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Tax and accounting

Tax day of reckoning comes for e-commerce companies

Alex Paladino  Global Managing Director, Head of Technology Practice Group, Thomson Reuters

Alex Paladino  Global Managing Director, Head of Technology Practice Group, Thomson Reuters

Stock prices for virtually every major e-commerce company took a nosedive on June 21st, immediately following a landmark Supreme Court ruling on internet sales taxes. They’ve since bounced back, but the pain this decision will inflict on internet retailers large and small has only just begun. 

The decision in the case, formally known as South Dakota v. Wayfair, puts the onus on retailers to start collecting local sales taxes in every state that imposes sales tax and where the retailer has qualifying sales, regardless of whether or not the retailer has a physical presence there. Under the previous interpretation of the law, retailers were only required to collect those local taxes if they had a physical presence in the state where the goods were purchased.

To the casual observer, this may not sound like a huge deal. Yes, many online retailers did not previously collect online sales taxes on out-of-state transactions. So, depending on where customers live and which online retailers they use, some online shoppers would catch a discount by buying over the internet. But the sporadic discounts were never really the reason for shopping online for most consumers.

Plus, according to U.S. tax law, the consumer was technically responsible for paying those taxes at the end of the year anyway. Few people ever did, of course, which meant roughly $17.2 billion in sales taxes went uncollected by state governments each year.

Shifting responsibility brings challenges for online retailers

With this new Supreme Court decision, the responsibility shifts from the consumer to the retailer. And, that’s where things get complicated for e-commerce companies. Now, instead of collecting taxes in one or two locations where they may be headquartered or maintain distribution centers, retailers must contend with a convoluted mix of state, county and city-specific sales taxes across more than 15,000 different taxing jurisdictions in the U.S.

And that’s the easy part. Beyond simply getting the sales-tax math right for every zip code in the country, retailers also need to factor in different tax rates for different types of products, intermittent back-to-school tax holidays and dozens of other variables.

Consider the challenge for a New York-based retailer selling goods to an online purchaser in Arkansas. They now need to collect a 6.5% sales tax on anything bought in the state. However, if the purchase happens to be made in Pine Bluff, they also need to collect a Jefferson County tax of 1.625% and a Pine Bluff city tax of 2.25%, bringing the total sales tax for goods sold in that single zip code to 10.375%. Meanwhile, the combined sales tax rate is 9% in Little Rock, 9.75% in Fayetteville, and 8.5% in Jonesboro.

Now, let’s imagine that the retailer in this example is a meal-prep service, such as Blue Apron, Hello Fresh or Plated, that sends boxes with ingredients and recipes to customers who assemble and cook them. Arkansas, like many other states, has different tax rates for food and, within that, different tax rates for different types of food. Currently, the Arkansas sales tax rate for unprepared foods, such as grocery items, is 1.5% and the sales tax rate for prepared foods, which are defined as food where two or more ingredients are mixed by the seller, is 6.5%. Both are still subject to county and city taxes as well.

What tax rate should theses meal-prep companies apply to their sales in the state? Ultimately, they’ll need guidance from the state – and from every other state in which they do business – on how their products will be classified and which rates should apply in each local tax jurisdiction.

That’s just one category of product in one state. The administrative hurdle confronting e-commerce companies at the hands of this Supreme Court decision is high. While many of the largest electronic retailers have been preparing for this, many mid-sized and smaller e-commerce companies are woefully unprepared.

In fact, our indirect tax team puts the current estimate of midsized firms that have systems in place for dealing with this level of local tax complexity at about 8%. The rest are literally playing with online tax calculators and building massive spreadsheets to try to wrap their arms around the enormity of the challenge.

Getting it right the first time

Chris Carlstead, managing director of our ONESOURCE Indirect & Property Tax team, recently spoke with a client on the need for tax technology to aid transaction-tax teams:

Getting tax right the first time creates efficiencies and positive [customer] experiences. In an e-commerce scenario, missing tax or charging the wrong tax could result in a customer abandoning a purchase. It used to be about avoiding penalties and fines… now it is about improving your top line through a better customer experience, and improving your bottom line through efficiency.”

Ultimately, as more states start aggressively enforcing their sales taxes on electronic sales of both physical and digital goods, e-commerce companies that are not prepared to collect taxes accurately at the individual zip code level will face some very real consequences. Whether that will result in a surge in audits and tax law suits, intervention by the federal government to bring some consistency to the process, or consolidation among internet retailers remains to be seen. What we do know now, though, is that those e-commerce companies that start addressing the issue will be in the best position to weather the storm.


Learn more

How can sales tax teams start addressing the issue? One way is to adopt emerging technologies that help automate sales and use tax. Stay tuned for future updates on this topic.

For the latest on Wayfair and tax technology, click here.

To learn more about how your sales tax team can survive smarter, click here.

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