Sales Tax Best Practices for E-Commerce Businesses

In today’s digitally-driven world, e-commerce has become a dominant force in not only the retail industry but in any business that sells online. Many of these businesses wouldn’t classify themselves as an e-commerce retailer but if your business has an online presence that permits a customer to place an order or make a purchase, then you are an e-commerce retailer. Retailers don’t just sell to individuals –any sale to a buyer that is the end user, which can be a person or a business, is considered a retail sale, and any business that makes these kinds of sales is regarded as a “retailer” under the sales tax laws. 

With the convenience of online shopping and the global reach it offers, businesses can tap into a vast customer base and achieve unprecedented growth. However, the e-commerce landscape is becoming more and more regulated, and laws are catching up with the times. To thrive in this dynamic environment, businesses must adopt best practices in all departments to ensure they don’t get into any trouble. Let’s explore some essential best practices for e-commerce businesses to successfully handle sales tax. 

1. Understanding Nexus

For e-commerce businesses, nexus has become a top-of-mind sales tax issue since the Supreme Court ruling in South Dakota v. Wayfair in 2018. Sales tax nexus occurs when your business has some kind of connection to a state. This is important to understand as you only have to charge sales tax in the states in which you have sales tax nexus. 

There are two main types of nexus: physical and economic. Physical nexus applies when a business has a physical location in the state (i.e., a brick-and-mortar store, warehouses, office, remote employee, traveling service or salespeople, etc.) Physical nexus is established when a business first have physical presence in the state and can go back even before 2018.  There is also no sales threshold safe harbor.  Economic nexus applies to businesses that don’t have a physical presence in the state. Economic nexus can be easier to determine but it can also catch many businesses that aren’t aware of the rules off guard – if merchants hit a certain threshold of revenue or transactions in a state, they must collect sales tax from buyers there. To see what the thresholds are by state, check out our Economic Nexus State Guide.

2. Product Classification and Taxability

Once a business understands where it is subject to tax, then the next step is to determine whether anything it sells is taxable. Each state can set its own taxability rules. To figure out how your products or services are taxed, a review of the classification of the item is necessary. Different states can classify items differently. A Twix bar might be commonly thought of as a candy bar, but because it has flour in it, many states classify it as a cookie which means it could be classified as “grocery food” and not be taxed the same as “candy”. SaaS might be classified as computer software, data processing, communication service, or a computer service. Once you determine the classification (which can vary by state), then the taxability can be researched! Remember that things might not just be taxable or exempt but could be taxed at an alternative rate or on an alternative base. 

3. Marketplace Facilitator Laws

For retailers that sell through marketplace facilitators like Amazon and eBay, sales tax may seem cut and dry. It’s their responsibility to collect and remit, right? The short answer is yes. But that doesn’t mean you don’t need to keep track of those sales. Depending on the state, these sales may or may not count toward your nexus threshold, so it’s important to keep track of all sales. It is also the seller’s responsibility to map their products to the proper product categories for tax purposes as provided by the Marketplace Facilitator.  If this isn’t done appropriately, the seller can be held responsible for the sales tax. 

As of November 2023, 21 states (including Puerto Rico) do not count sales from marketplace facilitators towards a company’s economic nexus, including Colorado, Florida, and Georgia. States like California, Connecticut, New York, and others do count marketplace facilitator sales towards the threshold, but many states have additional rules and guidelines, and those laws and administrative rules are subject to change. For a full list of states and how they treat marketplace sales in calculating economic nexus thresholds, check out our Economic Nexus State Guide.

4. Automation Systems

If you only make sales on marketplaces, you shouldn’t need a sales tax calculation system as the marketplace will calculate the tax in all states as of January 2023. But, you might need to include the marketplace sales on your sales tax return and then take a deduction (silly, right?). 

However, if you are selling through multiple channels including if you sell directly on your webpage or through other types of ERP or invoicing systems, then you might need some sort of sales tax automation system. Once you understand the different types of solutions that are available, the most important step is to take an in-depth look at where automation can address your business needs. Some e-commerce and invoicing systems may have limitations to their ability to integrate into a tax bolt-on system and others may have it “baked in”. 

Once the sales tax is calculated on customer invoices, the data also needs to be reported and the tax paid to the tax authorities. All the states have some sort of online filing capabilities that can be used. However, if your business needs to file in many states, the use of a sales tax compliance solution or outsourced provider might make sense. Keep in mind sales tax returns can be due as frequently as monthly and are due between the 15th and last day of the month. There are several options. We’ve talked about options and processes for tax automation in an article published in State Tax Notes that might be of interest – No Excuses: Automation Advances Make Sales Tax Collection Easier for Everyone.

At the end of the day, even something like a simplified Excel spreadsheet could be the right solution for your company. The most important thing is that the solution you choose streamlines and manages the processes you need. 

5. Drop Shipping

Retailers who utilize drop shipping (when third-party suppliers fulfill customer orders) know that it can be a cost-effective way to reduce inventory and meet delivery deadlines. But it’s important to keep sales tax in mind when incorporating drop shipping into your business strategy. 

It can be difficult to understand the obligations for collecting and remitting sales tax when drop shipping is involved. In general, if the retailer has nexus in the delivery state, the retailer will be responsible for collecting sales tax on the retail sale. The retailer will issue a resale certificate to its supplier to avoid paying tax for the ship-to state. 

But, if your supplier has nexus and you do not in the ship-to state, the supplier is responsible for collecting sales tax unless you can issue a resale certificate that is deemed valid for the ship-to state. This is where things get complicated as the retailer might be able to issue a resale certificate even if it isn’t registered in the ship-to state (hint – this works in most of the states!). Understanding what is acceptable as either the retailer issuing certificates or suppliers accepting certificates will help reduce frustration and manage tax adjustments. Check out our FAQ – How do Drop Shipments work for sales tax purposes? for more details! 

If neither your business nor the supplier has nexus in the customer’s home state, sales tax is not collected, and it is the customer’s responsibility to pay consumer’s use tax on the item. 

By implementing these best practices, companies can worry less about the sales tax side of selling and focus on creating a competitive advantage, fostering customer loyalty, and thriving in the ever-evolving e-commerce landscape.