In addition to convenience, one of the biggest benefits of shopping on the Internet is that there’s often no sales tax charged for online purchases.
But when is sales tax charged on Internet purchases? The answer depends on whether the business making the sale has what’s known as “nexus” in the state where its customer lives. States define the nuances of nexus differently, but in simple terms, nexus means a company has a physical presence in that state.
This can apply to any kind of physical presence: a retail store, a warehouse, an office, or even a sales office. If it’s determined that a business does have nexus in a state, then that company is required to collect applicable state and local sales tax on all purchases made by customers who reside in that state.
On the flip side, a business doesn’t have to collect these taxes on purchases made by customers who reside in states where it doesn’t have nexus. This explains why sales taxes are collected on some Internet purchases but not others.
Here’s an example: James, who lives in Georgia, is a collector of classic rock albums on vinyl, and one of his favorite Web sites is that of a vintage music store in California called Groovy Records. He’s been buying albums from groovyrecords.com for years and has never had to pay sales tax, so he was surprised recently when sales tax was added to his order.
When he called the store, James found out why: Groovy Records had just opened a new store in Atlanta. Since the company now had nexus in Georgia, it was required to collect state and local sales taxes from all of its customers in the state.
The precedent for the tax treatment of Internet sales was established well before the Web exploded. In a 1992 Supreme Court ruling, the justices decided that states can’t require mail order businesses to collect sales tax unless they have a physical presence in that state. They believed that forcing sellers to comply with thousands of tax jurisdictions nationwide would be too cumbersome and would restrict interstate commerce. The ruling was extended to online retailers when Internet sales first emerged later that decade.
Some states and municipalities don’t have sales taxes, and most states have exemptions to collecting sales taxes on certain items (like food and clothing). Therefore, online businesses aren’t required to collect taxes in these instances.
Determining when and when not to charge sales tax on online purchases can be confusing and challenging. As a result, many Internet retailers use shopping cart software or services that determine this automatically on an order-by-order basis.
If an online business fails to collect the appropriate sales tax when it’s required, the customer is technically obligated to remit the tax to the state themselves. In this case, the tax is called a “use” tax. However, collecting use taxes on small purchases is, for the most part, impractical, so states have traditionally only attempted to collect them on big-ticket items that must be licensed, like boats and automobiles.
This is starting to change, though, as some states deal with record budget shortfalls. New York residents, for example, must now determine how much tax they should have paid on all Internet, mail order, and out-of-state purchases during the past year and include this on their state income tax returns.