Most states charge sales tax on some goods and services. A business that sells a taxable item in one of those states may be required to collect sales tax and remit it to the appropriate tax authority, even if the business is located in another state. Because sales tax rules and rates differ across the country, from state to state and often from jurisdiction to jurisdiction, figuring out when to collect tax (and how much to collect) can be incredibly difficult.
If you don't know the rules and run afoul of tax laws, you could find yourself facing an audit, penalties, and other consequences. To help you avoid that, this article will cover what you need to know about charging sales tax on out-of-state sales.
Understanding sales tax and out-of-state sales
In the past, you usually had to charge sales tax only in states where you had some type of physical presence. So if your office was located in California and you had a warehouse in Washington, you had to charge sales tax on items sold in California and Washington — but not elsewhere.
A major change to sales tax rules happened in 2018, though. In a case called South Dakota v. Wayfair, the Supreme Court ruled that states could require businesses to collect sales tax under certain circumstances even if the seller didn't have a presence in the state.
Because of Wayfair, businesses that sell across state lines may now be required to comply with the sales tax collection rules in states where they have buyers, whether or not they have a physical presence there.
This means companies are required to know and comply with the sales tax rules in potentially dozens of states nationwide.
Nexus: The key factor in determining sales tax obligations
So how do you know whether your business must collect sales tax and follow local sales tax rules in a state where it sells products?
It all comes down to something called nexus — a connection to a state that creates a tax obligation. Once you’ve established nexus in a state, you may be required to collect sales tax there. There are two types of nexus: physical and economic.
While there are slight differences in the definition from state to state, physical nexus may be established if:
- You have employees working in the state.
- You have property sorted in the state.
- You own, rent, or lease physical space in the state.
- You install or assemble goods in the state.
- You provide certain services in the state.
- You have exhibits at trade shows in the state.
The Wayfair case also opened the door for states to pass economic nexus rules. This means that doing a certain amount of business in a state may trigger an obligation to register to collect sales tax, collect taxes on taxable transactions, submit sales tax forms, and remit the collected amounts to the appropriate tax authorities.
Almost every state passed economic nexus rules after Wayfair, although the thresholds differ. Typically, economic nexus is established once:
- A certain number of transactions takes place in the state — such as 200 transactions.
- A certain volume of sales takes place in the state — such as $100,000 or $250,000 in sales.
You need to track your sales in each location where you do business to see whether you’ve hit the state’s economic nexus threshold and therefore must begin collecting sales tax on eligible sales.
When do you need to charge sales tax on out-of-state sales?
Understanding when you need to charge sales tax on out-of-state sales is going to require you to know whether you have nexus there. You also need to understand marketplace facilitator laws, as those affect your specific obligations to personally collect taxes.
Here's what you should know:
Scenario 1: You have nexus in a buyer's state
If you have physical nexus in a customer’s state, you will need to collect sales tax on taxable sales there. If you have physical nexus, you'll check whether origin- or destination-based rules apply in that state, and then collect the correct amount of tax, either based on where you are located or based on where the buyer is.
If you have economic nexus in a customer’s state, you will need to collect sales tax based on the rules where the buyer is located. You will need to check the economic nexus threshold in the state where the buyer is based to determine whether you meet the threshold. Here are some examples of different economic nexus thresholds:
- Alabama: $250,000 in sales
- Arkansas: $100,000 in sales or 200 transactions
- New York: $500,000 in sales and 100 transactions
Most states that have economic nexus thresholds have either a $100,000 or $250,000 threshold. A few have a $500,000 threshold.
Scenario 2: You don’t have nexus in the buyer’s state
If you do not have economic or physical nexus, you do not need to collect sales tax when you ship items to a buyer in a particular state. The buyer may be required, under state law, to declare the transaction and pay use tax.
Scenario 3: You sell through an online marketplace
Most states have passed something called marketplace facilitator laws. These laws require online marketplaces such as Amazon or Etsy to collect sales tax on behalf of resellers on their platform.
If your ecommerce sales occur through these types of marketplaces, you generally do not need to worry about personally collecting and paying sales tax on those transactions. The platform does it for you.
If you have any sales outside of the marketplace, you do need to follow sales tax rules. And, in some cases, the marketplace sales count towards determining whether you meet the economic nexus threshold.
As a result, you'll still need to keep track of the volume and amounts of transactions, and the sales tax charged, on sales through online marketplaces that collect sales tax for you.
How sales tax applies to different types of products and services
You not only need to know whether your company has tax obligations, but also need to understand the sales tax obligations for different kinds of products or services. If you sell exempt or non-taxable products, you don’t have to collect sales tax on those items.
Most states charge sales tax on the majority of goods sold, but there are common exceptions. For example, some types of food are typically not taxable, even in states that charge a sales tax on most purchases. Some states may also exempt certain types of clothing, or clothing below a certain value, from taxation.
Things become more complicated when it comes to services, as there are many different rules for what kinds of services are taxable. The same is true for digital goods, such as e-books that are not shipped; for software as a service (SaaS), and for digital subscription services. While a growing number of states are moving towards taxing SaaS and digital goods, many states don't yet. SaaS is taxable in only around 25 jurisdictions right now, for example.
Since there is a lot of variation in the rules about exactly what is taxed, you must know the rules that apply to determine taxability in every state where you could potentially have economic or physical nexus. Otherwise, you might over-collect or under-collect sales tax and find yourself facing penalties.
What happens if you don’t collect sales tax correctly?
If you are required to collect sales tax and you fail to do so, you could be audited by the state. You could face fines, fees, and penalties for not collecting taxes. Penalties can vary by jurisdiction. For example, in Florida, you may owe the greater of a minimum penalty of $50 or 10% of the amount of tax owed.
The longer you go without complying with your tax obligations, the larger the unpaid balance you could end up with and the bigger the fines, fees, and penalties you could owe. A failure to pay could also make it more likely that you will be subject to audits.
You don’t want to be investigated or end up owing a lot of money in back taxes to states because you failed to comply with the rules. Instead, you should consider using an automated system to ensure that you know when you have established nexus. These systems can also collect the taxes that are due, register with states as necessary, file your tax forms, and even remit what is owed.
For example, Numeral makes complying with sales tax rules effortless. Numeral can track your transactions, alert you when you've established nexus, register on your behalf, and collect and remit taxes. Numeral will even open your tax mail from different states.
You can manage tax compliance in just minutes a month with Numeral, even if you have lots of out-of-state tax obligations to fulfill.
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Best practices for managing multi-state sales tax compliance
To avoid problems with state taxing authorities, your company should follow these best practices:
- Registering for sales tax permits: In any state where you've established physical or economic nexus, you should register for a sales tax permit to collect tax.
- Using tax automation software. Software solutions like Numeral can register for you and take care of both the tax collection and all of the paperwork.
- Keeping updated on state tax law changes. Rules frequently change, both in terms of economic nexus thresholds and in terms of what goods and services are taxable. Keep track of these rule changes to ensure that you are always in compliance with the current regulatory framework.
- Document exemption certifications. If you sell to some tax-exempt buyers, such as resellers or nonprofits, you will need to keep an exemption certificate on file to show you did not have an obligation to collect tax on that transaction.
Most sales tax compliance platforms will handle all of these tax duties for you, including storing exemption certificates so you are audit-ready.
Destination-based vs. origin-based sales tax
Another sales tax nuance to be aware of is the difference between destination-based states and origin-based states.
In origin-based states, if you have a local physical presence, no matter where you send items within your state, you charge sales taxes based on the rules where your company is shipping them from. Let’s take Pennsylvania as an example: If you are located in Philadelphia but send your product to Pittsburg, local Philadelphia sales tax rules would determine exactly how much sales tax you owe.
Origin-based sales tax rules apply in a minority of states, including:
- Arizona
- Illinois
- Mississippi
- Missouri
- Ohio
- Pennsylvania
- Tennessee
- Texas
- Utah
- Virginia
California is origin-based for purposes of charging city, state, and county taxes but destination-based when there are supplementary local taxes.
The remainder of the states (and Washington, D.C.) are destination-based.
In these locations, you must follow the rules where you send the item. Take New York as an example: If you are in Brooklyn and sending goods to Syracuse, you'd follow the local sales tax rules in Syracuse.
Destination-based vs. origin-based rules for out-of-state sellers
So, what if you are out of state and subject to a state's sales tax rules because you've met economic nexus requirements? In this situation, destination-based rules typically apply.
For example, if you are in Pennsylvania, an origin-based state, and you are sending goods to Illinois, another origin-based state, you would apply the local Illinois rules in the area where you are sending the goods to determine how much sales tax is due.
This makes sense because, after all, if Illinois law requires you to pay its local sales tax as an out-of-state seller, it would make very little sense to calculate the amount of tax due based on Pennsylvania sales tax rules.
The bottom line
Many businesses do need to charge sales tax on items shipped out of state. But if you are selling goods or services in a state where you have established physical or economic nexus, then you will need to comply with local tax rules.
A tax consultant at Numeral can help you understand how Numeral manages compliance for you, so you can charge the exact correct amount of tax on every transaction, no matter where it occurs.
