By: Nate Matherson
Thanks to the internet and an increasingly global economy, it's pretty easy for foreign companies to start attracting customers in the U.S. and selling products and services in any of the 50 states. However, there are some financial logistics to be aware of.
Of course, you'll want to set up U.S.-based checking accounts to easily collect payments from customers and get a business credit card to easily provide payments to U.S.-based partners. That's the easy part with Adro to help.
Unfortunately, there's also a hard part: Complying with sales tax obligations.
The good news is that, unlike in the EU, Canada, and many parts of the world, there's no Value Added Tax (VAT) or Goods and Services Tax (GST) to worry about in the U.S. The bad news is that every one of the 50 states has its own sales tax rules. You must know these sales tax rules everywhere you do business to avoid facing audits and penalties.
This guide will explain the basics of sales tax in the U.S. so you can understand what your obligations are, when those obligations kick in, and how to find a simple way to fulfill them.
How does sales tax work in the US?
In the U.S., as in most parts of the world, companies collect sales tax from customers and pay taxing authorities.
Traditionally, U.S. states could only require companies to collect and remit sales tax if the company had established physical nexus within the state's borders. This meant the business located some part of its operations within the state, whether that meant operating a store locally or employing people in the state, or manufacturing or warehousing goods locally.
In 2018, however, everything changed when a case called South Dakota v. Wayfair made its way to the U.S. Supreme Court, the highest court in the United States. The Supreme Court determined that physical nexus was no longer required to establish sales tax obligations, although it was still sufficient. Under the new rules, economic nexus could now trigger these obligations as well.
The Court's ruling meant that states could continue to impose an obligation to collect tax on businesses with a local presence, but could also require businesses from outside the state -- or even outside the country -- to file and remit taxes. Once a company established economic nexus, it would become responsible for following all the state's sales tax rules.
This now means that out-of-state and foreign businesses need to know the laws on sales tax in every one of the 50 states they sell products to and ensure they comply with them to avoid penalties.
Marketplace facilitator rules
After Wayfair, businesses that establish economic or physical nexus must assume responsibility for sales tax collection in most cases. However, there is one exception. If all of your cross-border business takes place on a marketplace covered by marketplace facilitator laws, your company won't personally be responsible for managing your sales tax obligations.
Marketplace facilitators partner with third-party sellers, and they enable those third-party partners to sell their products or services. Amazon, Etsy, and eBay are examples of marketplace facilitators. To be considered a marketplace facilitator, usually the company must have some active role in the process, which could include listing products, collecting payments, or helping with shipping.
Under marketplace facilitator laws, these companies collect and remit sales tax for all transactions on their platform. If you sell only via a marketplace facilitator, you don't have to worry about handling these tasks yourself.
If you have other sales channels, though, you still must understand and follow sales tax rules on those transactions.
Home rules or local rules
Keeping track of sales tax rules in 50 states is difficult enough, but there's also an added challenge.
While most states establish rules and collect sales tax on the state level, there are a small number of states called "home rule states" that give the authority to make and enforce sales tax rules to local taxing authorities in cities, states, counties, or special taxing districts.
In home rule, or local rule, states, your business must know the rules established by each different jurisdiction within the state. Home rule states include:
- Alabama: Alabama is not officially a home rule state, but there are city and county government bodies that independently collect local taxes.
- Alaska: Alaska does not have a state sales tax, but there are local jurisdictions within the state that impose sales tax.
- Arizona: The state administers tax rules for most local jurisdictions, but tribal governments can make and enforce their own tax rules.
- Colorado: Colorado has 272 total municipalities, 97 of which are home rule municipalities with their own tax rules.
- Idaho
- Louisiana
If you are selling within a home rule state, you must comply with the state's sales tax rules and the sales tax rules within each local area that has its own requirements
Exemptions
While many products and some services are taxable in the U.S., not every purchase is subject to sales tax.
For example, many but not all states exempt groceries from sales tax. Rules for when digital products and services -- like eBooks or SaaS -- are taxed also vary from jurisdiction to jurisdiction.
In addition to some products not being taxable, certain buyers also don't have to pay sales tax. For example, if you are selling to a reseller or to some nonprofits or government agencies, you won't collect sales tax from them. You will, however, need an exemption certificate on file to prove you didn't have to collect.
What do businesses need to know as they grow?
One of the reasons the Supreme Court upheld South Dakota's law taxing sellers without physical nexus is that the law contained provisions exempting smaller merchants.
Other states modeled their own regulations on this South Dakota model, so if your company does a small amount of business somewhere, that's likely not going to be enough to trigger economic nexus. You must hit a certain volume of sales, such as $100K in sales, or you must complete a certain number of transactions within the state, such as 200 total transactions.
As your company grows, it becomes very important to track your sales so you will know immediately when you've established nexus and sales tax obligations are triggered. Thresholds for establishing nexus are typically around $100,000 in sales volume on the low end and $500,000 in volume on the high end, while states that use a transaction number usually say you've established nexus once you have sold 100 or 200 products locally.
After you've triggered economic nexus, you must register with the state before you can begin collecting sales tax. Triggering economic nexus also triggers the obligation to collect the sales tax due from customers, file tax forms with the revenue authorities, and remit payment.
As you grow, the frequency with which you must take complete tasks can also change. While you may have needed to file and pay only semi-annually when your sales volume was lower, this obligation may update to quarterly or even monthly as your sales volume increases.
How to stay compliant
Staying compliant with sales tax obligations is critical. To ensure you don't put your business at risk of an audit and penalties, you must:
- Track nexus in every state where you sell goods or services so you'll know when your tax obligations are triggered.
- Understand the rules for which items and entities are taxable so you don't charge tax on something you shouldn't or fail to collect tax on a taxable sale
- Register with each state as soon as you establish economic or physical nexus
- File sales tax forms periodically with state, and sometimes local, revenue departments
- Collect the appropriate amount of sales tax from customers
- Remit sales tax without overpaying or underpaying the amount due
- Ensure you keep all required documents in case of an audit, including exemption forms
Managing all of this for 50 different states and countless local jurisdictions in home rule states can become a substantial burden.
Sales tax software can automate your sales tax compliance, tracking nexus for you, alerting you when it is reached, registering on your behalf, filing your paperwork, storing exemption certificates for you, and remitting taxes due. Certain platforms will even respond to correspondence from states on your behalf.
Common mistakes
Unfortunately, far too many companies make major errors when it comes to sales tax, especially when they're scaling operations and dealing with these issues for the first time. Some of the most common errors include:
- Failing to register for a sales tax permit on time once nexus is established
- Collecting the incorrect amount of tax, resulting in customers being overcharged or undercharged
- Not filing sales tax paperwork on time
- Failing to understand which items and entities are taxable, or not verifying and storing exemption certificates properly
- Paying sales tax late
- Failing to realize when your filing and payment obligations have changed based on a change in the volume of your sales
You don't want to risk owing back sales tax and penalties, so avoid these and other common errors.
Businesses -- including foreign businesses -- risk being audited at any time. Many things could trigger an audit, including one of your customers or suppliers being subject to one and details about your company being revealed during the process.
Finding a compliance solution can be the easiest way to avoid costly errors. You can be confident that your sales tax obligations are met, so you can focus on growing your business and growing the balance of your U.S. accounts with Adro without worrying about local taxing authorities derailing your plans for success.
Nate is the Head of Growth at Numeral. He has founded multiple venture-backed companies and is a two-time Y Combinator Alum. He is based on Charleston, SC.
