Covid-19 and the social distancing it requires has pushed more of our purchasing online. In fact, since March an extra $107 billion has been spent online, according to Adobe Analytics.
For small business owners forced to close their doors for months and now still seeing dramatic drops in walk-in traffic, that online shift and exposure to new customers has likely been a lifeline.
But it also may mean they aren’t charging the necessary sales tax on those purchases. According to a recent survey by Avalara, only about half of businesses are familiar with the sales tax rules for online transactions with customers in other states.
As state and local governments are grappling with major budget deficits over the coming year, they’re going to be diligent about collecting all the tax they’re due. That means online sales taxes could potentially be a big area of focus for state tax collectors.
When the pandemic first hit, state departments of revenue slowed their enforcement on things like collecting sales tax due from businesses. But now that governments have adjusted — for the most part — to having a largely remote workforce, expect that grace period to end, says Liz Armbruester, SVP of Avalara’s global compliance operations.
“Departments of revenue also provided a grace period just to help businesses keep the lights on so they allowed a delay in the filing of returns,” she says.
“But most of that has passed and it’s back to regular business. Now, those businesses have an obligation to ensure all their transaction data — everything that happened during that period of time — is accounted for.”
The Supreme Court ruling that changed everything
The reason that compliance may be so scattered is that the requirement to collect and remit a sales tax on online transactions is relatively new.
In June 2018, the U.S. Supreme Court ruled that state and local governments had the right to collect sales taxes from purchases made online, no matter where the seller was located. (Prior to that landmark case, South Dakota v. Wayfair, sellers only had to remit sales tax if the online purchase was made by someone in the same state.)
Following the ruling, states and localities spent about a year implementing their own rules and regulations for how they’d go about collecting those sales taxes. So the rules have only been in place for about a year or so in many places.
As part of that rule-making process, small businesses were generally made exempt from complying. For example, if you own a maple syrup shop in Vermont and typically got a smattering of online orders every year totaling around $10,000 across 15 states, you wouldn’t have to remit a sales tax on those transactions. It’s not enough of an economic presence in any one state.
But in the Covid-19 era of home cooking and stocking up on anything that lasts years, maybe your little maple syrup shop is doing record business online. Maybe you’re selling $100,000 in products just in Virginia alone. If you’re online ordering system isn’t set up to charge customers Virginia sales tax rate on those transactions, you could be getting a bill that would cut into your profits.
“Alongside that growth [for small businesses] there comes an obligation that comes to remit a sales tax,” says Armbruester. “That’s money due to states that they’re potentially not collecting and I think they’re going to target small businesses.”
The tax rules are changing
Even if you are familiar with the relatively new rules for charging sales tax online and think you’re exempt, the situation is rapidly changing. When states first adopted sales tax regulations for online purchases, they set economic thresholds that a business had to meet before they were required to remit sales taxes for online transactions.
In more than half of states, business who sell through marketplace facilitators like Etsy or eBay don’t have to worry about a threshold because applicable sales taxes should be automatically applied by the facilitator on their transactions.
For direct sellers, the annual threshold for most states was at or near $200,000 in sales to customers in-state and 200 transactions. At least a dozen states have changed their Wayfair threshold rules over the last year.
Arizona, Georgia, and Tennessee have lowered their sales thresholds this year (although Arizona’s was part of a phased-in approach).
Other states (including California, Colorado, Iowa, Mass, North Dakota and Washington) have moved away from the number of transactions thresholds, focusing just on gross receipts.
How to prepare
This is likely just the beginning, says Brian Kirkell, principal at the audit, tax and consulting firm RSM. Because of the economic crisis brought on by Covid-19, state legislatures have been focused on public health and budget issues so there’s been less activity in this area than was expected at the beginning of this year.
The real question, is what kind of action we’ll see in 2021 as state legislatures begin new sessions and try to close massive budget gaps.
Kirkell and Armbruester think that states are more likely to put their auditing energy and their policy-making into marketplace facilitator collections and rules rather than targeting individual small businesses.
“The reason? Incremental benefit,” says Kirkell.
Lowering the threshold from $200,000 to $100,000 in a state with a 5% sales tax rate might net an additional $5,000 in tax payments per business. In other words, “it would cost more than it’s worth to audit and assess,” he says.
Marketplace facilitators are liable for sales tax on third-party sales in all but four states— Florida, Kansas, Mississippi, and Missouri — all of which now have marketplace facilitator legislation in the pipeline. (New Hampshire doesn’t either, but it doesn’t have a sales tax.)
To keep track of these developments and changing thresholds, there are a few free online tools you can use to determine whether you have an economic presence via your online sales in any state.