How Does Online Sales Tax Work for Businesses?

The landscape of online sales tax has transformed, altering how businesses operate and how consumers are taxed when making internet purchases. This evolution has introduced new complexities for businesses, particularly those engaged in e-commerce, requiring a deeper understanding of tax obligations across various jurisdictions. Online sales tax now involves a nuanced set of rules and responsibilities that businesses must navigate to remain compliant.

The shift in online sales tax rules reflects the growth of digital commerce and states’ efforts to ensure equitable tax collection between online and brick-and-mortar retailers. Businesses selling goods or services over the internet must now contend with a patchwork of state-specific regulations, which can vary widely.

Understanding Economic Nexus

Historically, sales tax collection obligations for out-of-state businesses were determined by a “physical presence” rule, stemming from the 1992 Quill Corp. v. North Dakota Supreme Court decision. This ruling established that a business only had to collect sales tax in states where it had a physical connection, such as a store, office, or employees. Online sellers without a physical presence in a state were largely exempt from collecting sales tax from customers in that state, creating a perceived advantage over traditional brick-and-mortar stores.

The landscape changed with the 2018 South Dakota v. Wayfair, Inc. Supreme Court decision. This ruling overturned Quill, determining that a physical presence was no longer a prerequisite for sales tax collection obligations. The Court introduced “economic nexus,” allowing states to require remote sellers to collect sales tax based on their economic activity within the state, even without a physical location. This decision expanded the reach of states’ sales tax authority.

Economic nexus signifies a substantial economic connection to a state, triggering a sales tax collection obligation. This connection is defined by specific thresholds related to the volume of sales or the number of transactions into a state within a defined period, often a calendar year. Common thresholds include a certain dollar amount of sales, such as $100,000, or a specific number of transactions, often 200, or sometimes both. These thresholds are not uniform; they vary significantly from state to state, requiring businesses to monitor their sales activity in each jurisdiction.

A related concept is “trailing nexus,” where a state might require a business to continue collecting and remitting sales tax for a period even after it no longer meets the established economic nexus thresholds. This obligation can persist for weeks, months, or even a full calendar year following the period when nexus was met. The rationale is that the business’s past economic activity may continue to generate residual sales or a lasting economic impact within the state. Businesses must be aware of these varying rules to ensure continued compliance, even if their sales volume fluctuates below thresholds.

How Sales Tax Rates are Determined and Who Collects

Sales tax rates are determined by sourcing rules, which define where a sale occurred for tax purposes. There are two methods: “origin-based” and “destination-based” sourcing. In origin-based states, the sales tax rate is based on the seller’s physical location, consistent regardless of the buyer’s location within that state. Conversely, in destination-based states, the sales tax rate is determined by the buyer’s location, requiring sellers to calculate the rate based on the delivery address. Most states with online sales tax requirements utilize destination-based sourcing for remote sellers, leading to varied rates across different customer locations.

The total sales tax rate is multi-layered, encompassing state, county, city, and various special district taxes. These individual tax components combine to form the comprehensive rate applicable to a specific transaction. For instance, a sale might be subject to a statewide sales tax, an additional county tax, a city tax, and potentially a special district tax for local initiatives. Businesses must accurately identify and apply these combined rates based on the precise location of the buyer in destination-based states.

Product taxability adds complexity, as not all products or services are subject to sales tax in every state. Certain food items, clothing, digital products, or services may have specific tax rules or exemptions. Some transactions or buyers may also be exempt from sales tax, such as sales for resale where the buyer provides a valid resale certificate, or purchases made by qualified non-profit organizations. Businesses must verify the taxability of their specific products and services in each state where they have a sales tax obligation.

A development in online sales tax collection is the implementation of “marketplace facilitator” laws. A marketplace facilitator is an entity, such as Amazon, eBay, or Etsy, that operates an online platform facilitating sales between third-party sellers and customers. These laws shift the responsibility for collecting and remitting sales tax from the individual third-party seller to the marketplace platform itself for sales made through that platform. This change was enacted to simplify compliance and enhance tax collection, as states can collect from fewer, larger entities rather than numerous small sellers.

While marketplace facilitators handle sales tax for transactions occurring on their platforms, individual sellers remain responsible for collecting sales tax on sales made directly through their own websites or other channels. This means a business selling both on a marketplace and its own site must understand its direct sales tax obligations in states where it meets nexus thresholds. The widespread adoption of marketplace facilitator laws has streamlined compliance for many small businesses that primarily sell through these platforms, but it does not eliminate all sales tax responsibilities.

The Process of Sales Tax Collection and Remittance

Once a business establishes economic nexus in a state, beyond sales solely facilitated by a marketplace that collects on its behalf, the initial step involves registering with that state’s tax authority. This registration secures a sales tax permit or license, a prerequisite for legally collecting sales tax from customers. The registration process involves providing business information, such as the business name, address, and entity type, to the state’s department of revenue through an online portal.

Following registration, businesses must implement systems to accurately collect sales tax from customers at the point of sale. For e-commerce businesses, this involves configuring their shopping cart software or e-commerce platforms to automatically calculate and add the correct sales tax to customer invoices. The collected sales tax is not considered business revenue; it is held in trust by the seller until remitted to the appropriate state tax authority. Businesses are legally obligated to display the sales tax amount on the transaction system.

Businesses are required to file sales tax returns regularly with each state where they collect tax. The filing frequency is assigned by the state upon registration and includes monthly, quarterly, or annual periods, though some states may require semi-annual or more frequent filings for high-volume sellers. The frequency is determined by the business’s sales volume or total tax liability. Even if no sales tax was collected during a filing period, most states still require a “zero” return to be filed.

The final step is remitting the collected sales tax to the state treasury. This process is completed electronically, through the state’s online tax portal. Most states require sales tax to be remitted by the 20th day or the last day of the month following the taxable period. Adhering to these deadlines is important to avoid penalties and interest charges.