What Every Online Retailer Should Know about Sales Tax
Many retailers that make their sales online erroneously think they only need to collect and remit sales tax in the state where they operate. However, there are many factors that can create sales tax nexus (the responsibility to collect and remit sales tax in a state) for online retailers in other states.
If you make sales online, here are a few questions you should ask yourself: Do you have employees working in other states? Do you store your inventory and use a fulfillment agent in another state? Do you have your goods drop-shipped by the supplier? Have you entered into affiliate marketing programs? All these activities and more can create sales tax nexus that may require you to collect tax in multiple states.
eCommerce retailers should be aware how the items they sell are treated for tax purposes in different states. A single commodity can be treated in many different ways depending on the sales tax laws and statutes in a state.
For a good example, let’s look at retailers that sell clothing.
Some states fully exempt clothing from sales tax. For example, in Minnesota clothing is generally exempt from tax. For purposes of the exemption, Minnesota defines “clothing” as all human-wearing apparel suitable for general use. Note that there are exceptions like fur clothing. Similarly, Pennsylvania and New Jersey generally exempt clothing and footwear from sales tax.
Other states have a price threshold for taxing clothing. If a piece of clothing costs less than the threshold, it is exempt; if it costs more than the threshold, it is taxable. In Massachusetts, sales of clothing and footwear are exempt up to $175 of the sales price of any article of clothing. If the price exceeds $175 then just the excess is taxable.
New York has a year-round sales and use tax exemption on sales of clothing and footwear costing less than $110 per item or pair. Clothing and footwear that costs $110 or more per item or pair are taxable on the full amount. New York’s exemption does not apply to locally imposed sales and use taxes unless the county or city imposing those taxes elected the exemption.
Things get even trickier when you look at how states classify what qualifies as clothing and what doesn’t. In Pennsylvania, sales of clothing and footwear are generally exempt from tax. But, the exemption does not apply to accessories, ornamental wear, formal wear, sporting goods and clothing normally used or worn when engaged in sports, and real or imitation fur if the fur is more than three times the value of the next-most-valuable component material.
As you can see, states can get pretty specific about what clothing is taxable and what clothing is exempt. For a retailer who makes sales online from clothing, this can lead to significant complications. Note that the Streamlined Sales Tax Governing Board has a common definition of clothing.
Online retailers should also be aware how the sales tax treatment varies from state to state for other items. If you make sales online, have you considered whether the shipping charges are subject to sales tax? In Illinois, if delivery charges are included in the selling price of an item, they are subject to sales tax. However, if the delivery charges are separately contracted for and not included in the selling price, then delivery charges are exempt in Illinois.
A separate contract for delivery is the best evidence to support this claim, but documentation that the purchaser had the option of taking delivery of the item at the seller’s location, or having delivery made by the seller for an ascertainable delivery charge, is also sufficient evidence.
What about shipping and handling? Can shipping and handling change the sales tax treatment of a shipping charge? Yes! In Alabama, shipping charges separately stated and delivered by the US Postal Service or other common carrier may be deducted from the tax base. However, shipping charges are not considered to be separately stated if they’re included with other charges, such as handling, and therefore the bundled charge is subject to tax. It can be a very small distinction that can lead to a big impact.
What about shipping charges if a sale includes one taxable item and one tax-exempt item? In Kansas, sales tax applies to shipping charges, regardless of whether they are separately stated. But if a single shipment contains both taxable and tax-exempt goods, the seller must collect sales tax on the basis of the percent of the shipping charge allocated to the taxable goods in the shipment.
Another item that online sellers should be aware of are sales tax holidays. Various states offer sales tax holidays (often annually) that run for a number of days, during which consumers can purchase specified goods (often with a price threshold) free of sales tax.
This means you may also need to have systems in place to deal with tax-free sales during the holiday dates. To check whether any states where you operate have a holiday, check our sales tax holiday chart.
Drop-shipping includes some of the most common questions I get from online retailers, particularly when a supplier charges the retailer tax when the retailer thinks the item should be exempt from tax. Not knowing the rules could end up costing your business between 8 and 10 percent of your purchase price. But, I’ve also talked to many online retailers that have registered to give a resale certificate not realizing what that means.
I will be presenting on drop-shipments at the Sales Tax Institute’s Basic Concepts of Drop-Shipments webinar on Thursday, April 28. For more details and to register, visit the course page. If you can’t join us, read more about this issue on our drop-shipment FAQ page.
Online retailers need to be aware of the many different factors that have an effect on the sales tax treatment of the sales they make. But, the first thing you need to figure out is where you need to even worry about sales tax. The information above is just an introduction to the issues you should be aware of. If you’d like to learn more about sales tax nexus and the impact it can have on your operations, download the Sales Tax Institute’s white paper, 5 Things to Understand about Your Nexus Footprint.
Diane L. Yetter is a strategist, advisor, speaker, author, and expert witness in the field of sales and use tax. She is president of YETTER, a firm that provides sales tax services, including system analysis and strategy, transaction tax automation implementation assistance, training, transactional planning, and general consulting to clients of all sizes in myriad industries. She is also the founder of the Sales Tax Institute, a premier think tank that offers in-person and online courses to educate business professionals about sales and use tax.