This is a guest post from Michael Gutfraynd. Michael is a CPA, MST and Founder and President of Goudy Square Consulting, which specializes in implementing sales tax automation tools for eCommerce and Marketplace businesses. He was previously a CFO and finance leader at several eCommerce, Marketplace and distribution companies.
Note that this is not meant to be taken as legal advice, but as guidance based on Michael’s experience with Goudy Square Consulting. Please consult your lawyer for your specific case.
There are more than 11,000 taxing authorities when it comes to sales tax, and each of them want revenue from every sale made within their boundaries (a connection to the jurisdiction for a business, known as nexus).
These jurisdictions rely on businesses to do all the work of collecting taxes from each individual sale and then sending the funds to the jurisdictions in an accurate and timely fashion.
Most jurisdictions combine their reporting requirements at the state level (Colorado is a notable exception), and 5 states don’t have a state sales tax (Alaska, Delaware, Montana, New Hampshire, Oregon).
The requirements extend to making sure that the amounts collected are accurate for each item sold and in each locality, city, county and state.
For example, a shirt is taxed at regular rates in California, not taxed in Minnesota, taxed at regular rates on any amount above $175 in Massachusetts and not taxed in Maryland for one week per year beginning on the second Sunday in August.
The tax rate in one part of Barrington, IL is 7.5% (up from 7.0% in June 2020), but across a street in Barrington it is 9.0%.
Every state requires the correct amount is charged to every customer on every transaction of every item, not more and not less than required. Overcollecting can lead to lawsuits from customers and under collecting requires the business to pay the difference out of their own pockets.
This can all become a little confusing, so lets break it down for you as eCommerce sellers, starting with the famous Wayfair case.
Sales tax before and after Wayfair
Prior to June 21, 2018, states had various sales tax rules that were controversial as to their enforceability at a federal level. The U.S. Supreme Court ruled in Quill Corp v North Dakota in 1992 a state could require a business to collect and remit sales tax if the business had physical presence in the state (office, warehouse, employees etc).
The world has changed quite a bit since 1992, and the rise of eCommerce has allowed countless new businesses to make their store available virtually to every person with an internet connection. Any business could easily be a remote seller (no physical presence) in any state. State and local governments have looked for creative ideas to get the revenue they felt was rightfully theirs (and put the local brick-and-mortar sellers at a price disadvantage over a remote seller that did not collect sales tax).
States passed a multitude of laws that changed what physical presence meant. There was Massachusetts stating that an internet seller putting a tracing cookie in a shopper’s browser constituted a physical presence. California enacted a rule that a business using a California based affiliate triggered nexus in the state.
This all left businesses with a hodge-podge of rules to determine if they had nexus in a state. They had to figure out to what degree these rules were enforceable under the Constitution, and assess the risk from the state conducting an audit versus the lost sales risk of collecting sales tax on remote sales while competitors didn’t (effectively charging consumers a lower price).
What is the Wayfair case, and how did it change things for eCommerce sales tax?
On June 21, 2018, the Supreme Court ruled in South Dakota v Wayfair that a state can indeed require sales tax collection on a remote seller (economic nexus), with certain minimum transaction requirements.
Over the course of the past 24 months, nearly every state has passed economic nexus laws (see map below), with the minimum requirement as little as 200 transactions per calendar year for most states.
On average, revenue from sales taxes make up 30% of state and local budgets. Since the COVID-19 pandemic, state and local governments are under increasing pressure to get every penny of revenue to shore up their shrinking budgets.
Due to the landmark Wayfair decision, the enforceability of sales tax collection requirements is much clearer and every business must consider how to best implement and facilitate sales tax collection in a way that keeps them legally compliant while not breaking the bank in these non-value add compliance costs.
Case Study: $20M annual company
The Amazing Nature Goods Company sells their outdoor accessories and branded apparel across the U.S on their own website, Amazon, Walmart and Etsy.
Note: This is a hypothetical case study mock up from Goudy Square Consulting.
Annual sales in 2020 are expected to be $20M and are spread throughout all states, including consumers and distributors. Prior to 2020, the Company filed sales tax in 3 states, which was taken care of by the same CPA firm that handles their income taxes.
Due to massive growth this year, the company has hired several new remote based employees, outsourced their website deliveries to Deliverr in order to be closer to its customers and started utilizing the Amazon FBA network. Amazing Nature Goods had a nexus study performed and due to a combination of physical and economic nexuses, and is now required to collect and remit in 36 states (and DC), which comprises about 90% of sales.
Amazing Nature Goods runs a Shopify eCommerce store with various customizations, Netsuite as its Enterprise Resource Planning (ERP) platform to handle inventory and accounting and Hubspot for its CRM, along with a multitude of other tools.
Its B2B segment is fairly new, and the company’s accounting department has not developed an automated method for tracking, validating and renewing resale certificates (its distributors charge sales tax to their end customers and request the company to not collect sales tax on their orders).
Shopify and Netsuite both provide a sales tax engine that calculates sales tax in real time during the payment process. However, each sales tax engine calculates the rates using different methodologies and requires additional validation to ensure accuracy.
Amazing Nature Goods has seen its sales significantly grow due to additional investments in marketing. Due to the increasingly competitive landscape, the company plans to invest more into building out an internal marketing department.
They turned to Goudy Square Consulting to help figure out the optimal way to stay compliant with complex sales tax laws and find the most cost efficient, accurate and lowest maintenance solution to deal with its sales tax complexity.
The following steps were taken to implement the best sales tax compliance solution, which you can use as a guide for planning out your own situation:
- Perform nexus study to determine proper sales tax jurisdictions
- Register to collect and remit sales tax in 33 additional states
- Select and negotiate the most cost effective sales tax software solutions to automate the processes
- Sales tax rate validation
- B2B sales resale certificate compliance
- Monthly/quarterly sales tax return filing
- Set up API integrations with Shopify/Netsuite and tax software
- Validate data importing correctly to tax software
- Set up correct product taxation categories
- Implement resale certificate exemption software solution on website
- Perform a full review of the implementation, including:
- Test transactions
- Data validation
- Shopify and Netsuite integration
- Data integrity
- Document storage
- Company User Acceptance Training (UAT)
- Validate successful enrollment in all tax jurisdictions
- Set up automatic filing of sales tax returns
- Ensure sales tax software integration is accepted by each state
For illustration purposes, the chart below estimates the cost of outsourcing the sales tax process to Goudy Square Consulting versus doing the project using a combination of in-house resources and a CPA firm.
So what does this mean for your eCommerce business?
Sales tax rules continue to evolve on a local, state and national level.
To date, there has not been the momentum necessary to implement a national sales tax and replace the current state and local based sales tax. There have also been various proposals to implement a VAT (value added tax) structure that is common throughout the world, which could amend or replace the U.S sales tax structure.
However, there are no current proposals remotely close to eliminating the current structure of sales tax compliance.
State and local governments budgets and revenues continue to be stressed, especially with the current COVID-19 crisis.
With nearly every state adopting an economic nexus rule, governments will seek to grow their revenues from sales tax and companies will need to get compliant, stay compliant and make sure they automate the compliance process to the greatest extent possible in order to invest in value-added activities that grow the company.