When running a business as a solo entrepreneur, paying attention to all tax filing laws and regulations is important. Business owners selling products may need to collect and remit sales taxes. While this sounds complicated, it’s often much simpler than you realize, particularly when using sales tax software or vendors.
Here’s a closer look at how to approach online sales taxes as a small business so you can stay on the right side of the law, whether your place of business is your home state or elsewhere.
What are sales taxes?
Sales taxes are a type of tax that many state and local governments require on goods sold in their jurisdictions. For example, if you live in Colorado and sell a product to a Colorado company or resident, you likely must collect sales tax and pay it to the state.
While sales tax is usually required for physical products, most services are not taxed. Also, depending on the state, some products, such as food or clothing, may not be taxed. If you’re in doubt, you can look up each state’s sales tax requirements online, often at their Department of Revenue website.
How to determine if you have to collect sales taxes
The first step in understanding sales tax is determining if it applies to your products or services. This can vary based on your company’s physical location, where you have business property, where your employees live, and the states where you sell. It can also depend on your total sales volume and the number of transactions or internet sales in a state.
Sales tax requirements when you have physical presence
You usually have to collect sales tax for in-person or online sales to someone in the same state as your business. While most states tax physical goods, digital products might be treated differently.
Some states require the collection of taxes on all digital products, some require sales taxes on certain digital products, and others don’t require sales tax for any digital products. If you make sales in a state, checking that state’s tax authority’s website can help you determine sales tax requirements for digital products.
You should check with your state taxing authority to understand which services are subject to sales tax and which are not. Whether a service or product is subject to sales tax varies wildly by state. Additionally, it’s important to note that taxes may be required by other states even if your state doesn’t consider a service subject to sales tax.
Some tangible personal property in specific states may also be sales tax exempt. For example, in California, these include groceries, prescription medication and some medical devices. Most states require businesses to obtain a sales tax permit, at which point the state will also assign you a filing frequency.
Sales tax thresholds
In some states, you must collect and remit sales taxes after reaching a specific dollar amount of sales. Some states impose a $100,000 in sales receipts as the threshold for sales tax, while other states (like Texas and New York) set the threshold at $250,000 or more. Sales volume is also considered, with some states requiring 200 or more transactions.
Even if you don’t meet sales tax thresholds, some third-party relationships could still put you into a category where you must collect sales tax (more on that in the next section). Because the rules are so complex, many business owners use sales tax software, like TaxJar, to determine what’s required.
Sales tax nexus in another state
You may trigger a sales tax nexus when you’re selling large amounts of goods or services in another state, even if you don’t live or work there. After the landmark U.S. Supreme Court ruling, South Dakota vs. Wayfair, Inc., physical presence is not required for sales tax nexus.
Tax nexus is a fancy term for doing enough business in a state that you have to register, remit sales taxes and meet other state-imposed requirements. If you’re a remote seller making a lot of online sales, you could have sales tax nexus in multiple states.
For instance, let’s say you’re a popular online seller that sells goods using Amazon’s Fulfillment by Amazon (FBA). While your physical presence and residence might be in Pennsylvania, you ship products to Amazon distribution centers in other states. Because you have business property physically present in another state, you could have sales tax nexus even though you haven’t left Pennsylvania.
Most states have resources to help out-of-state sellers, including online companies, better understand their sales tax obligations. One example is the California Department of Tax and Fee Administration’s Tax Guide for Out-of-State Retailers. State-created guides like these are easy to find with a quick online search and are especially helpful for e-commerce businesses and online retailers.
Which states don’t collect sales tax?
A small group of states don’t require any sales tax. As of this writing, those states include:
- New Hampshire
It’s worth noting that these “no sales tax” states may have exceptions. For example, Alaska has local sales taxes you may have to collect. Delaware has a gross receipts tax on some goods and services. Oregon collects a bicycle excise tax.
If you sell to anyone living in these states, you may be able to sell tax-free. But it’s still worth checking if your products are an exception in local jurisdictions to ensure sales tax compliance.
Nonprofits such as charitable organizations are exempt from income tax and sales tax.
How to calculate sales taxes for online sales in different states
Now that you know you must collect sales tax, how can you do this efficiently and effectively?
There are two popular ways to track sales taxes for each state you’ve sold to, including by hand or through software. If you’re a small-volume retailer and your profits don’t justify the cost of sales tax software, you can do your sales taxes by hand with a spreadsheet or a sales tax calculator.
Some states have a calculator available through their state’s Department of Revenue’s website, making determining how much tax you need to charge easier. For example, Minnesota has a calculator that generates the general and local sales tax amount for anywhere in the state.
The formula for calculating sales taxes is as follows:
Purchase Price x Total Sales Tax Rate = Sales Tax
For example, a 5% sales tax on a $10.00 purchase would look like this:
$10.00 x 0.05 = $0.50
The sales tax rate should include both state and local taxes to ensure accurate sales tax reporting.
How to manage the sales tax that you collect
Managing the sales tax you collect can seem overwhelming. Fortunately, there are a few ways to handle this task, depending on your budget and how comfortable you are overseeing your company’s finances.
When selling through a third-party marketplace like Amazon, eBay, Etsy or Walmart, the marketplace may collect and remit sales taxes on your behalf for sales through the website. When setting up your sales on these websites and apps, pay close attention to how their sales tax collection and reporting works so you don’t accidentally double up when they’re paying taxes.
Managing sales taxes independently
If you decide to handle the collection and payment of sales tax on your own, you must keep track of sales by state, how much sales tax you collected and the state or municipality to which it must be remitted. If you have well-run bookkeeping for your business, this could be easier than it sounds.
Here are some tips to help you get started:
- Create a spreadsheet, then enter the buyer’s state, purchase amount and sales tax amount.
- Consider a separate bank account to keep the sales tax money separate, and don’t use it for any other reason. Putting a little extra in the account might be beneficial, giving you the cash to pay any taxes you miscalculated or omitted.
- Get a sales tax ID for each state and remit taxes by the dates indicated by the state’s revenue department.
- Bonus tip: Check which states offer a discount when paying before the due date.
If you run your own sales tax system, you’ll likely have to modify your bookkeeping process and track sales taxes for your income statement. You don’t have to pay income tax on sales taxes you collect and pay to a government entity.
Streamlined sales tax and use tax agreement
Many states work together to make the collection of sales tax easier for online businesses. If you’re a business that qualifies as a seller in a state that participates in this agreement, you might be entitled to sales tax calculation and reporting at no charge.
Currently, there are 23 full member states and one associate member state. You can see which states participate by visiting the Streamlined Sales Tax Governing Board.
Software for managing your sales taxes
Some accounting software can import customer information from your payment processor and automatically calculate sales taxes by jurisdiction. This works even if you use a merchant account for card-based payments or a third-party provider like PayPal or Square. Sales tax software saves you time and effort when organizing the information and getting the total amount you’ll need to separate for paying sales taxes.
If your accounting software doesn’t handle this, it’s also possible to find specialized sales tax software. But most small businesses are best off using sales tax features in the accounting and bookkeeping system they already use.
Additionally, many e-commerce websites automate the sales tax collection process so you don’t have to track and calculate the sales tax on every transaction. However, you may still need to manage the remittance of the sales tax on your own.
Third-party service for managing sales taxes
Managing your sales taxes and getting the right amounts to the right states is a lot of work on top of running your online business. It’s easy to make mistakes that require fixing later, potentially increasing your tax bill. You can eliminate the pitfalls of sales tax collection and remittance by working with a third-party tax compliance service that handles sales taxes on your behalf.
Time is valuable when you’re running a business independently, and tracking sales taxes across multiple states is time-consuming. Retaining the services of a third-party sales tax provider frees your time and lets you focus on ensuring your customers get the best possible experience and growing your business.
You’ll still have to track your sales and set money aside for collected sales taxes, but the tax compliance service handles the rest so that you don’t have to worry about paying the sales taxes alone.
Sales taxes for online businesses can be complicated and add another task to daily operations. Fortunately, small business owners can simplify the process using accounting software or a third-party service that significantly reduces the compliance burden.
Regardless of the option you choose, your first step is to research sales tax requirements in the states you sell to and determine if you meet the thresholds or other requirements to pay e-commerce sales taxes in those states. If you do, following the tips above can simplify the process, potentially saving you time and money when dealing with sales taxes.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or financial advice. You should engage a qualified tax professional or accountant to evaluate your business and help determine applicable tax obligations.
Jon Dulin has over 15 years experience in the financial services industry and 20 years investing in the stock market. He has his undergrad and graduate degrees in Finance, is FINRA Series 65 licensed and has a Certificate in Financial Planning.