Online Sales Tax Explained

A man shopping on a tablet during Cyber Monday
••• Corbis via Getty Images / Getty Images

Whether it's Black Friday or Cyber Monday, or the day after Christmas, or any day, if you sell online business, you have to deal with sales taxes. First some background in sales tax, then a discussion of the current situation for online sales tax. 

How Sales Taxes are Set

Sales taxes are determined by states and localities within those states. Five states have no sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon; Alaska and Montana allow localities to have sales taxes. Each state sets its own rates and laws for sales taxes.  

The current federal law setting the sales tax collection standard is based on the 1992 Quill decision. In this decision, the Supreme Court determined that a merchant is not required to collect sales tax unless the merchant has a "physical presence" in that state.

This tax presence is called a tax nexus; having a tax nexus in a state means you must collect sales tax in that state. Each state also sets the conditions for determining tax nexus within that state. 

Sales Tax for Same-state Sales

If the physical location of your business (your tax nexus) and your customers are in the same state, you must collect sales tax on any purchases made by those customers. Sales taxes may be set based on either the location of the seller or of the buyer. These are called origin-based or destination-based sales taxes. 

How Online Sales Taxes are Set

If you sell products online, you may or may not have to collect sales tax from customers who order from your website. 

Over the past few years, more and more states have been joining the ranks of those passing legislation requiring businesses with a tax nexus. These states are attempting to expand the tax nexus concept to gather in more tax revenue for their states.

States have set laws using different definitions of tax nexus, including: 

  • Affiliate nexus, which allows the state to collect tax if an affiliate is located in the state
  • Click-through nexus, which is more general, allowing a sale by clicking on a site to be taxed
  • Economic nexus, in which states set a minimum sales level for online seller, after which the seller must remit sales tax. 

State sales tax laws are constantly changing and being challenged.   

...many states have enacted legislation that expands nexus beyond Quill, including New York-style click-through nexus, Colorado-style  reporting and notification, and Massachusetts-style cookie nexus.

In the beginning, online retailers like Amazon resisted efforts to establish nexus for online sellers. But now that Amazon has fulfillment centers in most states, an Amazon affiliate with merchandise in one of these fulfillment centers has a tax nexus in the state and must charge sales taxes in that state. 

In April 2018, the Supreme Court is hearing the case of South Dakota v. Wayfair, with the Court's decision to come in June 2018.