Sales Tax Issues for Online Retailers

It is no surprise that states are seeing significant growth in sales tax revenue, a trend fueled by changes in consumer spending during the pandemic. According to a report issued by the National Association of State Budget Officers, median sales tax revenue grew by more than 9% in fiscal 2021, which ended June 30th, and state revenues increased by 12.8%.

Most states ended fiscal 2022 with revenue growth and revenues exceeding the expected forecast. Several factors contributed to fiscal 2022’s revenue growth. First, the pandemic curtailed spending on services that were not generally taxable. Many Americans redirected their spending on new furniture, gardening supplies, or materials for home improvement projects, which are all taxable. Second, the government issued stimulus checks which pumped more spending money into the economy for those not hurt financially by the pandemic. The third reason for higher sales tax revenue was the Wayfair decision in which the Supreme Court expanded the physical nexus requirement to include economic nexus (e.g., a remote seller established nexus with a state based upon the dollar amount of sales and/or the number of transactions). South Dakota v. Wayfair, Inc. – 138 S. Ct. 2080 (2018). This landmark decision attempted to level the playing field between brick-and-mortar and remote online retailers.

While cities and counties have their own sales tax rate in many states, most cities and counties follow the taxing rules of their home state. Thus, the state legislature that sets the rules for sales tax for online retailers at the state level is implementing them locally also. Alabama, Alaska, Arizona, Colorado, and Louisiana are “home rule” states which permit the municipalities or counties to govern themselves with certain restrictions. For example, Colorado has 271 municipalities, but only 72 municipalities have opted to self-collect sales tax. Unfortunately, this can lead to confusion when an online retailer charges sales tax and must remit the tax to the locality.

Sales tax compliance can be very complex as each state has its own tax rates and laws indicating which products and services are taxable or exempt. Many small businesses are looking to state legislatures to simplify the sales tax rules as compliance becomes more administratively burdensome. For example, New Mexico drafted and instituted a statewide uniform state and local sales tax rate for out-of-state sellers. In addition, the Streamlined Sales and Use Tax Agreement (SSUTA) called for simplifying state and local tax definitions and rates to minimize the administrative burdens on retailers. More than half the 45 states plus the District of Columbia have a sales tax and conform to SSUTA. However, much more must be done to simplify small businesses’ sales tax compliance burden.

Since the 2018 Wayfair decision, the states have become more aggressive in enforcing sales tax rules on online retailers. For example, New York, Ohio, Pennsylvania, and Washington have increased their efforts to find online retailers who are not complying with the sales tax rules. The states are mailing out notices or letters to question a retailer’s business activities in the state to determine if there is nexus for sales tax purposes. Also, many states are hiring more sales tax auditors to audit more companies and identify related vendors who may not comply with sales tax. This compliance requirement has burdened small businesses as they may have to hire state tax consultants to assist with these audits and manage responses to notices.

Due to the increase in online retail sales within the past few years, learning how to navigate the many regulations, tax requirements, and filing responsibilities is overwhelming for most small businesses. While it may seem challenging to determine where your business may have nexus, Withum is here to assist you.

Author: Bonnie Susmano, JD, MBA | [email protected]