How Is Sales Tax Determined for Online Purchases?

Sales tax is a consumption tax imposed by state and local governments on the sale of goods and some services. While its application to online purchases was once unclear, the landscape has evolved significantly. This evolution, driven by the rapid growth of e-commerce, prompted states to ensure tax fairness and revenue collection from online transactions. Online sales tax determination now involves several factors, extending beyond physical presence to include economic activity and the nature of items sold.

Seller’s Connection to the Buyer’s State

A foundational concept in sales tax is “nexus,” the sufficient connection a seller must have with a state to be legally required to collect sales tax from buyers there. Nexus can be established through various activities, obligating the seller to register with the state’s tax authority and collect sales tax.

One way nexus is established is through a physical presence. This traditional form arises when a business has a physical footprint in a state, such as a retail store, office, warehouse, or employees. Even storing inventory in a third-party fulfillment center can create a physical nexus.

For online sales, economic nexus has become a prominent factor. This concept emerged from the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., which allowed states to require out-of-state sellers to collect sales tax based solely on their economic activity in that state, regardless of physical presence. States set specific thresholds, typically based on a certain dollar amount of sales or a number of transactions into the state annually. While thresholds vary, a common benchmark is $100,000 in sales or 200 separate transactions within a calendar year, though some states may only have a sales threshold.

If an online seller does not have nexus in a buyer’s state, they are not obligated to collect sales tax. In such cases, the buyer may be responsible for “use tax,” a complementary tax levied on the storage, use, or consumption of taxable items for which no sales tax was paid. The consumer is responsible for self-reporting and remitting this tax directly to their state’s tax authority.

What is Taxable

Not every item or service sold online is subject to sales tax, and taxability varies significantly by state. States define what is taxable through their laws, meaning an item taxable in one state might be exempt in another.

Tangible personal property is generally taxable in most states. This category includes physical goods that can be seen, weighed, measured, felt, or touched. Examples typically include clothing, electronics, books, and other physical products shipped to the buyer.

The taxability of services is more nuanced. Historically, services were often exempt from sales tax, but many states now tax specific services. Services are generally not taxable unless explicitly enumerated by state law. Examples include certain digital services, cleaning services, or landscaping services.

Digital goods also present a complex area of sales tax. These include items like e-books, streaming services, software downloads, and digital music. The tax treatment of digital goods varies widely, with some states taxing them fully as tangible personal property, while others do not tax them at all. Some states differentiate between downloaded products, which might be considered tangible personal property, and online access or streaming services, which are often treated as services. Tax laws for digital products are continually evolving, and states may reclassify or expand what is considered taxable in this category.

Some common exemptions might apply to consumers, such as groceries or prescription medicine, which are often exempt from sales tax in many states. These exemptions are usually defined by state statute and can reduce the overall tax burden on essential goods.

Determining the Correct Tax Rate

Calculating the precise sales tax rate for an online purchase can be intricate, as it involves multiple layers of taxation and specific sourcing rules. The total sales tax rate is typically a combination of state and local taxes, which can vary significantly even within the same state.

The base rate is the state sales tax, set by the individual state’s legislature. On top of this, local jurisdictions, such as counties, cities, and special districts, often impose additional sales taxes. These local rates are added to the state rate, creating a combined rate that can differ from one zip code to another, or even street by street. This layered approach means that a single state can have hundreds or even thousands of unique sales tax rates across its various jurisdictions.

Sales tax sourcing rules dictate which jurisdiction’s tax rate applies to a transaction. For online sales, the most common method is destination-based sourcing. Under this rule, the sales tax rate is determined by the buyer’s shipping address or the location where the product is received. Most states use destination-based sourcing for interstate sales, particularly for remote sellers.

A few states use origin-based sourcing, where the sales tax rate is based on the seller’s location within the state. In these states, if a seller is located in an origin-based state and sells to a customer within that same state, they would charge the sales tax rate applicable to their own business location. However, for sales made across state lines, even origin-based states generally apply destination-based rules. Online retailers often rely on sophisticated tax software to accurately calculate these rates, as the precise determination requires identifying the specific taxing jurisdictions associated with a buyer’s exact address.

Special Considerations for Online Sales Tax

Marketplace facilitator laws have significantly altered sales tax collection responsibilities for many online sellers. These laws shift the obligation to collect and remit sales tax from individual third-party sellers to the marketplace platform itself, such as Amazon, eBay, or Etsy. If a sale occurs through a compliant marketplace, the marketplace facilitator is responsible for calculating, collecting, and remitting the sales tax, regardless of whether the individual seller has nexus in the buyer’s state. This simplifies compliance for many small and medium-sized businesses selling through these platforms, though sellers still need to understand their obligations for sales made outside of marketplace platforms.

The taxability of shipping and handling charges also varies by state. Some states consider shipping and handling charges part of the sales price and tax them if the underlying product is taxable. Other states may exempt these charges from sales tax, or have specific rules, such as taxing them only if they are not separately stated on the invoice.

Consumer use tax remains an obligation for buyers. If an online seller is not required to collect sales tax on a purchase, the buyer is legally obligated to self-report and pay the corresponding use tax to their state. This tax rate is generally the same as the sales tax rate that would have applied had the seller collected it.

For returns and refunds, sales tax is typically handled by reversing the original transaction. If a product is returned by a customer, the sales tax collected on that product is also refunded to the customer. This ensures that the customer is not taxed on a purchase they ultimately did not keep, and the seller adjusts their sales tax remittance accordingly.