The conversation of internet taxes is very complicated. In May 2013, the US Senate voted in favor of the Marketplace Fairness Act which is supposed to simplify how sales tax is levied on items purchased from the internet. The Act called for a simplified method of free software that each state would have to provide so e-commerce website owners could more easily collect, report, and submit the sales taxes collected from online sales.
The Act contained an exclusion to exempt online sellers from collecting tax if they had less than $1 million in online sales.
You are probably thinking "Wow, $1 million in online sales; I wish I could have that with my jewelry store." Well, truthfully, there are certain types of e-commerce businesses that can easily achieve that $1 million mark with only 3 employees. Those businesses use a lot of drop shipping methods and affiliate and commission sales strategies. That group of small e-commerce business owners has been most vocal against the Act because they would not have the resources to manage the required paperwork for compliance.
Even though the Act calls for free state provided software to submit the taxes, it does not take into account the cost requirement for the retailer to implement how they would collect the tax through their website or manage the reporting of those collected taxes. Officially, this internal process is referred to as the "integration costs" which I estimate could be as much as $100,000 for some businesses with fully customized websites and software.
From my point of view, the Marketplace Fairness Act would be a lot fairer if the exemption was $30 million, not $1 million. At the $30 million level, the states would be guaranteed to collect sales tax from the largest e-tailers without harming the business practices of the small businessman.
As of this writing, the Marketplace Fairness Act is currently stuck in the House of Representatives as they deliberate the impact of this Act on businesses. The biggest burden is, or course, the integration costs I mentioned above. One suggested alternative is to make e-tailers apply their state tax to every online sale, even if the buyer is in another state. This is viewed as a lower burden since every retailer should already be equipped to collect and submit their local taxes. Experts are now debating if this is a good idea or not.
Even though this new Act is being debated, it's important to realize that the debate is over how to collect tax that is already owed, except people are not paying it. You see, there are 46 states which collect sales tax. If you live in one of those states, you are supposed to declare all your internet purchases when you file your state tax return on April 15th every year. When you declare your online purchases you are also supposed to pay the sales tax on it.
Let's be realistic here: when was the last time you told your state about your online purchases so you could willingly pay additional tax?
And that's the problem. The states know they are losing revenue, but they have no way to enforce the collection of it. The only way to get the tax money is to apply it at the point of sale.
In 1992, the US Supreme Court ruled in favor of Quill Corporation in the case of Quill v. North Dakota, a ruling which has shaped the methods in which sales taxes are collected for mail order catalogs, and internet sales. The ruling declared that a business must have a physical location within the state in order to be responsible for collecting sales tax from residence of that state.
The Quill ruling actually refers to a "nexus" rather than a "physical" location, and since then every state has created different definitions of what a nexus is. For example, you have a nexus in Texas if you have a trade show booth at an event within that state. In Florida you will have a nexus if you sell gift cards at convenient stores. Most states agree that any warehouse location constitutes a nexus.
Does one of your employees work from home in another state? You surely do have a nexus in that other state too.
According to the tax laws of today, based on the Quill ruling, you should be collecting sales tax from any buyer living in a state where you have a nexus. This applies to all your sales, regardless if you have more or less than $1 million.
Now things get even worse... Currently there are more than 9,600 different tax jurisdictions in the US. Some states have different tax rates for every municipality. I have direct experience with California, so I'll use them as my example.
In 1999, I owned a computer consulting company and also sold Cisco routers, Acer monitors, and Okidata printers. I had a small e-commerce website from which I would drop ship all purchases directly from my distributors. As it turned out, one of my distributors had a warehouse in California. In order to maintain compliance with tax laws, they would not allow me to ship to anyone in that state unless I had a Certificate of Authority to collect sales tax for that state.
I complied at the time, but it was very difficult. I had to create an e-commerce tax module that could calculate tax based on 400 California zip codes. That tax module worked amazingly well for the few years I was an active online computer e-tailer. This same tax module is built into the website CMS that my company offers today. The bigger burden was filling out the monthly California tax form to submit the collected tax.
As I explained above, the nexus method of determining tax collection responsibility is currently in force today, but each state has trouble enforcing it. Had it not been for my distributor in 1999, I would not have even known about the tax situation for California. Therein lays another issue of how a small business owner is even supposed to be aware of all these tax laws. You could ask your CPA, but they probably won't know the answers for each of the 50 states.
In recent years, the position that most website owners take is to simply ignore all other states other than the one where their retail store is. I certainly do not agree with this position, and as a website consultant I'm always warning my clients of what I know about the laws, and helping them navigate through it.
The battle of internet tax fairness is far from over. As you plan your e-commerce website, I strongly suggest you plan for tax collection issues. If you're in the early stages of choosing e-commerce software, make sure you ask your developer if they have plans to comply with the impending tax changes. Eventually you will need to collect tax for all states, maybe not all zip codes, but at least all 50 states.
It takes a long time to set up an e-commerce website; the last thing you want to do is go back to the drawing board because your website CMS can't handle future tax calculations.
