How to Charge Sales Tax for an Online Business

Online businesses operate in a dynamic environment, making sales tax compliance a complex but essential aspect. Understanding these obligations is fundamental for sustained success and avoiding penalties. This guide outlines the steps for online businesses to navigate sales tax requirements, from determining where to collect to how to remit.

Understanding Sales Tax Obligation

Online businesses must first determine where they have “sales tax nexus,” the connection between a business and a state that triggers a sales tax collection obligation. This dictates the states where an online business must collect sales tax. Two primary types of nexus are physical and economic.

Physical nexus is established by a tangible presence in a state. This includes a physical office, a retail storefront, employees, or storing inventory in a warehouse, even through a third-party fulfillment service like Amazon FBA. Even temporary activities, such as attending a trade show, can establish a physical presence.

Economic nexus is a more modern concept that arose from a Supreme Court decision. This ruling permitted states to require remote sellers to collect sales tax based on their economic activity within the state, regardless of physical presence. Thresholds vary significantly by state, typically based on a certain dollar amount of sales or a number of transactions annually.

Many states set thresholds around $100,000 in sales or 200 separate transactions within a calendar year. Some states require both thresholds, while others use an “or” test or have removed the transaction threshold. Online businesses must continuously monitor their sales activity to identify when these thresholds are crossed, triggering the obligation to register and collect sales tax.

Determining Sales Tax Rates and Taxability

Once a sales tax obligation is established, businesses must understand which products or services are taxable and at what rate. Item taxability varies by state; some states tax digital products and services, while others primarily tax tangible goods. Verify the specific rules for each state where nexus exists.

Sales tax rates combine state, county, city, and special district taxes, resulting in thousands of different rates nationwide. This complexity is further influenced by whether a state follows an origin-based or destination-based sales tax system. In origin-based states, sales tax is calculated based on the seller’s location, simplifying compliance for in-state sales.

Most states operate under a destination-based system, where the sales tax rate is determined by the buyer’s location. This system can be more intricate for online businesses, as they may need to apply numerous local rates within a single state.

Certain sales may be exempt from sales tax. Common exemptions include sales for resale, where a buyer provides a valid resale certificate. Purchases by specific entities, such as government organizations or qualified non-profits, can also be exempt, provided they present a valid exemption certificate. Sellers must obtain and verify these certificates to justify not collecting sales tax.

Registering for Sales Tax Permits

Before collecting sales tax, an online business must register with the appropriate tax authority in each state where nexus is established. This mandatory registration grants the business a sales tax permit or license. Operating without a proper permit can lead to penalties and legal issues.

Each state manages its own sales tax registration process, typically through its Department of Revenue or a similar state tax agency website. While the exact steps vary, the general procedure involves completing an online application. Businesses should gather necessary information beforehand, which usually includes the business name, address, Employer Identification Number (EIN), business structure, and estimated sales volume.

Complete registration before making any taxable sales in a state where a sales tax obligation exists. Many states offer online portals that streamline the application process. Some states may also require local registration in addition to state registration.

Setting Up Sales Tax Collection

Once sales tax permits are obtained, online businesses must configure their e-commerce platforms to accurately collect sales tax. Most popular e-commerce platforms, such as Shopify, WooCommerce, BigCommerce, Etsy, and Amazon Seller Central, offer built-in sales tax settings. These settings allow businesses to specify their nexus states and activate tax collection.

Configuring these settings involves inputting the states where the business has a sales tax obligation. Businesses can specify product taxability and select between origin-based or destination-based calculations. Platforms may also provide mechanisms for handling tax-exempt sales, such as allowing customers to input exemption certificate numbers during checkout.

For businesses facing complex sales tax scenarios, especially those with destination-based nexus in multiple jurisdictions, automated sales tax tools are available. Services like Avalara, TaxJar, and Stripe Tax integrate with e-commerce platforms to automate complex rate calculations, reporting, and filing. These tools help ensure accurate tax collection across numerous local tax jurisdictions.

Businesses using custom solutions or manual invoicing must manually apply the correct sales tax rates based on the customer’s shipping address and product taxability. This approach requires careful attention to detail and ongoing research into applicable rates and rules. Maintaining accurate and regularly updated tax tables is essential for businesses that do not use automated solutions.

Filing and Remitting Sales Tax

After collecting sales tax, online businesses must file sales tax returns and remit funds to the appropriate state tax authorities. Each state assigns a filing frequency—monthly, quarterly, semi-annually, or annually—typically based on the business’s sales volume or tax liability. Most new businesses are initially assigned a monthly frequency, which may be adjusted later based on reported sales.

The process of preparing sales tax returns involves aggregating sales data, separating taxable from non-taxable sales, and calculating the total sales tax collected for each state and any relevant local jurisdiction. Returns generally require reporting gross sales, taxable sales, collected tax, and any allowable deductions. Failing to file or pay by the due date can result in penalties and interest charges.

Most states provide online portals for electronic filing and payment, often the required method. Sales tax automation software can streamline this process by automating data aggregation, preparing return-ready reports, and facilitating direct electronic filing and remittance. This automation helps reduce errors and ensures timely compliance.

Maintaining accurate records of all sales, collected tax, and filed returns is essential for audit purposes. Businesses should retain sales slips, invoices, receipts, and documentation for exempt sales for three to four years, or longer if required by the state. These records must clearly distinguish between taxable and non-taxable sales to demonstrate proper compliance.