns the Quill Corp. v. North Dakota decision, the slow pace of congressional activity on the matter so far suggests it will take quite a while for change to happen.

What should ecommerce retailers do in the meantime?

  • Stay on top of the news. Monitor proposed changes to the Internet sales tax by keeping abreast of industry and business news. That way, you'll have plenty of warning if laws do change.
  • Let the machines handle it. Many ecommerce shopping cart solutions now automatically calculate sales tax rates based on customer location. Choose a shopping cart solution that integrates with your existing tax preparation and accounting software, and you'll make things even easier.
  • Talk to your accountant, tax preparer and/or attorney if you have any concerns about the way your ecommerce site is currently handling sales taxes.
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