Sales Tax on Internet Transactions


Contrary to popular belief, goods that you purchase over the Internet are just as subject to tax as if you purchased them at the local mall. The confusion arises because stores in the local mall are required to collect the tax from you, the customer, while virtual stores with no physical presence in your state are not. When you purchase taxable goods from a store which does not collect the sales tax, you are supposed to report the purchase yourself and pay what the states call a “use” tax.

Use tax is just another name for sales tax. The only real difference is that a sales tax is collected by the store and a use tax is paid directly to the state by the customer. Businesses are accustomed to paying use tax because they are audited on a regular basis by the states. Individuals, however, almost never pay use tax and there is no effective way for the government to enforce its requirements, although some states are beginning to try. Michigan, for example, added a line to its annual income tax return to capture use tax reporting on individual taxpayers.

The reason that virtual stores aren’t required to collect sales tax is that years ago the courts deemed that requiring mail order companies to collect and remit tax in jurisdictions where they have no physical presence (nexus) would pose an undue administrative burden. The concept of “nexus” means that a business becomes subject to a state’s tax jurisdiction when it begins to have physical activity within a state. Physical activity can mean a store or office location, an employee in the state or even employees traveling into a state to make sales calls. Once a business has nexus, it must register with the state and comply with its tax requirements.

A typical Internet store will collect sales tax when goods are shipped to an address in its home state and in other states where it has distribution facilities. It is not uncommon for these businesses to set up distribution facilities in those few states that have no sales tax. These Internet businesses will carefully avoid establishing nexus in other states and maintain a competitive advantage by selling without the collection of sales tax. Companies with physical presence in every state, such as Wal-mart, have even gone so far as to create businesses like as totally separate entities without nexus so that they too can offer transactions without sales tax.

Historically, sales tax has made up approximately 25% of the tax base for state and local government. As more and more sales are made over the Internet, it will be more and more likely that some change will bring Internet sales under the auspices of sales tax collectors.

Advances in technology could enable some sort of national sales tax collection plan with appropriate remittances back to the states. The challenges are in tying the vendors to a comprehensive software solution and overcoming the diverse definitions of taxable, exempt and partially exempt transactions that exist from state to state.

Rick Gossett

Rick Gossett

Rick Gossett has been COO of Tarkenton Companies for more than 20 years and is an expert in business operations, responsible for business software development, unique partnerships, business educational content, consulting, and more. Rick was the originator of Tarkenton Companies’ consulting services and, initially, personally answered every question. Before joining Tarkenton Companies, Rick owned and operated a private practice as a CPA. Prior to that, he was a Senior Manager at Pannell Kerr Foster in tax and audit, as well as Principal in Ernst & Young’s small business advisory group.