Compliance can be complicated because sales tax rates and laws vary by state (and country). What’s more, different cities or counties within a state may even have different rates and requirements. There’s a lot to keep track of, and there are many potential pitfalls.
The penalties for mishandling sales tax can be steep, financially, legally, and reputationally. So, implementing a robust, reliable tax management strategy is vital.
How does e-commerce sales tax work?
Understanding a few basic principles will help you avoid falling foul of sales tax rules and regulations.
At a high level, these are the things that you need to get right:
- Tracking “nexus” — that is, understanding where you need to collect sales tax.
- Correctly classifying your products.
- Registering for sales tax permits where necessary.
- Collecting the right tax amounts.
- Filing documents and remitting tax amounts on time.
Nexus and the 2018 South Dakota v. Wayfair, Inc. case
An e-commerce business is said to have nexus in a state when it has established a presence there that creates an obligation to collect sales tax. There are two types of nexus: physical and economic. Nexus thresholds vary from state to state, so figuring out where you have nexus isn’t always straightforward.
Physical nexus is simply a physical presence in a state. Having a store, an office, inventory, or employees or representatives in a state will likely establish physical nexus there.
Physical nexus used to be the only type of nexus that businesses had to keep track of. But in 2018, the Supreme Court’s ruling in South Dakota v. Wayfair, Inc. allowed states to start setting economic thresholds for nexus — typically, a total amount in annual sales and/or a number of transactions in a year.
This gives states more flexibility in how they define nexus, and it means that online sellers must pay attention to where their sales are happening and when they hit economic thresholds in the states where they do business.
Complicating matters, these thresholds vary from state to state. For instance, in Nevada, the threshold for total sales is $100,000. Next door in California, it’s $500,000. In Arkansas, you establish economic nexus when you have 200 separate transactions there in a calendar year. In New York, there is a revenue and transaction threshold.
Understanding sales tax rates and registering for permits
Sales tax rates vary from state to state — and in many states, local jurisdictions also set their own sales tax rates. This means you might need to collect a base state tax and an additional county- or city-level tax on a sale, depending on where a buyer lives.
For instance, Texas has a statewide sales tax rate of 6.25%, but some cities and counties add their own taxes on top, meaning the total rate for a sale in Texas could be as high as 8.25%.
Once you know the amounts you need to collect, you must register for sales tax permits in every state where you have nexus.
Registering usually requires submitting an application to a state’s Department of Revenue. After you’re registered, you need to start filing returns immediately — reporting and paying the sales tax you’ve collected.
Filing frequency varies by state and usually depends on sales volume; it could be monthly, quarterly, or annually.
The importance of getting it right
Not collecting or remitting sales tax in states where you have nexus can have serious consequences.
If you fail to collect sales tax on eligible sales, a state can not only require you to pay what you should have collected, but also tack on interest fees and penalties for underpayment.
Noncompliance might also lead to a costly, time-consuming audit by tax authorities.
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7 best practices for handling sales tax
Keeping track of where you have nexus is probably the most complicated part of the process. Once you’ve done that, you can determine how much sales tax you need to collect in each location and when you need to file.
Here are some tips for keeping it simple:
1. Determine where you have nexus
Start by reviewing each state’s nexus criteria and identifying the states where they apply to you. Each state sets its own thresholds, so check whether you meet them, based on factors like sales volume or transaction count.
Another important aspect to consider is sourcing — whether sales are taxed based on your location (origin-sourced) or the customer’s location (destination-sourced).
Origin-based sourcing is simpler, as you need to apply sales tax rates based only on your own location. However, destination-based sourcing, which most states use, means you’ll need to calculate rates according to each customer’s location.
2. Register for a sales tax permit in states where you have nexus
Once you know where you have nexus, register for sales tax permits with the authorities in those states.
These permits let you legally collect and remit sales tax. Registration costs range from free to around $100. Nearly all states offer online registration.
Note that these permits often have expiration dates. Permits in some states, such as Arkansas, are active until canceled, while those in other states, such as Colorado, need to be renewed every two years. It’s really important to keep track of these renewal dates to avoid accidentally doing business without a valid permit.
3. Classify products correctly
States have varying rules about which products are taxable, and they sometimes charge different tax rates for different kinds of items. As a result, e-commerce sellers must correctly classify their products so they can determine whether they must collect tax on a sale and, if they must, how much tax to collect.
It’s important to note that state tax rules on which items are taxable can be very detailed.
For example, in some states, clothing is not generally taxable, but athletic wear is. In other states, clothing or footwear costing more than a specific dollar amount is subject to sales tax, but not less expensive items. And in the 24 states that are members of the Streamlined Sales and Use Tax Agreement (SST), candy that contains flour is taxed differently from candy that doesn’t contain flour. For example, a candy bar such as a Kit Kat, which contains flour, may be taxed at a lower rate than a Hershey’s bar, which doesn’t.
Because of these complicated rules, correctly classifying products by type and identifying whether they are taxable or exempt is very important. It’s usually wise to automate this process, due to the many rules that apply to the taxation of goods and services.
4. Understand state-specific exemptions
Sellers do not have to collect tax on all products they sell. Exemptions exist for two primary reasons:
- Certain products are exempt from tax. For example, many states deem food, clothing, and some professional services nontaxable. When a seller sells these items, they should not collect sales tax on them. Look out for sales tax holidays, too. Some states temporarily waive sales tax on select items, like school supplies or clothing during back-to-school season.
- Certain buyers are exempt from tax. This can include government entities, nonprofits, schools, and resellers. When a business sells goods or services that are normally taxable to these exempt buyers, the business should not collect sales tax.
Since exempt buyers aren't paying taxes on taxable items, they must provide exemption certificates, which prove to the seller that they should not be taxed on their purchases.
Sellers must have a valid exemption certificate on file for any buyers who aren’t charged sales tax on a taxable item. If your business is audited, you’ll need these exemption certificates to show that you’re in compliance with the law.
It’s important to note that exempt transactions can sometimes count toward establishing economic nexus.
5. File your sales tax returns on time
Each state has specific filing schedules, and they are often tied to sales volume. For instance, if you’re collecting less than $100 in tax each month in a state, you may need to file only quarterly, while higher monthly amounts could mean filing monthly.
It’s important to file a return for every state you’re registered in, even if you didn’t collect any tax in a state during the filing period. Submitting a zero return means you avoid late fees or penalties that some states impose for missed filings.
It helps to keep a visible, updated filing schedule for each state. For example, in Missouri, monthly sales tax returns are due on the very last day of the month, while quarterly returns are due on the last day of the month following the quarter’s end.
Tip: Create a tax calendar that maps out every filing deadline for each state where you’re registered.
6. Document everything and stay on top of changes
Keep meticulous records of the sales tax you’ve collected, exemption certificates, filing deadlines, rate changes, and all your filings.
It’s important to stay on top of any changes and planned changes, too. Tax laws change frequently.
Tip: Set up alerts for rate changes in your nexus states, new marketplace facilitator laws, changes in economic nexus thresholds, and product taxability updates.
7. Automate your sales tax tracking and filing
Manually tracking sales tax might work when your business is just starting out and has nexus in only one or two states. But as you expand, manual filing can begin to eat up a lot of time and leave you at risk for mistakes. With more than 12,000 tax jurisdictions across the US, a dedicated sales tax automation tool can help you streamline the process.
E-commerce sales tax software can simplify everything from tracking nexus to automatically calculating the right tax rates based on each buyer’s address, and even filing your returns on schedule. As your business grows, investing in a tool like Numeral, TaxJar, or Avalara can help you confidently stay compliant, save time, and reduce the risk of errors.
Note that certain tools will handle just the rate calculations, some will handle just the registrations and filings, and others will do both.
State-by-state breakdown of e-commerce sales tax requirements
What happens if you’re selling on Amazon or eBay?
If you’re selling through a platform like Amazon or eBay, your sales tax process can look a little different. These platforms are subject to marketplace facilitator laws, which means they’re responsible for collecting and remitting sales tax on your behalf in states where such laws are active.
How marketplace facilitator laws work
Amazon, Walmart, and Etsy, for example, all sell products from third parties. Marketplace facilitator laws require these platforms to collect and pay sales tax on these transactions.
Marketplace facilitator laws can greatly simplify e-commerce sales. Small sellers who choose to sell their products through these marketplaces don't need to worry about whether those transactions create economic nexus with multiple states. And these sellers don’t have to worry about having to register to collect sales tax in multiple locations and comply with all of the individual state tax rules.
Nearly every state in the U.S. has marketplace facilitator laws in place. Typically, these laws require the marketplace to collect and remit sales tax on behalf of sellers immediately, regardless of sales volume, though a few states set a low-dollar-amount threshold for when enforcement begins.
For example, Amazon offers an automated tax collection service. You can configure tax settings based on the states where you have nexus, and Amazon will calculate, collect, and remit sales tax on your behalf. Note that it’s still up to you to determine where you have nexus and properly set up the platform’s tax settings.
On eBay, sellers are also given the option to charge sales tax, and eBay automatically collects and remits tax for certain states due to marketplace facilitator laws. But again, you’ll need to keep track of any states where you might have additional obligations beyond what the platform collects, and you’ll have to stay on top of your filings.
What about Shopify?
If you’re selling on Shopify, you must manage your own sales tax compliance, as the platform doesn’t automatically collect or remit sales tax for you. Shopify does provide tools that make managing sales tax easier, but it’s up to you to set them up based on your nexus obligations.
To get started, you’ll need to configure sales tax collection in your Shopify settings.
This means identifying where you have nexus and entering the right tax rates for those regions. Shopify can calculate these rates automatically, but it’s up to you to stay on top of where your business has nexus and update your settings as things change.
While collecting sales tax through Shopify is pretty straightforward, remember that you’re responsible for filing and remitting amounts to the right states. The easiest way to do this is to use a Shopify app or third-party sales tax software like Numeral to automate tax collection and filing.
Read our step-by-step guide to setting up sales tax on your Shopify store.
What happens if you get audited?
State officials can perform a sales tax audit on your business in order to make sure you're in full compliance with sales tax laws.
Audits can happen to any business for any reason but often occur if the taxing authorities believe you have under-reported your sales or if something doesn’t quite match, for example, making payroll returns in a state, which may signify physical nexus, but not remitting sales tax.
The purpose of the audit is to determine whether your business has collected and paid the correct amount of sales tax that you owe.
When you’re audited, you'll be asked to provide your financial documents. Auditors will review your records and will take a close look at your taxable transactions to make sure that you collected and paid taxes as required by state and local laws. Auditors typically look at:
- Whether there are discrepancies between the sales tax returns you submitted and your primary source data.
- Whether you charged customers the correct amount of sales tax on all purchases where tax was due.
- Whether you have valid sales tax exemption certificates on file for all exempt sales.
- Whether you paid state and local taxing authorities the full amount of sales tax that you collected from customers.
If you fail a sales tax audit, you will need to pay all past-due taxes, as well as penalties and interest. In the event that the auditors determine that you intentionally defrauded the state, you could also face criminal charges.
What if you owe sales tax from previous transactions due to noncompliance?
If you owe sales tax from previous transactions because you didn't comply with state laws, you are at risk of being audited and being made to pay back taxes plus penalties and interest. Some states might also require you to pay what you should have collected out of your pocket. It's best to be proactive in resolving this type of situation instead of waiting until a state begins investigating you.
One option is to participate in a sales tax amnesty program. States sometimes offer amnesty programs at the discretion of taxing authorities to encourage companies to come forward, voluntarily report unpaid taxes, and come into compliance.
When an amnesty program is offered, the state may waive or reduce penalties and interest. It may also provide relief from audits during the period covered by the program. However, you'd have to wait for the states where you're out of compliance to choose to offer one of these programs, and they happen infrequently.
Voluntary disclosure agreements (VDAs) are another alternative, and this may be a more viable option since you control when you enter into one. When you create a VDA, you negotiate an agreement with the Department of Revenue for the state where you owe back taxes. If there are multiple states, you can choose to submit a Multistate Voluntary Disclosure application.
You can reach out anonymously to negotiate the terms of a VDA, often using an accountant or lawyer as your agent. This allows you to agree on the terms — including the waiver of penalties and interest — before you officially report unpaid sales tax.
Your agreement should address the specific fines and fees that will be waived, as well as limitations on the look-back period and the creation of a payment plan. Once you have an agreement, you can comply with it to resolve your tax issues and come into compliance.
Origin-based vs. destination-based rules
States and local areas have different rules for how sales taxes are calculated. When a seller sells an item to a customer, the seller must determine which tax rules apply to that transaction. This can depend on:
- Whether a state follows origin-based or destination-based rules
- Whether the seller is a remote seller or is operating in their home state.
If your home state is origin-based and you're doing business in your home state, you collect sales tax based on the rules where your business is located.
For example, Pennsylvania is an origin-based state that has a 6% state sales tax. Philadelphia also charges a 2% local tax. If your business is located in Philadelphia, then no matter where your Pennsylvania-based customers are located (even those in areas without the 2% local tax), you must charge 8% in sales tax in order to follow the tax rules in Philly — the place where the sale originates.
By contrast, if your home state is destination-based, you collect sales tax based on where the item is going. South Carolina is a destination-based state with a 6% sales tax. If you are headquartered in Chesterfield, which has a 2% local tax, but you send your goods to a buyer in an area of the state that doesn’t apply a local tax, you'd charge only a 6% tax, because you follow the rules that apply in the area where your item is going.
Things are different for remote sellers, though, as states often have different rules for businesses that are paying taxes due to establishing economic nexus (including Pennsylvania). Specifically, even many origin-based states apply destination-based rules to remote sellers. This means they require remote sellers to charge taxes based on the rules in the area where the customer is located.
What is SST?
SST stands for Streamlined Sales Tax. It is an initiative meant to simplify the collection of sales tax across multiple jurisdictions.
Around half of all U.S. States that impose sales and use taxes are members of the Streamlined Sales Tax initiative, including Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin, and Wyoming.
SST member states are typically required to have just one local tax rate, and they must use standard definitions for administrative terms, products, and services. Sellers can also use a single platform, the SST Registration System, to register to collect sales tax in all of the member states, and they can use a standard one-page exemption certificate for all exempt transactions within SST states.
What should dropshippers know?
Dropshippers send products directly from manufacturers to consumers, without keeping items in inventory. Unfortunately, sales tax compliance can become complicated for dropshippers. In general:
- Dropshippers collect taxes from customers on taxable transactions if they have nexus in the state where the customer is.
- Those dropshippers provide resale certificates to the supplier they get products from. The dropshippers don't pay taxes on the items they're buying directly from the supplier to send to customers.
- When dropshippers collect taxes from customers in states where they have nexus, they remit those amounts to the relevant local tax authorities.
- Suppliers keep sales tax exemption certificates on file in case of an audit.
Both suppliers and dropshippers have obligations under this framework.
Suppliers must ensure that there is a valid exemption certificate for every dropshipper that they’re providing products to without charging taxes. Dropshippers must make sure they track when they establish economic or physical nexus in a given jurisdiction. And it’s worth noting that some states do not accept out-of-state resale certificates, further complicating things.
As soon as a dropshipper has established nexus in a state, they must begin collecting the appropriate amount of tax from customers to avoid falling out of compliance and risking an audit.
What sellers need to know about cross-border sales and tax compliance
Cross-border sales usually require the collection of value-added tax (VAT) or goods and services tax (GST), on top of any other local sales taxes. Unlike U.S. sales tax, VAT and GST are consumption taxes paid by the end customer, and they’re often included in the product price.
The requirements and rates for VAT or GST vary from country to country. If you’re selling to customers in the EU, VAT generally applies across the board, with rates varying between 17% and 27%, depending on the country.
Some countries have specific rules for low-value goods or digital products. For example, Australia requires a 10% GST on imported goods costing more AUD $1,000, while the EU has a threshold-free VAT policy for all imported goods.
For most regions, a rule of thumb is this: If you’re selling to individual customers (as opposed to businesses) and your sales exceed the country’s threshold, you’ll need to register to collect tax, and then collect, and remit the appropriate amounts.
Register for tax collection in each country with significant sales
Once you know where you’re likely to have tax obligations, the next step is registration. Countries set different thresholds for when to register for VAT or GST, usually based on annual sales volume.
For instance:
- European Union: In 2021, the EU introduced the One-Stop Shop (OSS) system, which makes VAT easier for e-commerce sellers. If your annual sales to EU customers exceed €10,000, you need to register for VAT in an EU country and can use OSS to remit VAT for all EU sales, rather than registering in each individual country.
- United Kingdom: Cross-border e-commerce sellers shipping to the UK need to collect and remit VAT if the consignment value is £135 or less. For amounts above £135, the buyer is responsible for paying VAT at customs.
- Canada: GST/HST registration is required if your Canadian sales exceed CA$30,000 annually — rates are different in each province.
Understand “distance selling” rules and import duties
Distance selling rules often dictate when you need to start collecting tax based on the destination country’s laws, especially in the EU. Once you pass a certain sales threshold, you need to collect VAT at the buyer’s rate, not your own. This applies even if you’re based outside the buyer’s country.
On top of this, you might need to pay import duties, especially if you’re selling high-value goods. Import duties are separate from VAT or GST and are usually calculated based on the product type, country of origin, and declared value.
Final thoughts
Understanding and managing sales tax is a crucial part of running an e-commerce business.
With laws now placing more responsibility on sellers to collect and remit taxes across various states (and countries), getting it right from the start will help you avoid errors that could lead to fines, penalties, and other serious consequences.
By identifying where you have nexus, understanding the specific rules for each region, and investing in automation tools that simplify managing your sales tax obligations, you can eliminate worry and make sure you maintain compliance.
