Six Misconceptions and Three Challenges of eCommerce Sales Tax Collections
Last week, LYONSCG received a briefing on sales taxes from our friends at Avalara, a provider of cloud-based tax and compliance software for eCommerce merchants. While sales tax strategies aren’t normally considered the most fascinating of topics, the presentation was very interesting and more importantly, it opened our eyes to the importance of sales tax calculation and collection by online merchants.
Our discussion started with a story of a merchant who was audited and wound up having to pay a sizeable sum in back taxes, fines, and penalties for non-collection of sales taxes. The lament of that merchant was “nobody told me this was important.”
Obviously, collecting too little (or worse, collecting no tax at all) could create problems for your organization. Likewise, collecting too much may create customer satisfaction issues, as consumers don’t want to pay more than they think they owe.
Of course, taxes are important, and along with death, noting is more certain. Not knowing your obligations does not absolve your business from sales or excise tax liability. To help clear some of the confusion, here are six of the most common misconceptions about sales taxes for online retailers:
- I’m too small to be audited.
Not true. No business, no matter how small, is exempt from sales tax collection. Smaller businesses may be viewed as more likely to have errors in their collection, hence may actually be stronger targets for compliance inquiries. Cash-strapped states are hiring additional auditors to find revenue owed due to tax collection.
- I’m a manufacturer – I don’t have to collect sales taxes:
If you sell direct to consumer (which could include items such as spare parts, replacement parts, service & support), those sales require the collection of applicable taxes.
- My business is only in one state.
That may be true, but you may still be obligated to collect sales taxes in that state. And with the confusing definitions of what creates a nexus in a particular state, merchants may have obligations they’re not aware of.
- We only sell services.
In some states, services are taxable.
- We only sell through distribution.
As with the manufacturing example, firms selling through distribution may create situations where they are obligated to collect sales taxes.
- We’ve never been audited.
Just because your business hasn’t been audited doesn’t mean you’re exempt from complying with sales tax collection requirements.
Once you’re convinced of the need to have a strategy for sales tax collection, understanding the challenges in determining sales tax rates for any given customer can be a major undertaking. Here are three of the challenges facing online merchants looking to comply with sales tax liability:
Understanding the multiple overlapping jurisdictions:
There are sales and/or excise taxes applied by states, cities, counties, municipalities, special taxing districts—and these districts don’t necessarily line up across well-defined political boundaries. Tax rates can’t even be identified by the zip code, as some zip codes have multiple different total tax requirements. Making matters worse for the merchant—those tax rates apply to different types of products—food, services, software, etc. With over 11,000 tax jurisdictions, trying to calculate tax liability with a spreadsheet may be impossible.
Understanding what collects sales taxes and at what rate
Sales tax calculation can make payroll look like a walk in the park. Understanding what exactly is taxable is the first challenge—for each of those 11,000+ jurisdictions. Food, clothing, media, business supplies, etc., all have different impacts. One has to alsoconsider how much of the expense is liable for tax—for example, shipping and handling fees collected in excess of actual cost to ship may create a tax liability in certain jurisdictions. There are different rules for seemingly similar products—downloaded software versus SaaS versus pre-packaged shrink-wrapped software as an example.
For years, retailers relied on the Quill vs. North Dakota ruling to equate their determination of business nexus to a simple “do we have a facility in that state?” However, acts such as employing sales people who work in other states, regularly attending trade shows, delivering product, renting storage or other normal business activities may create nexus for tax calculation purposes, even if you don’t have a physical branch or office. This stands to become even more important to merchants with the proposed Marketplace Fairness Act, which is legislation that would enable state governments to collect sales taxes and use taxes from remote retailers with no physical presence in their state.
All in all, sales taxation is a complex topic. Our briefing from Avalara just scratched the surface, but provided useful information for merchants to keep in mind when determining sales tax collection requirements.