Collecting Sales Tax from Online Sales – FAQ

By December 20, 2018 February 6th, 2019 Ecommerce Accounting
Ecommerce sales tax

At some point, ecommerce businesses have questions about collecting sales tax from online sales. Frankly online sales tax is a mess and becoming more of a mess. Finding the correct answers to these questions is important, sometimes vital, to a company’s survival and success. We have compiled a list of the most common questions we hear, along with the associated answers and links for additional reading. Let us know if you have additional questions so that we can update our list!

What is the South Dakota v. Wayfair ruling?

If you are in ecommerce, you have probably at least heard of the South Dakota v. Wayfair ruling in June 2018. This ruling now allows states to tax ecommerce businesses who don’t have “physical presence” within their state. Basically, states are now deciding their own sales tax laws. Most states who have taken advantage of this ruling are requiring businesses with a significant amount of sales within their state, to collect and remit sales tax.

Read more here.

Do you have to charge sales tax for online sales?

It depends. In states where you have “physical presence” (company location, warehouses, employees, etc.) you will need to pay sales tax. For other states, it depends on your “economic activity” within that state. In more simple terms, if you have a lot of sales in a state (economic nexus), you may need to pay sales tax. But each state has differing rules.

What does it mean to have nexus in a state?

Sales tax nexus is when your company is required to pay sales in a specific state because of somehow being connected with that state. There are three main types of sales tax nexus that require you to pay sales tax: (1) physical nexus, (2) economic nexus, and (3) click-through or affiliate nexus.

What does economic nexus mean?

After the South Dakota v. Wayfair ruling, economic nexus became important in the sales tax world. Economic nexus is the ability for states to tax businesses based on “economic activity”. Essentially, if you have a large amount of sales within a state, that state can require you to collect and pay sales tax. Not all states have economic nexus laws, but many are moving quickly to benefit.

Read more about economic nexus here.

What states have economic nexus laws?

Economic nexus laws are constantly changing. Below is a map with the economic nexus laws by state. Find more detailed info here.

Do I have to collect sales tax on one channel if I have Nexus because of a different channel?

Yes. For example, if Amazon FBA has given you Nexus in Washington, you will need to collect Washington sales tax on ALL other channels you sell on. Remember this for all nexus rules. You will need to consider sales across all channels in determining nexus, then you will need to apply sales tax rules across all channels for any states in which you have nexus.

If I am a foreign-based company, do I need to worry about U.S. sales tax?

Yes, you will need to consider U.S. sales tax for any sales you have in the U.S. The U.S. has been known to seize inventory held in the U.S. for foreign-based companies that are not meeting sales tax obligations.

What are the penalties for not paying sales tax?

Penalties vary between states. Keep in mind there are two penalties: (1) penalties for not filing on time, and (2) penalties for not paying on time. Usually penalties increase the longer a business has not filed or payed, up to around 5-20% for each penalty. Penalties due to negligence, tax evasion, or fraud can get significant – up to 100% or $25,000+ (usually whichever is greater) in some states. Read more about the risks of not filing here.

Does Amazon automatically collect and remit sales tax?

The answer is no, in most states. Six states have sued Amazon, resulting in Amazon being responsible to collect and remit sales tax in those states: Connecticut, Minnesota, New Jersey, Oklahoma, Pennsylvania, and Washington. Read more here about Amazon tax collection in these states.

In other states, you still have the responsibility to collect and remit sales tax based on nexus laws. You can setup your Amazon account to automatically collect sales tax. As your business’ nexus changes, keep in mind that you will need to adjust your sales tax settings accordingly. Here are the general steps to setup Amazon to automatically collect sales tax:

  1. Login to Amazon Seller Central
  2. Go to settings > tax settings > View/Edit your Tax Collection and Shipping & Handling and Gift Wrap Obligations Settings
  3. Choose product tax codes
  4. Choose states in which you have nexus (you will need your sales tax registration numbers)
  5. Choose a custom sales tax rate (optional) – You can adjust the rate in states where out-of-state sellers have an option between a flat tax rate OR a sales tax rate based on the buyer’s address. The default rate is based on the buyer’s address

Choose shipping & handling and gift wrapping sales tax options – the shipping & handling and gift wrapping sales tax laws differ between states.

Does Shopify automatically collect sales tax?

No, but you can setup your Shopify account to automatically collect sales tax. Keep in mind that as your business’ nexus changes, you will need to update your Shopify sales tax settings. Here are the steps to setup your account:

  1. Login to Shopify admin
  2. Settings > Taxes > Tax rates
  3. Click Unites States
  4. In “Calculating taxes” section, turn on “Calculate taxes automatically”
  5. In “County, municipal, and state taxes” section, add a physical presence for all your nexus states. With nexus states based on non-physical-presence laws, enter any zip code for that state.

For more details from Shopify, click here.

What is the journal entry for sales tax?

Journal entry for collecting sales tax:

  Debit Credit
Cash $xxx
   Sales Tax Liability $xxx

 

Journal entry for paying sales tax:

  Debit Credit
Sales Tax Liability $xxx
   Cash $xxx

Where should you find sales tax on your financial statements?

Sales tax SHOULD NOT be on your profit and loss statement. It is not a cost to your business. Rather, sales tax is a liability that you owe to the state. You should have a sales tax liability account that increases as you collect sales tax and decreases as you pay sales tax.

Read more here about how to handle your sales tax funds from the time you collect until the time you pay.

On financial statements, is sales tax an expense or liability?

Sales tax is a liability owed to the state. You should not see sales tax on your profit and loss statement, as it is not an expense.

How does an ecommerce business stay sales tax compliant?

Sales tax compliance is very complex in the ecommerce world. We highly recommend using sales tax automation software. At LedgerGurus we use Taxify and TaxJar, which are great software for small- to medium-sized businesses. These automation software companies automatically connect with your sales channels to collect sales tax based on up-to-date nexus laws. They also can automatically file and pay sales tax on time.

  TaxJar Taxify Avalara
Supported integrations eBay, Magento, Shopify, Amazon,Square, WooCommerce, PayPal, Stripe, Etsy, Walmart, Bigcommerce, ecwid, Squarespace Amazon, Bigcommerce, eBay, Magento, PayPal, Shopify, Square, WooCommerce, Xero, other sales tax software like TaxJar 600+ accounting systems, ERP and CRM providers, and ecommerce platforms
Monthly starting price  $17 (up to 1,000 transactions) $47(up to 1,000 transactions) $199 (1-25 states)
Targeted customer Small- to medium-sized eCommerce companies Small- to medium-sized eCommerce companies Large corporations
Ratings (Capterra) 5/5 Stars 4/5 Stars 4.5/5 Stars

Should I hire a sales tax consultant or expert?

Yes, we highly recommend connecting with a sales tax consultant or expert. There are three types of professionals that you should consider, depending on your situation:

  1. A SALT (state and local tax) consultant: a high-level sales tax individual who understands nexus laws, the implications, the risks involved in sales tax compliance, and can help you create a strategy. You should only need to meet with them occasionally for guidance. They are great to meet with if you are a little behind on getting compliant, becoming exposed to sales tax laws, and/or you have any circumstances that make your nexus unclear. If you need a list of people, LedgerGurus can recommend consultants we really like.
  2. Sales tax compliance accountant: If you aren’t using a sales tax automation software, this is someone who can stay on top of managing your filings (monthly, quarterly, or annually depending on your company size). You can often find someone like this at a local tax firm or at firms that specialize in sales tax.  You can also hire someone in-house to manage this for you, but someone really needs to be on top of it.  Make sure to calendar all your filing obligations and make sure it’s happening.  We have a list of some people we like if you need a recommendation.
  3. Ecommerce sales tax expert: This is a solution like LedgerGurus that can manage sales tax settings on your sales channels, integrate and manage sales tax software like Taxify or TaxJar, and has the compliance support to stay on top of all your sales tax compliance needs. If you have nexus in more than five states and need your sales tax compliance to be more scalable, we highly recommend an ecommerce sales tax expert.