Sales Tax Background
Sales tax is a tax on the total final personal consumption of residents in the jurisdiction levying the tax. Historically, the cost of compliance has fallen mostly on retailers who sell eligible goods and services from a physical location inside that particular jurisdiction. These retailers must collect and remit sales tax to the government on behalf of their customers.
But with internet sales, businesses may not have the same tax compliance responsibility. If an online business does not have a physical presence in the resident’s state or jurisdiction, then that business does not need to collect and remit the sales tax for an eligible purchase made by that resident. With online sales growing quickly, this means that more and more transactions are not being taxed at the point of purchase.
Technically when making purchases of eligible goods and services online, residents are still required to pay the same amount of tax directly to their government. However, whether for lack of knowledge or lack of enforcement, most people do not do so. According to an MPR news story, in 2010 “only 734 individuals paid the State of Minnesota for uncollected sales taxes, putting a mere $371,000 in the state's coffers.” The government estimates that the actual amount owed was closer to $400 million. This means that less than .1% of sales/use tax owed was actually collected.
Understandably, states are interested in changing the rules to require online businesses to collect and remit sales tax for purchases made by their residents, even if they do not have a physical presence in that jurisdiction. There are many valid arguments made on both sides of the debate, but I would like to address some of the problems of such a requirement from a small business’ perspective.
Snake Oil, LLC
I am a small business owner. My business partner and I design and sell a party game called Snake Oil. We mostly try to sell our game wholesale to retail stores, but we also have made our game available for purchase online from anywhere in the United States.
For our company, and many other small companies, collecting and remitting sales tax for any purchase made online from any state is a cost too high to bear. We would immediately stop selling our goods online.
To illustrate why the cost of compliance would be too high for us, I want to share the current processes we go through to 1) collect online sales tax through paypal and 2) to remit that tax to the State of Minnesota.
Collecting Online Sales Tax with PayPal
In this table, which I copied from our Paypal account, you can see the complexity involved in setting up sales tax calculations based on state and zip codes. Because our business is in MN, all online purchases made from MN require the baseline 6.875% sales tax. If a purchase is made in Ramsey County, where we are located, it is taxed at 7.125% (state + local). Finally, if a purchase is made in Saint Paul, where we are located, it is taxed at 7.625% (state + local + transit). In order to get PayPal to charge the correct amount of tax, we have to enter it in based on zip codes manually. The good news for us is that any purchase made from someone outside of Minnesota requires us to collect no sales tax.
Remitting Sales Tax to State of Minnesota
Because of our company’s small size, we need to remit sales tax to Minnesota quarterly. Doing so accurately requires use of QuickBooks accounting software and detailed record keeping that tracks purchases and sales tax payable. At the end of each quarter, businesses use E-Service Minnesota to report their revenue and file their sales taxes online. If record keeping is done well, the entire process requires 1-2 hours. There is a handy video that you can watch to learn the process.
Dealing with the sales tax complexities of one state is not easy.Indeed the instruction booklet for Minnesota sales taxes is already 19 pages long. But I cannot imagine a system in which our business needed to collect and remit taxes for each state separately. Each state - even each city! -has unique rates, rules, and exceptions. Each state also has its own system and deadlines for remitting sales taxes.Small businesses do not have the ability to manage all of these differences, and if required to do so, they simply would cease to exist.
Current Draft Legislation Protects Small Business
Fortunately, almost all draft legislation at the state and national levels has recognized the immense burden that these rule changes would place on small businesses. Most would exempt businesses below a certain amount of annual remote revenue (i.e. $500,000) from the requirements.
The internet is powerful because it has allowed practically anyone from anywhere to participate in the marketplace, which results in more economic activity and vitality. While the arguments for requiring online businesses to collect and remit sales tax for all states are strong, in our current system, they would present too much of a burden to small businesses.