How to create a robust US sales tax strategy for online trade
Peter Boerhof, VAT director at Vertex, discusses the complexities of US sales tax as well as the factors online sellers need to consider to meet the tax obligations of each state.
Good times are ahead for organisations who are planning to sell online to customers in the US, with the region’s e-commerce market expected to be worth over $563 billion by 2025. However, as the US has one of the world’s most complicated tax regimes, it is critical for businesses to strengthen their sales tax strategies to ensure compliance and to take advantage of sales opportunities.
Why is US sales tax so complex?
There is no standardised tax system in the US as each state sets its own tax rules and often take widely varying approaches. As a result, every state has a different tax framework, with varying regulations covering everything from tax liability and tax rates through to exemption rates and reporting requirements. In addition, local area tax jurisdictions also have authority over some aspects of taxation which adds an additional layer of complexity. So, what does this mean for day-to-day tax management?
The root cause of US sales tax liability is the principle of nexus – in other words, the requirement that a qualifying connection exists between the state exercising its tax power and the taxable subject.
While historically this was based on businesses having a physical nexus, when it comes to digital sales the term has been interpreted in different ways by individual states. Increasingly, in response to the growth of e-commerce and falling tax revenue from bricks and mortar, states are also implementing economic nexus rules, directly related to the level of sales activity to customers within the state. This means that non-state digital sellers are still liable for sales tax.
Without the right tools in place, online sellers can find the process of navigating the different tax obligations of each of the 50 states overwhelming. To help mitigate the risk of non-compliance and ease the burden on tax teams, adopting an automated tax engine is crucial to a robust sales tax strategy. It is also important that team professionals understand some key considerations about the process of establishing tax liability.
What you need to know – five practical considerations
1. Have you established nexus?
Determining if you have nexus in a state and if this nexus is physical, economic, or both, should be your first consideration.
Physical nexus is not reserved just for in-state sellers as it can be created by a wide range of activities such as downloading cookies to a customer’s computer or even paying people to help you establish and maintain a market in a state (you can have physical nexus in a state, without having an office location there). It is important to understand state specific rules on sales revenue value, thresholds and calendar periods, as some states have strict definitions of what counts as physical nexus whereas others don’t.
With economic nexus there are only two aspects used to assess this: sales revenue value and number of transactions (including renewal of subscriptions). Some states use just one of these measures while others use both. As there is no consistency between states on the level of revenue or number of transactions used to determine economic nexus, businesses need to make sure they are constantly monitoring sales on a state-by-state basis.
The law does not require you to fall into both categories – either one is sufficient.
2. What happens if there is no nexus?
You may think that having no physical or economic nexus in a state means your business has no tax obligations, however, this may not be the case.
In situations where the seller does not collect sales tax, a complementary tax called ‘use tax’ is required to be paid by the buyer. Some states have chosen to offer remote sellers the option of complying to strict tax notification and reporting requirements rather than registering for sales tax under nexus provisions.
3. What tax rate should be applied to products?
Product level taxability refers to the classification of products and services to ensure the correct tax rate is applied. Individual tax jurisdictions can choose to exclude certain types of goods from tax or provide a reduced rate depending on the item sold.
However, this is not simple. Digital growth has resulted in states struggling to define new technologies in their tax frameworks, which means definitions can be vague. And, with cloud-based sales the picture changes again, with states taking many different approaches to tax liability. This complexity can be extended even further as local tax jurisdictions may also apply different rules that make it difficult to understand if a product or service is liable or not.
4. Are you selling to multiple states?
Given the wide range of rules and the rapid rate of change, every business selling in multiple US states can face practical compliance challenges. For example, you will need to know whether to apply destination or origin-based tax rules to your product or service, determine customer location at Zip code level, and identify the tax exemptions and exclusions on goods and services within each state. To prove tax exemption, the customer must provide you with a tax exemption certificate that will require validation checks.
5. Do you understand the reporting process?
Both the process of reporting sales tax and the detail of information required varies from state to state. Typically, reporting needs to contain everything from sales per tax rate at line-item level, to transaction details such as customer name, invoice number, and invoice date.
Additionally, while returns are usually monthly, quarterly, or annually, some states have more unusual frequencies, including semi-annual or occasional. In most cases, the higher volume of sales, the more often you need to file and pay (with some states requiring pre-payments). Due dates are also just as varied. However, reporting for relevant tax jurisdictions may not just be at state level but can also include city, country, and metropolitan area if there is no flat rate for sales tax across states.
If you are interested in learning more about how to plan a US sales strategy and how an automated tax engine can help fulfil your digital growth ambitions, download our report here.
VAT director, Vertex