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How to Collect Sales Tax for Online Sales: A Step-by-Step Guide

LegalGPS : Oct. 15, 2024

9:47

When running an online business, one of the most confusing aspects can be navigating the world of sales tax. With each state having its own rules, rates, and systems, understanding how to calculate, collect, and remit sales tax is crucial to staying compliant and avoiding costly penalties.

This blog will guide you step by step through the process of collecting sales tax for online sales, from determining where you need to collect to filing tax returns. We’ll also look at common pitfalls and provide actionable tips for minimizing liabilities.

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Do You Need to Collect Sales Tax?

The first question every online business owner needs to answer is: Do I need to collect sales tax? The answer depends on a key concept called nexus, which establishes whether your business has a significant enough presence in a state to require sales tax collection.

Understanding Nexus

Nexus is essentially the connection between your business and a state that obligates you to collect and remit sales tax. Nexus can be established in several ways, including:

Physical Presence: Having an office, warehouse, or employee in a state qualifies as a physical presence.
- Example: If you operate a warehouse in Texas but sell goods online to customers nationwide, you likely have nexus in Texas and need to collect sales tax on sales to Texas customers.
Economic Nexus: Even without a physical presence, many states have adopted laws that trigger nexus based on the volume or dollar amount of sales in the state.
- Example: South Dakota’s economic nexus law applies if your online sales exceed $100,000 or involve 200 separate transactions in the state, even if you don’t have an office or employees there.
Click-Through Nexus: This type of nexus is created when you have affiliates in another state who refer customers to your site in exchange for commissions. If their sales exceed a threshold (e.g., $10,000), you may be required to collect sales tax.
- Example: Your fashion business in Arizona has affiliates in California who promote your products. If these affiliates refer enough sales to surpass the threshold in California, you’ll need to collect California sales tax.

Once you've determined where you have nexus, you need to familiarize yourself with the tax rules in those states.

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Tax Systems: Who Pays the Sales Tax?

Each state has its own system for collecting sales tax, and understanding whether you or the customer is responsible for paying it is essential.

Vendor Tax System vs. Consumer Tax System

Vendor Tax System: The most common system, where the seller is responsible for collecting, reporting, and remitting sales tax. This means you collect the tax from your customers at checkout and remit it to the state.
- Example: Your online store based in Georgia sells to customers within Georgia. You collect sales tax based on the Georgia tax rate and remit it to the state’s Department of Revenue.
Consumer Tax System: The customer is responsible for reporting and paying sales tax directly to the state (commonly known as use tax). This applies when a seller does not collect sales tax but the state still requires the customer to pay.
- Example: A customer in Colorado buys from an online retailer based in Oregon (a state with no sales tax). The customer must report and pay use tax to Colorado, even though the seller did not collect it.
Combined System: Some states use a mixed system where the seller collects sales tax but the customer is ultimately responsible for ensuring it is paid. This can make it tricky for online businesses, but proper systems help smooth the process.

Origin-Based vs. Destination-Based Sales Tax: Where Do You Collect?

Once you determine where you have nexus, the next challenge is figuring out which tax rate to use. States can use either an origin-based or destination-based tax system.

Origin-Based Sales Tax

In origin-based states, the sales tax rate is determined by your business location, regardless of where your customers are located.

Example: Your business is in Houston, Texas, where the total sales tax rate is 8.25%. You sell a product to a customer in Dallas, Texas, but you will charge the Houston rate of 8.25%, even though the Dallas rate might be different.

Destination-Based Sales Tax

In destination-based states, the sales tax rate is determined by the buyer’s location. This means you need to charge sales tax based on the customer's address, which can vary significantly.

Example: Your business is based in Florida, but you sell a product to a customer in Orlando (within Florida). You will charge the Orlando sales tax rate for that transaction.

For online businesses, most states require you to use a destination-based sales tax model for remote sales. This means the tax rate is based on the customer’s location, not where your business is based.

Tip: Use tax automation tools like Avalara or TaxJar to calculate the correct tax rate based on the buyer’s ZIP code, as this can become very complex with many transactions.

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How to Get a Sales Tax Permit

Once you know where you need to collect sales tax, the next step is obtaining a sales tax permit from each state. You can typically apply for this permit online through the state’s Department of Revenue website. Here's what you need to know:

Steps for Obtaining a Sales Tax Permit

Identify Required States: Only apply for permits in states where you have nexus. Unnecessary permits may create unexpected liabilities, including the need to file zero returns (discussed later).
Provide Business Information: This typically includes your business name, Federal Tax ID (EIN), business address, and types of goods or services sold.
Permit Fees: Some states charge for permits (e.g., $19 in Washington), while others provide them for free (e.g., in Delaware).
Timeline: Some states issue permits in a few days, while others may take several weeks. Be sure to plan ahead.

Caution: Once you obtain a permit in a state, you are required to collect and remit sales tax for every transaction in that state, or file zero returns if no sales were made.

How to Calculate and Collect Sales Tax

Sales tax rates differ not only from state to state but also from county to city within each state. Calculating and collecting the correct tax is critical for compliance.

Calculating Sales Tax Rates

You’ll need to factor in multiple layers of taxes:

State Sales Tax: The base rate charged across the entire state.
- Example: The state of Missouri has a base sales tax of 4.22%.
County Sales Tax: Added on top of state tax and varies by county.
- Example: In Boone County, Missouri, the county adds an additional 1.75%.
City Sales Tax: Some cities also impose an additional tax.
- Example: The city of Columbia, Missouri, adds another 2% sales tax.

In total, a sale in Columbia, Missouri, would require a tax rate of 7.97% (4.22% state + 1.75% county + 2% city).

Tip: Use tax software like QuickBooks or TaxJar to automate sales tax calculations across multiple jurisdictions.

Reporting Sales Tax

You’ll typically need to report and remit sales tax either monthly, quarterly, or annually, depending on your total sales volume. Failing to report, even if you had no sales, can lead to penalties.

Example: If you obtained a sales tax permit in Colorado but didn’t make any sales during a particular period, you still need to file a zero return to avoid penalties.

What Happens If You Fail to Pay Sales Tax?

Failing to collect or remit sales tax can lead to severe penalties, both civil and criminal. States take sales tax evasion seriously and can impose fines, penalties, and even jail time for willful violations.

Voluntary Disclosure Programs

If you realize you’ve been unknowingly failing to pay sales tax, you may qualify for a voluntary disclosure program. These programs allow businesses to come forward and pay back taxes without facing full penalties.

Sales Tax Penalties

Penalties for non-compliance vary by state:

Missouri Example: Failing to file or pay sales tax results in a penalty of 5% of the unpaid tax per month, up to 25%. If the total tax owed exceeds $10,000, criminal charges may apply.
Over-Collection Penalty: Charging customers a higher sales tax rate than required and keeping the difference can result in significant fines.

Conclusion: Take Control of Sales Tax for Your Online Business

Managing sales tax for online sales is no easy task, but with the right tools and strategies, it becomes much more manageable. From determining where you have nexus to understanding state-specific rules and automating calculations, staying compliant is essential to running a successful e-commerce business. By avoiding common pitfalls and understanding your obligations, you’ll not only avoid penalties but also gain the confidence to expand your online business with peace of mind.

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