Ecommerce Sales Tax Compliance for Online Sales and Online Sellers

Do ecommerce sites have to charge tax?

Ecommerce sites have to charge tax on taxable goods and services according to any sales tax rates or laws set by the purchaser's delivery or billing state, as long as they've established an economic nexus. If an ecommerce site doesn't meet nexus, they don't have to charge sales tax. Ecommerce sellers do not have to charge tax for goods sold in states that don't charge sales tax. 

Do you need to collect sales tax?

Knowing if you need to collect sales tax is essential to understanding ecommerce sales tax laws that affect you. Answer the following questions to determine where you fit. If you're running a business but can't answer these questions, you may need an accountant.

Are you running a business or a hobby?

First, are you operating a business, at least in in the eyes of the Internal Revenue Service? If your store is small and doesn't bring in much money, the IRS might categorize it as a hobby. Hobbies don’t have to collect sales tax, but they can’t claim any losses as deductions either.

The IRS considers an activity a business if “it is carried on with the reasonable expectation of earning a profit.” You may not be making a profit right now, but if you’re spending significant time, effort, and money on your ecommerce endeavor, you're more likely in the business category.

Are you selling taxable goods?

Each state determines sales tax – there is no federal sales tax – and every state has different rules about what goods are taxable. Five states (Oregon, Delaware, Alaska, Montana, and New Hampshire) don't charge any tax.

All states that charge sales tax have some exemption for wholesale goods because the retailer will charge the customer sales tax. Some states exempt items sold as ingredients or as parts for manufacturing.

In seven states (Massachusetts, Minnesota, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont), clothing is exempt from sales tax. Of the states that charge sales tax, 32 of them exempt groceries.

Where is your business located, and where are your customers?

When you have an online business, your office is located in one place, but your customers are all over. How do you know which customers need to pay sales tax? In 1992, the Supreme Court ruled that mail-order businesses, which, by extension, include ecommerce, only had to collect sales tax in states where they had a physical presence.

However, things changed with the 2018 South Dakota v. Wayfair, Inc. case. The Court ruled that ecommerce businesses must remit sales tax in each state where the business meets nexus or a volume and/or revenue threshold. The ruling doesn't change sales tax exemptions for customers who live in states that don't collect sales tax.

If you have a retail store or are selling in a physical location (art market, pop-up shop, trade show, etc.), you're subject to sales tax laws in that location.

What is a sales tax nexus?

A sales tax nexus establishes the connection between a taxing jurisdiction or state and an online seller. When you sell a certain dollar amount or reach a certain number of sales in a given state, you meet nexus and must collect and remit sales tax for purchases in that state.

There are five types of sales tax nexus: economic, physical presence, marketplace facilitator, click-through, and affiliate. Online sellers who don't operate with third parties or a physical presence are usually subject to economic nexus laws.

Each state creates and controls its nexus laws and thresholds. Most states set their economic nexus as $100,000 in sales or 200 separate transactions for online sellers. Some states establish nexus at $250,000 in sales, regardless of transaction numbers.

However, there's more than one way to meet nexus. For example, you must collect and remit sales tax wherever your business has a physical presence (i.e., a brick-and-mortar store, an office, or a warehouse).

Currently, only three states (Oregon, Delaware, and New Hampshire) don't have sales tax and, therefore, no economic nexus laws. Alaska and Montana don't charge sales tax, but some localities have economic nexus laws.

Once you've established a sales tax nexus in a state or jurisdiction, you must register as a retailer in that area to begin collecting sales tax from buyers and remit it to the proper authorities.

"The biggest mistake is creating assumptions about whether you do or don’t have nexus, and that’s before you're even doing the sales tax filings," says Alex Oxford, founder of TaxValet.

"Businesses just assume they don’t have to worry about paying sales tax in other states. And that’s a huge problem. When it comes to actually doing the sales tax returns or getting set up, the biggest mistake is setting up the tax calculation settings incorrectly so that they’re not collecting the right amount of tax from customers. And so they’re not paying the right amount to the states."

Nexus types to help you stay tax-compliant

1. Economic nexus

Online sellers and ecommerce business owners are mostly subject to economic nexus laws. You trigger an economic nexus when your online store meets certain sales (by dollar value or individual transactions). Every state has different laws, and even items exempt from sales tax can contribute towards your nexus threshold.

2. Physical presence nexus

Online sellers who have a physical presence in a state via brick-and-mortar storefronts, offices, or inventory in warehouses are subject to physical presence nexus laws.

Only five states (Alaska, Montana, Oregon, Delaware, and New Hampshire) don't have this nexus law. In some cases, remote employees may establish a physical presence for your business.

3. Marketplace facilitator nexus

If your small business only sells on marketplaces like Etsy or Amazon, you're subject to marketplace facilitator nexus laws. For the most part, these laws pass the tax obligations to the marketplace itself. They'll collect and file sales taxes on your behalf.

You might still need to register for sales tax, depending on your state. Most of these laws date back to 2019, so keeping up with state requirements is essential. The landscape changes often.

4. Click-through nexus

When a remote partner or agency promotes your products and gets a buyer to click on a link that leads to a sale on your marketplace or website, you may be subject to click-through nexus laws. Only 20 states have this nexus law, but thresholds differ from state to state.

For example, in Connecticut, gross referral sales must exceed $250,000 during the preceding four quarters. In Idaho, the sales threshold is smaller — $10,000 — over the preceding 12 months.

5. Affiliate nexus

Whereas a click-through nexus establishes a connection via click, affiliate nexus establishes a connection via person. That person might be an out-of-state employee or other representative affiliated with your business.

Some 30 states have this kind of nexus law, and many merely require an affiliate to have a presence in the state, regardless of gross sales or receipts. 

Does Shopify automatically collect sales tax? Marketplace sales tax collection explained.

Shopify calculates sales tax based on default sales tax rates so that you can collect those fees. But Shopify doesn't file or remit sales tax for you. Shopify updates default sales tax rates regularly but suggests sellers confirm rates independently, which a tool like Avalara AvaTax can help them do.

Shopify sellers can override default tax rates or exempt products from tax anytime. They can even include a calculated sales tax rate in a product's price, so customers don't see a sales tax line item at checkout.

Whether you choose to sell on a platform like Shopify or a marketplace like Amazon, how you calculate, collect, and remit sales tax should factor as much in your decision as their respective ecommerce platform fees and marketplace fees.

Because Shopify doesn't file or remit sales tax, it's not subject to marketplace facilitator nexus laws like Amazon, eBay, and Etsy. These marketplaces collect and remit sales tax on your behalf.

"Almost every single state in the country is a marketplace facilitator state," says Oxford. "And so if you’re only a marketplace seller, you’re more likely than not going to not have substantial liabilities.

But if you start selling on your own website, Shopify, WooCommerce, Magento, or another platform, wherever that sales tax nexus from the FBA inventory or the 3PL is, it's going to cross-contaminate your direct-to-consumer sales. And now you have to begin worrying about collecting sales tax on those transactions."

However, marketplace sellers should keep up with their sales tax thresholds in case they establish a physical or economic nexus without realizing it.

For example, you might have a physical nexus in a state where you're storing inventory. The more spread out your business becomes, the more you have to pay attention to tax compliance across states.

Buy online, pick up in-store (BOPIS) and online sales tax

It's hard to imagine a world without the convenience of buy online, pick up in-store and mobile orders. But this consumer-friendly shopping experience can be tricky for sellers with a physical — and digital — presence who offer these options and take payments at a POS terminal.

Typically, platforms that calculate sales tax rates for you do it based on the customer's shipping or billing address. However, if a customer picks up an item in-store, the sales tax collected should reflect the rate where that store is located.

To complicate matters further, rates can vary across states, even streets, where a store on one side is in a sales tax jurisdiction that's different from the store across from it. 

Buy now, pay later (BNPL) and when to charge sales tax

Better than layaway, BNPL allows buyers to get what they want now and pay over time. But retailers must understand how these payment plans affect sales tax.

Imagine you have a consumer who buys an item that retails for $100 but selects a plan for four installments of $25. Which is correct?

1. The consumer pays the total tax on the $100 purchase at the time of the initial sale.
2. The consumer pays a percentage of sales tax on each installment of $25.

Actually, they both are. But that depends on the state in which the sale is made. And many states rely on historical layaway sales tax laws to make the distinction. For example, California sales tax laws state there’s no “taxable sale until the full purchase price is paid.”

In Arizona, sales tax is collected when “title or possession transfers to the purchaser or at the time receipts from the transaction are determined to be nonrefundable, whichever occurs first.”

Refunds and sales tax laws

When you agree to refund customers, you’re responsible for paying back their total payment for a given item, sales tax included. But’s let’s say you have a flexible return policy, and a customer wants a refund for a month-old purchase. You agree, but you've already remitted the sales tax to their state agency.

If you think you can just remit less sales tax next month to make up for it, that’s only partially true. Sales tax rates change a lot. So if the sales tax rate for that item changes between last month and this month, you could accidentally overpay or underpay.

Instead, many state agencies want you to file an amended sales tax return where you can claim the credit. 

Cross-border ecommerce and sales tax laws

Last year, 64% of manufacturers, retailers, and logistics service providers (LSPs) conducted business across borders or planned to do so this year, according to a survey from Reuters and Avalara. But as appealing as it is to expand to international markets, the challenges are many.

43% of sellers cite shipping delays as the top challenge. 41% cite higher supply chain costs and managing harmonized system (HS) codes. 37% cite tariffs and duties. So if you're in the US and considering selling internationally, there are a few things you'll need to contend with:

• HS codes
• International shipping rates
• Tariffs and duties
• Value-Add Tax (VAT) compliance

HS codes for exporting goods from the US

US merchants shipping overseas use 10-digit Schedule B numbers to classify products — the first six digits of which is the HS code. The World Customs Organization (WCO) manages and updates HS codes every five years. And the US Census Bureau’s Foreign Trade Division manages Schedule B numbers.

The Census Bureau's Schedule B search tool can help you identify numbers for physical products. But beware of special circumstances for items sold in sets and shipments valued at over $2,500 that you may need to report through the Automated Export System (AES).

International shipping rates

Packages you send internationally are subject to the same shipping criteria as those you send domestically, where weight, dimensions, courier, and destination affect the price. And, as a merchant, you'll need to weigh the cost to ship versus the value.

For example, the USPS can ship packages or large envelopes over 1 pound that contain items worth less than $400 and weigh less than 4 pounds for as little as $17.

Or they can ship items in one to three business days for around $74. Solutions like ShipStation or Shipping Easy can help you find the best rates and access special discounts.

Tariffs, duties, and VAT compliance

A tariff is what a destination country charges a merchant for importing goods. The duty is the dollar amount owed. US-based sellers can search for tariffs in over 100 countries using the Tariff Classification Research Tool.

You'll need the product's HS code to complete your search and generate any associated tariffs. The most common import tariffs are ad valorem, which are fixed and based on a percentage of the product's value.

International sales are subject to sales tax. In the EU, these are value-add taxes. VAT rates range from the minimum of 15% to 27% in Hungary, with the average VAT rate sitting around 21%. Overall, a tax calculation solution will be essential to managing international shipping and expansion at scale. 

Sales tax exemptions for online sellers

At some point, you've probably heard that some nonprofits and religious organizations are tax-exempt. But what about sales tax exemption? Generally, the same rules apply.

For one, states can't tax direct sales to the Federal Government. However, contractors working with the Federal Government are subject to sales and use tax if contractors themselves are using the tangible property or services purchased. State and local governments may also be sales tax exempt.

Most commonly, states exempt certain charitable, religious, educational, or nonprofit organizations from sales tax when they use the items they purchase for exempt activities. Sellers can verify a person or group's exemption status via federal- or state-issued exemption letters or numbers.

Finally, sales tax exemptions may also apply to certain goods and services. Rules vary by state, but generally, certain repair or installation services are exempt from sales tax when you invoice them as separate line items.

"When you’re checking out a customer during the sales process, there are some nonprofits that are tax exempt as well," said Soon-Chul Choi, Webgility COO and CPA. "You want to make sure that they have the best experience possible. By leveraging automation and technology, you can improve in those areas."

Sales tax holidays for online sales

Sellers aren't permitted to collect sales tax on items purchased in state or local sales tax holidays. School supplies, disaster preparedness goods, and appliances are often exempt under certain holidays. In some states, sales tax holidays fall on tax-free weekends.

For example, Texas has a sales tax holiday in April for emergency preparation supplies and in May for Energy Star and water-efficient products. The state's general sales tax-free weekend happens in August. Twenty-three states have sales tax holidays in 2024. 

Sales tax compliance: Getting started

Determine your sales tax liabilities. Review your sales volume and locations, number of transactions, inventory locations, remote employees or referrers by state or jurisdiction. Due diligence will help you identify what states you need to collect sales tax in and each state’s economic threshold.

Once you establish nexus, register as a retailer in your nexus states. You can do this yourself by downloading and submitting a state’s form. Or use a sales tax registration service to check it off your to-do list faster. Once you submit your registrations, you can begin calculating and collecting sales tax.

If you're calculating sales tax on your own, keep a reference guide nearby. Hands down, the best way to ensure you're calculating and collecting the right sales tax is to use a calculator that integrates with your store or ecommerce platform directly.

How to track ecommerce sales tax

If you only have one tax rate...

If you’re using QuickBooks as your Amazon FBA accounting software, keep in mind that it's designed for businesses with a standard tax rate.

If you’re charging all your customers the same tax rate — for example, your business is located in a state with a single tax rate, and you only conduct business in that state — you can find the information you need within QuickBooks.

If not, don't worry. We'll cover that in the next section. In any case, you'll see the tax field at the bottom of each transaction's sales receipt.

If you have variable tax rates...

Many ecommerce businesses use variable tax rates, meaning they calculate sales tax based on the customer’s location. These location-based sales tax states, like California, can have over 100 sales tax jurisdictions.

If your shopping cart calculates variable sales tax or you use sales tax software like Avalara AvaTax, you won’t need the QuickBooks tax field because it’s designed for a static tax rate.

If this is your situation, you can still easily get a tax report. You'll just have to override the QuickBooks sales tax rate and then use the software that calculates the taxes to run your report.

First, you’ll need to set the QuickBooks default tax field to 0.0%. Next, when you set up ecommerce accounting automation software to record your transactions in QuickBooks, configure it to record tax as a line item instead of in the tax field.

When an order syncs in QuickBooks, your transaction detail will appear with the correct sales tax as a line item and the “tax” field as $0.00.

Via sales tax liability reports...

As mentioned above, you can’t use the QuickBooks sales tax report if QuickBooks thinks you haven't collected any sales tax. So how do you now calculate your sales tax liability?

You can run a report in QuickBooks to give you a snapshot of how much you’ve collected in taxes, but it won’t tell you how much you owe to each tax district.

To get this information, you’ll have to go straight to the source. You need to run a sales tax report in the program that initially calculated your sales tax—your shopping cart, marketplace, tax calculation software, etc.

So now that you’ve collected sales tax from your customers and you know how much you owe to each tax authority, all that’s left to do is file your returns and remit those payments so you can get back to focusing on your business—and sleep well at night knowing that you’re in full compliance.

1 This content is for information purposes only and should not be considered legal, accounting, or tax advice, or a substitute for obtaining such advice specific to your business. No assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a customer's particular situation. Webgility Inc. does not have any responsibility for updating or revising any information presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent research. Webgility Inc. does not warrant that the material contained herein will continue to be accurate nor that it is completely free of errors when published. Readers should verify statements before relying on them.
2 Based on an analysis of 815 sellers who use Webgility and whose order volumes increased (134) after one year. Average increase based on their order volume in the first month after purchase versus their order volume after a year. Data acquired October 2023.
3 Offer ends April 30, 2024.