Automating Sales Tax for Everyone: The Simplest Guide for Shopify Merchants
Barkin Doganay · October 29, 2024 · 7 min read
Sales tax is a nightmare for many Shopify merchants. Several have aired their frustrations and fears about tax compliance in various forums online after being notified about their sales tax liabilities.
Imagine this: You started an e-commerce business on Shopify (or any marketplace), and you successfully promoted it and brought sales to your stores. You've been operating for over a year, and you thought you were on top of your business. However, one day, to your horror, you received a letter about your tax liability. And you don't know what to do because you have zero knowledge about sales tax compliance or tax payment.
Do not worry because you are not alone. Sales tax compliance is a struggle for many business owners in the country, including those using e-commerce platforms like Shopify.
In fact, according to the Tax Foundation [1], the costs for tax complexity and compliance are on the rise, with companies increasing their funds for compliance by an average of 32% from 2017 to 2023. The budget's growth was attributed to complex international rules.
In the next section, I will discuss sales tax compliance, especially those that affect the Shopify merchants. Additionally, I will discuss the challenges of manual sales tax compliance and the benefits of sales tax automation.
Understanding Sales Tax Compliance for Shopify Merchants
Business owners need to understand sales tax compliance by heart, whether they are selling on Shopify or other platforms. As a business owner, when you establish an economic nexus, you must do your tax obligations.
In this section, I will discuss sales tax and its importance for Shopify merchants. Let's get started.
What is Sales Tax?
Sales tax is a consumption tax imposed on the sales of goods and services like furniture, clothing, dry cleaning, haircuts, construction services, cosmetics, toiletries, and more. It is a percentage of the total price that consumers pay as it is added to the final cost.
Sales tax varies by state. It is one of the government's sources of revenue at the state and local levels. The revenue from sales tax is used to fund government programs like education, transportation and healthcare.
Sales Tax Obligations for E-commerce Sellers:
Sales tax applies to online businesses following the 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc. The ruling reshaped how sales tax obligations are determined for online sellers, which directly affects Shopify merchants.
Prior to the introduction of economic nexus, businesses must have a physical presence in a state to collect and remit sales tax. However, the 2018 ruling allows states to require out-of-state sellers to collect and remit sales tax based on their economic activity, even without a storefront or warehouse.
The economic nexus thresholds vary by state. However, many states set it $100,000 in sales or 200 transactions annually.
As a Shopify merchant, when you exceed the thresholds in a state, it is your obligation to register, collect, and remit sales tax for that state.
If you sell nationwide, you have sales tax obligations in multiple states, increasing compliance requirements for you. Timely and accurate compliance saves you from penalties, fines, and legal issues. It also enhances customer trust because accurate tax charges at checkout improve transparency and satisfaction.
Meanwhile, non-compliance could trigger audits, which can be costly and time-consuming, not to mention, disrupt your business operation and even damage your reputation. Worse, your business license or permit can be revoked if you ignore your sales tax obligations.
Key Compliance Standards Affecting Shopify Sellers
As mentioned, following the introduction of economic nexus, several essential compliance standards have affected Shopify sellers. In this section, I'll get down to the nitty-gritty of it.
Here are the compliance standards that directly affect Shopify merchants.
Economic Nexus Laws
As mentioned, business owners, even those who only operate online, have sales tax obligations when they make $100,000 or have 200 transactions annually. For example, in Arkansas, if you sell an item for $5 and 200 items are sold, then you make $1,000. That is enough for you to collect and remit sales tax.
You must determine the economic nexus thresholds in your state and keep records of every economic activity, measured by sales revenue or number of transactions. Also, reassess nexus quarterly or annually.
When you determine nexus, register for a sales tax permit. Apply for a sales tax permit in each state where you established an economic nexus and set up tax collection.
Product Taxability Rules
Business owners need to be knowledgeable about the tax variation based on product and service types. For instance, tangible personal property or those items that can be touched, like clothing or furniture, are generally taxable in most states.
However, food and groceries are taxed at a lower rate. In some states, groceries are exempted from sales tax. Prepared foods like restaurant meals or hot deli items are often taxable, but unprepared foods like bread and milk are non-taxable in some states like Illinois.
Prescription medicines are typically exempted. However, over-the-counter items may be taxable. Taxes for clothing and apparel also vary from state to state, as some clothing is exempt up to a certain amount.
In New York City, clothing and footwear under $110 are exempt from sales tax. On the other hand, Texas collects sales tax on clothing and even on sales tax holidays, only those under $100 qualify for an exemption.
As for services, professional services are generally not taxed. However, personal services like haircuts and cleaning services may be taxed, and online subscriptions and SaaS products may also be taxed.
Products and services are taxed differently. It is essential that you correctly categorize the items you offer to collect the right amount of tax. Otherwise, states may impose fines for incorrect tax collection or remittance, subjecting you to penalties and audits.
However, this is no easy feat, especially if you do it manually due to complex tax laws that frequently change. Also, if you establish nexus in several states, different rules apply depending on the jurisdiction.
Additionally, if you sell taxable and non-taxable items, it could complicate taxation much more if you offer bundles of goods that need to be taxed differently.
Exemption Certificate Management
An exemption certificate is a document that buyers present to sellers to certify a purchase is exempt from sales tax. It serves as proof that the seller is not required to collect sales tax because the buyer meets the criteria for exemption.
Exemptions usually apply to purchases of goods intended for resale or items used in manufacturing processes or agriculture. Nonprofit organizations and government agencies often have tax-exempt status.
The exemption rules and certificates may vary by state.
Filing Frequencies and Deadlines
The frequencies of sales tax fling are determined by each state's tax authority depending on the amount of sales tax expected to be collected. Usually, the more sales tax you collect, the more frequently you need to file, which can be done -- monthly, quarterly, or annually.
Businesses with high sales volumes and sales tax collections usually file monthly. New businesses may also be assigned to do the same until their sales patterns are established. The due date can be on or before the 20th of the following month, depending on the state.
Businesses with moderate sales volumes and tax collections may file quarterly. The reporting period covers three months, reducing administrative work as the filing is less frequent than doing it monthly.
Due dates for annual fling are typically the following:
- Q1 (Jan-Mar): Due April 30
- Q2 (Apr-Jun): Due July 31
- Q3 (Jul-Sep): Due October 31
- Q4 (Oct-Dec): Due January 31
Small businesses with low sales volume and minimal sales tax collections can file annually, with the reporting period covering the entire calendar year. This is often due by January 31 of the following year. However, the dates can vary.
The filing frequency is assigned by state tax authorities when you register for a sales tax permit. The frequency is based on estimated tax liability (projected amount of sales tax collected) and size of business (with large businesses often required to file more frequently).
If you have sales tax nexus in multiple states, you must register in each state. It is also important that you understand the different requirements because each state may assign different filing frequencies, so you have to manage multiple deadlines.
Record-Keeping Requirements
Business owners should also maintain accurate sales and tax records because they are legally required to report sales and remit the correct amount of taxes to federal, state, and local tax authorities. Bookkeeping can help facilitate smooth and efficient audits because accurate records will allow for easier verification, reduce stress, and save you from possible disruption in your business operation.
Inaccurate or incomplete records can lead to underreporting tax liabilities and may result in penalties, interest charges, and fines. Worse, severe non-compliance can lead to audits, legal actions, and revocation of business licenses.
Maintaining accurate sales and tax records is fundamental to running a successful and compliant business. It safeguards your company against legal risks, enhances financial management, builds customer trust, and supports growth.
By prioritizing meticulous record-keeping and leveraging tools like sales tax automation software, you position your business for long-term success and stability.
The Challenges of Manual Sales Tax Compliance
You can use a sales tax automation solution like Kintsugi that automatically calculates sales tax accurately and keeps up with the changing tax laws and rates. By automating sales tax, you do not necessarily have to keep yourself up to date with the changing tax laws, but it will still help if you are informed.
You can process your sales tax if you wish to do it yourself. However, this isn't easy.
In one Avalara survey [2], 53% of the respondents admitted that they found sales tax compliance challenging due to complex tax rules and rates that were subject to change. Additionally, 42% find the cost of managing consumer use tax obligations high for their business.
You can turn to sales tax agencies like tax consulting firms, accounting firms, or legal and tax law firms to help you with sales tax. However, working with human experts doesn't guarantee a smooth sales tax compliance experience.
Here are the drawbacks of doing sales tax manually that you should consider seriously.
1. Complexity Across Jurisdictions
This is the No. 1 struggle among business owners with sales tax compliance. This is understandable because you have to navigate over 12,000 tax jurisdictions, each with its own rates, rules and regulations.
2. Frequent Changes in Tax Laws and Rates
To make things even more difficult, tax laws and rates regularly change at the state and local levels. Varying nexus laws and thresholds determine one's tax obligations. Thus, you have to stay up-to-date to ensure compliance.
3. Lack of Real-Time Tax Rate Updates
Manual systems do not reflect the tax rates and rules in real time. The delay in implementing changes can result in non-compliance.
4. High Risk of Human Errors
Manual calculations involve humans, which increases the chances of wrong calculations, data entry, and record-keeping. Also, the manual process takes time and increases the risk of accepting invalid or expired certificates without proper verification. Inaccurate filings may result in penalties, fines, and interest charges.
5. Time-Consuming Processes
Another major drawback of manual sales tax compliance is the time it takes to complete the entire process. Since humans are involved, the preparation and filing of tax returns for multiple states and localities, as well as managing exemption certificates and verifying customer tax-exempt status, take long.
6. Expensive
Calculating sales tax for each transaction takes time and may require additional staff. Employing tax professionals to handle sales tax compliance or training staff to keep them updated on the latest tax laws and compliance requirements is expensive as it means additional labor cost.
In addition, money is time and time spent on manual compliance, if you do it, is another lost resource. You could have concentrated your time on growing your business.
7. Inefficient Record-Keeping
Maintaining accurate and organized records is another challenge when doing your sales tax manually. Also, tracking and storing exemption certificates is inconvenient when done manually. Manual systems lack comprehensive reporting and make it challenging to retrieve necessary documentation during audits.
8. Limited Scalability
When your business expands into new markets, there will be more compliance challenges. The whole process becomes increasingly unmanageable as the company grows.
Benefits of Automating Sales Tax Compliance
While sales tax compliance can be done manually, it's hard work, time-intensive and costly. On the other hand, sales tax automation makes the whole process a breeze. You can confidently concentrate on growing your business without worries.
Here are some reasons why you should automate sales tax compliance.
Cost Savings
Labor costs are reduced when automating sales tax because automation handles calculations and updates and eliminates the need for extensive staff involvement. Also, with its accurate calculations, you are safe from penalties and risk of audits, which can be an expensive and grueling experience.
Compliance Assurance
The most important thing about sales tax automation is its accuracy, as it guarantees peace of mind. It automatically incorporates the changes in tax laws and rates, so you are always compliant.
You do not need to keep track of the ever-changing sales tax rates and laws because the automation system will take care of that for you.
Accurate Record-Keeping
When automating sales tax compliance, rest assured that all the necessary documents like invoices, exemption certificates, and correspondence are well organized and ready for audits. All the documents are accessible with a few clicks when you need them for audit trails.
Efficient and Scalable
Manual systems struggle when your business grows, but automation can handle it with ease. Sales tax automation systems like Kintsugi can easily manage increased sales volumes and expansion into new jurisdictions. It also allows seamless integration into ERP, HR, and e-commerce like Shopify.
Better Customer Experience
Sales tax automation ensures that customers are charged the right amount of tax, which demonstrates professionalism and reliability on the merchant's side. This can help improve your business' reputation among your customers.
Guaranteed Customer Support
Sales tax automation systems offer 24/7 customer support. As a business owner with a lot of things on your plate, you do not want to waste your time waiting for a concrete answer when you have tax-related concerns.
If you notice a problem with your filing late at night, if possible, you want it to be addressed right away. However, the tax firm or accountant who works on your filing may not be available, so you have to wait. That's not the case with sales tax automation providers as they provide 24/7 support.
Kintsugi has a dedicated Slack support that can connect you to its knowledgeable support or a tax expert within minutes.
Overall, sales tax automation offers a more economical and efficient solution to sales tax compliance minus manual workloads and human errors. It frees you to concentrate on strategic business functions and customer satisfaction.
By automating your sales tax, you will end up with significant cost savings and operational advantages over time.
Enhancing Store Security Through Compliance
Sales tax compliance keeps your business secure for several reasons. First, it protects you from penalties, charges and possible legal issues. Second, it enhances data security by keeping you from the risk of audits, which can expose your financial systems, business' sensitive information and potential data breaches.
It will also improve your financial security because accurate tax filing, collection, and remittance prevent unexpected liabilities and economic losses. This also ensures smooth business operation as you are safe from unwanted interruptions that compliance-related issues might bring.
Considering all these things, sales tax compliance keeps your store secure and stable.
Building Customer Trust Through Compliance
Sales tax compliance can also strengthen customer trust because they will see your professionalism and reliability. With transparent pricing, where you apply the correct sales tax, customers will have a smooth experience until checkout because they need not deal with additional cost surprises.
Without overcharging or undercharging customers, you can prevent disputes and chargebacks. A seamless and hassle-free shopping experience also contributes to customer satisfaction.
Fair pricing builds long-term customer relationships and buyers feel positive about supporting businesses that contribute taxes used for community development. Consistent compliance fosters trust and encourages customers to return for repeat purchases, which can lead to customer loyalty.
These reasons illustrate how diligent sales tax compliance fulfills legal obligations and plays a significant role in building and maintaining customer trust. By prioritizing compliance, you create a solid foundation for positive customer relationships and long-term business success.
Implementing Sales Tax Automation on Shopify
Considering the cost and time you will save by automating sales tax compliance, it’s time to turn to automation. Now, you can focus on your Shopify business confidently, knowing that you are fully compliant and everything is well taken care of, from collecting the right tax rate to keeping accurate records.
Shopify merchants can use a sales tax automation solution like Kintsugi that automatically calculates sales tax accurately and keeps up with the changing tax laws and rates. By automating sales tax, you do not need to keep yourself updated with the changing tax laws, but it will still help if you are informed.
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Sources
[1] Tax Foundation. https://taxfoundation.org/research/all/federal/us-business-tax-compliance-costs-survey/
[2] Avalara survey. https://newsroom.avalara.com/2024-03-26-Avalara-Survey-Finds-Businesses-Are-Turning-to-Automation-to-Manage-Tax-on-Purchases
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