What Online Sales Are Subject to Sales Tax?

When you sell items online, some of your customers may owe taxes on their purchases. Whether you need to collect sales tax depends on where both you and your customers are located.

If your customers are in the same state as the physical location of your business, they owe sales tax on items

they purchase from you. For instance, if you have a presence in Texas, you'll need to collect sales tax for all sales made in Texas. Even if a customer calls your California office and the merchandise ships from a fulfillment house in Michigan, you'll still be liable for the taxes.

The waters get even muddier if you use a third-party merchant account. If your customer is in the same state as your merchant account provider, the customer will owe taxes on any purchases your provider processes.

The good news is that if you are shipping merchandise to a state where your business (or your merchant account provider) does not have a location, you will not need to collect sales tax. Some large online retailers have gone so far as to establish separate legal entities to spare their customers having to pay sales tax. Of course, this is not an option for most small e-businesses.

Even if you do not collect sales tax from customers located in your state, they are still responsible for this tax. You can expect your sales tax payments to be scrutinized closer than ever as states crack down on sales and use tax laws.

But the tax-free ride for online retailers may end soon, as some states and brick-and-mortar retailers are pushing hard for a national Internet sales tax. States claim they're being deprived of millions of dollars of tax revenue, while offline retailers say their online competitors have an unfair advantage.

Starting in June 2008, for example, the state of New York began collecting sales tax from Amazon.com. While Amazon is based in Seattle, many of the retailers who sell goods through Amazon are New York–based. Amazon has filed suit in the New York Supreme Court arguing the law is unconstitutional.

Sales tax brings in an average $150 billion every year and accounts for nearly a third of a state's income. With the potential to pad this amount by taxing online sales, state governments are not likely to give up on the idea of a national sales tax. And enough state pressure may be able to force the federal government to pass such legislation.

Nevertheless, for right now, all you need to worry about is collecting sales tax from customers located in the same states as your locations. If an Internet-wide tax bill is passed, there are other ways that you can entice your customers to purchase your products, such as offering an equivalent discount, free shipping, or free gifts.

While there is some cause for concern among online businesses about the prospect of a national sales tax, they should be able to weather the storm if they can come up with new incentives to keep their customers coming back.