Quick: What’s the sales tax rate for small businesses in New Hampshire? Northeasterners who’ve visited the Granite State during ski season can tell you: zero. But what about Wyoming? Or North Carolina? Even if you never visit these states, complying with tax regulations in every state is now essential for any small business that takes their operations online.
Due to a complex patchwork of state-level requirements, tax compliance can be an intricate issue for online businesses, but one with real consequences. If you decide to move your small business’s sales online, here’s what you need to know.
Your Business’s Sales Tax Nexus
Before 2018, it was easy for a business to know its sales tax nexus, which is the connection that businesses have to local tax regulations. A business typically just had physical sales tax nexus, and it was usually where the business was located (or, in some cases, where its goods were stored).
All that changed, thanks to a 2018 Supreme Court decision in the case of South Dakota v. Wayfair, a ruling that established that individual states can create their own economic sales tax nexus laws. Now, businesses transacting sales online must comply with unique sales tax regulations in every state where customers transact with the businesses. The decision created big challenges for online businesses whose customers could anywhere be across the United States.
Picture a single franchise knitting business, for example. They sell clothing and other woven goods on Etsy. Previously, because it was a business with a single location—let’s say Indiana for the sake of example, the business owner, Courtney, only had to worry about complying with Indiana sales tax. Her business’s sales tax nexus was only in Indiana, even if she sold her goods online to customers in other states— let’s say California and Texas. Today, following the South Dakota v. Wayfair decision, Courtney must ensure that her business complies with the sales tax nexus in each state where she transacts a sale. (Even California and Texas.)
“This creates a huge compliance cost due to the complexity of charging the correct sales tax by state,” noted Keegan Shepardson, a small business advocate for the U.S. Small Business Administration’s Office of Advocacy, in a 2019 update on the decision’s impacts.
With more than 30 million small businesses in the United States (99.9% of all businesses in the country) and the 2020 pandemic forcing many businesses to shift sales online, the implications are enormous. And, for many, this shift to online sales may be permanent: “We’re not going back to the same economy—we’re recovering, but to a different economy,” Jerome Powell, chairman of the Federal Reserve, recently noted.
The Consequences of Not Meeting Tax Compliance
If you don’t meet tax compliance, you may be charged with a misdemeanor unless the amount of tax evaded exceeds $10,000, which is a felony.
Before the Wayfair decision, “some observers estimated that states were collectively missing out on anywhere from $13 billion to $23 billion a year in potential online sales tax revenue,” according to Governing.com. After the ruling, the majority of states enacted regulations to begin collecting sales taxes from online transactions, as well as penalize businesses that failed to remit their share of sales tax.
To understand the rules for sales tax nexus thresholds in each state, TaxJar has compiled a state-by-state guide to sales tax compliance. TaxJar customers can also stay sales tax compliant with individual states using AutoFile. TaxJar uses the information received from your eCommerce providers and marketplaces to prepare and submit returns to the state, along with remittance. Learn more here.
Beyond the risk of committing sales tax evasion, unremitted sales tax carries the risk of future costs for your business. If your business doesn’t collect the correct sales tax from customers at the time of transaction, and the noncompliance is discovered by regulators, you’ll likely have to pay back taxes plus interest, as well as potential penalties.
However, for many businesses (especially those with lower revenues), the risk of noncompliance may be outweighed by the cost of investing in new software or support from specialized professionals, such as tax accountants.
Balancing risk versus tax compliance is a decision that every small business owner must make. It comes down to your risk tolerance, CRO of TaxJar Ryan Thompson said in a recent podcast appearance.“Maybe try to do some math around where you’re approaching that risk tolerance, and then focus on those states first on where to be compliant.”
How to Stay Updated on Changing Taxes
Staying up to date on sales tax law and compliance is challenging because there are approximately 14,000 jurisdictions in the United States, and sales tax laws are ever-changing. As far as we see it, there are three ways: study and monitor tax regulations religiously, hire a full-time accountant, or use a software-based sales tax service like TaxJar.
“Sometimes, sales tax even varies within the state, so the sales tax in one city may not be the same as another, even if they are both in the same state. Any errors in compliance will result in the business itself losing money,” noted SBA advocate Shepardson.
Additionally, sales tax rules differ for businesses that engage in multidistribution and multichannel strategies, including selling on online platforms such as Amazon and Walmart and on marketplaces like eBay. More rules apply to resellers who sell other businesses’ products.
This nesting-doll effect of tax compliance can confuse even the most astute business person. Short of brushing up on sales tax code for more than 14,000 jurisdictions, businesses are increasingly turning to SaaS-based products and integrations to ensure tax compliance.
With tools like TaxJar, businesses can integrate data sourced from eCommerce platforms and marketplaces and automatically ensure that they’re complying and remitting the right amount of sales tax.
Sales Tax is Certain
There’s no way to avoid the inevitability of sales taxes. And with the onus for sales tax compliance placed squarely on businesses as a result of South Dakota v. Wayfair and with more businesses moving online in light of the pandemic, now is the time to get smart about sales tax compliance. Start your free, 30-day TaxJar trial today.