Understanding Sales Tax for Small Business Owners
Posted in: Business, Finance

Understanding Sales Tax for Small Business Owners

When you start thinking about starting a business, it’s only natural to have a lot of questions about what you need to do to get started. Would my business need any permits or licenses? How would I fund this business? How do I create a business plan? Should I work with a business partner? On top of all those questions, there’s the matter of collecting sales tax.

Sales tax rates vary from state to state, and some states don’t charge a sales tax at all. Or, in some cases, there might be a local sales tax in addition to a state sales tax. So, where do you even begin with understanding what sales tax means for a small business?

What Does Sales Tax Apply To?

First things first, it’s important to understand what sales tax applies to. Generally speaking, sales tax applies to a wide range of tangible products, including electronics, books, plants, fabric, furniture, and appliances. Software can also fall into the category of tangible products.

In most cases, certain types of products are exempt from sales tax, such as food and prescription and non-prescription medications. If your business is more service-oriented, you may still need to collect sales tax. In some states, nearly all services are subject to sales tax, but in others may tax some types of services but not others.

In some cases, whether or not sales tax can be collected on a purchase can depend on who is purchasing it. A non-profit organization, for example, can be exempt from paying sales tax on items used for an exempt purpose. Or if you sell directly to a government agency, there’s a good chance that it will be exempt as well, but there’s a chance it might not be exempt if it’s to an agency at the state or local level. Items sold for resale can also be exempt from sales tax.

For help figuring out whether or not sales taxes apply to the types of products or services you offer, it’s best to consult a tax professional. Given how complex this question can be, they will best be able to help you understand what is required on your part. Even when a product is often exempt from sales tax, that may not always be the case.

For example, while food usually doesn’t get covered by sales tax, it is taxable in a few states. Things can get even more complex if you’re selling digital products, such as ebooks or audiobooks, or if you bundle sales of tangible products with a service, so a tax professional will best be able to help you figure things out.

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Understanding Sales Tax for Small Business Owners

Sales Tax & Online Sales

Having the ability to sell products online gives small business owners the chance to reach a wider customer base than ever before. You don’t even necessarily have to choose between doing brick-and-mortar and online sales; online sales can be a great supplement to sales in a brick-and-mortar location. But the downside to selling online is that it makes collecting sales tax more complex.

Things used to be much simpler for business owners who sell remotely instead of having a physical storefront. If a business sold products across state lines over the phone or through catalogs, the 1992 Quill vs. North Dakota Supreme Court ruling established that sales tax could only be collected if the business had a physical presence in the state. But given how massive online shopping became in subsequent years, many states were eager to start collecting sales tax from businesses who sell products in one state while being physically based in another.

In 2018, the Supreme Court changed their stance and gave states the option to collect sales tax from remote sellers in their South Dakota vs. Wayfair, Inc. ruling, in which the court ruled that the requirement for a physical presence in a state gave large online retailers a way to avoid taxation, while smaller, local brick-and-mortar businesses were put at a disadvantage.

However, that 2018 Supreme Court ruling complicated things for business owners. According to Howard & Howard, it meant that online retailers of all sizes needed to think about complying with nearly 10,000 different tax jurisdictions in 45 states.

To collect sales tax from remote sellers, a state needs to have laws about remote sellers establishing a nexus in the state. And, just to make things more confusing, there isn’t one main consensus about what counts as a nexus.

In many cases, there’s an economic nexus requirement, which is a threshold of making a minimum number of sales and/or a minimum dollar amount worth of sales in a state. (Often, this threshold is $100,000 worth of sales or 200 separate transactions, but varies from state to state.) Or if a state’s nexus law involves having a physical presence in a state, this could include an office, a warehouse, or a storefront. Or a state could have rules that involve having representatives or salespeople working on your behalf in the state or reaching a minimum amount of sales from an in-state referral agent.

There may also be the concept of a marketplace nexus that applies to your situation. A good example of when a marketplace nexus could be relevant is if a business sells products through a program like Fulfilled by Amazon, where a business partners with another company that provides a platform for e-commerce and payment processing. In a situation like that, the marketplace facilitator, Amazon in this case, would be responsible for collecting sales tax instead of the business that sells through them.

Sites like Etsy and eBay also have marketplace facilitator laws that apply to them. Both of these sites have policies about collecting and remitting sales tax on the seller’s behalf when applicable. However, there may be some situations where you still need to do some work.

According to Webretailer, eBay is currently collecting sales tax for sales shipped to most states, but you may need to collect sales tax yourself for sales made in a state where you have a nexus, but there isn’t a marketplace facilitator law that applies to eBay.

Etsy also notes that you may still have to file a state sales tax return if you have a physical presence in a state where Etsy collects and remits sales tax on your behalf.

For more details about which laws apply in each state, Sales Tax Institute has a great chart to help you find the information you need.

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How to Collect Sales Tax

Once you’ve figured out if you need to collect sales tax, the next step is to apply for a sales tax permit from the necessary state(s). It’s also a good idea to meet with a tax professional to find out what you need to do in terms of maintaining necessary records and how often you need to remit your sales tax. Once again, this is something that each state has their own requirements for.

For example, some states may collect on a quarterly basis while others collect on a monthly basis. The information you’ll need to provide could also depend on your volume of sales. Meeting with a tax professional early on is definitely one of the best ways to avoid any unwelcome surprises later on.

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