There is no doubt that e-commerce sales have grown tremendously over the last 20-plus years. That is in part because online purchases are taxed differently than in person sales, and small businesses have noticed the advantages of this system.
The setup is quite simple: a small business may house their servers or warehouse their goods in one state, all while shipping their products to the other 49 states. It is important to know that small businesses are not required to collect sales tax in a state in which they have no physical presence. Until recently, small business owners could expand their consumer base across the country largely without ever collecting a penny in sales tax. This approach yields more clients, more sales, and more revenue. However, as the old cliché goes: “More money, more problems.” In this case, it’s “more money, more tax problems.”
Business owners who sell their products online, store inventory in another state, or rely on online referrals in another state need to know if another state will try to come after them for unpaid use taxes.
Sales taxes are imposed on the sale of goods and services within a state’s borders. In general, sales taxes are collected at point-of-sale and are added on top of the purchase price.
Use taxes, on the other hand, apply when a customer buys a product from a business in a different state. For use taxes, the business does not collect the sales tax because it does not technically “exist” in the state. It is then the customer’s responsibility to remit the use tax to the state in which they reside in when they go online to buy from out-of-state retailers.
The reality is that customers frequently evade the use tax requirement because in the end they choose simply not to pay. This is one reason why online businesses are doing so well these days. Customers prefer shopping online instead of brick-and-mortar stores because it is convenient, but also because shoppers would rather avoid paying an upfront sales tax if possible. For this reason many states have noticed decreasing sales tax revenues. The result is that states have placed tax liability in the form of remittance obligations on e-commerce businesses. To make it more confusing, the sales tax rates of states vary.
What does this mean for online businesses, particularly those that sell their products to residents of a different state? States are finding new ways to force businesses to collect use tax by targeting businesses conducting trade over the internet. Take the case of Isabel Rubinas, a small business owner from Glen Ellyn, Illinois, who runs her online business, Lollipop Seeds, from her kitchen table. Most of her orders are processed through an Amazon program called Fulfilled by Amazon. To Rubinas’ surprise, the California Department of Tax and Fee Administration levied her bank account in the amount of $2,700 for use taxes owed stemming from online sales to California residents. Rubinas sued the State of California in federal court in Illinois, but the court dismissed her claim saying she needs to sue in California state court. The court acknowledged that Rubinas will need to spend more time and money pursuing her case in California, but this did not stop the court from dismissing the case.
California law places tax remittance obligations on online businesses. It requires online retailers to “collect the tax from the purchaser, file a return, and remit the tax.” Failing to pay will result in a levy on the business-owner’s bank account as Rubinas learned the hard way. California is just one example. There are 43 other states that have already begun to force out-of-state businesses to collect and remit use taxes stemming from sales to their residents via the Internet.
Illinois, on the other hand, does not place the burden of tax remittance on online retailers. In other words, tax liability falls on customer buying products online. Therefore, from a taxation standpoint, there is still a difference between running an online business and a physical store in Illinois. The brick-and-mortar store must collect sales tax at the time of purchase, while the online business may sell its product—without concern for tax remittance obligations—if the customer resides in Illinois. Wisconsin tax laws, by contrast, mirror California’s tax system. Therefore, once an Illinois business makes a sale online to a resident of Wisconsin, the business is obligated to collect and remit the tax on the purchase back to Wisconsin. It is important to know that tax obligations change depending on whether products are sold online, where inventory is stored, and perhaps most importantly, in which state the customer resides.
The lesson for business owners is clear. Failure to understand the tax and remittance obligations across different states may lead to unexpected tax liability. Tax authorities in each state expect online businesses to understand the rules and to pay on time. Otherwise, they will go after the business owner’s back account directly to retrieve what is owed.