Tax Liability Arising From Online Sales – Chicago Business Attorney Blog – November 2, 2021
There is no doubt that ecommerce sales have grown dramatically over the past 20+ years. This is in part because online purchases are taxed differently than in-person sales, and small businesses have noticed the benefits of this system.
The setup is pretty straightforward: a small business can host their servers or store their goods in one state, while shipping their products to the other 49 states. It is important to know that small businesses are not required to collect sales tax in a state in which they have no physical presence. Until recently, small business owners could expand their consumer base across the country largely without ever collecting a dime in sales tax. This approach generates more customers, more sales and more income. However, as the old cliché goes: “More money, more problems. In this case, it is “more money, more tax problems.”
Business owners who sell their products online, stock inventory in another state, or rely on online referrals in another state should be aware of whether another state will attempt to sue them for unpaid usage taxes.
Sales tax are imposed on the sale of goods and services within a state’s borders. Typically, sales taxes are collected at the point of sale and are added to the purchase price.
Use taxes, on the other hand, apply when a customer purchases a product from a company located in another state. For user taxes, the business does not collect sales tax because it does not technically exist in the state. It is then the customer’s responsibility to remit the usage tax to the state in which they reside when they go online to purchase from retailers located outside of the state.
The reality is that customers frequently escape the usage tax requirement because at the end of the day, they simply choose not to pay. This is one of the reasons why online businesses are doing so well these days. Customers prefer to buy online rather than in physical stores because it is convenient, but also because buyers prefer to avoid paying an upfront sales tax if possible. For this reason, many states have noticed a decline in sales tax revenue. The result is that states have imposed a tax liability in the form of remittance obligations on e-commerce companies. To make it more confusing, state sales tax rates vary.
What does this mean for online businesses, especially those that sell their products to residents of another state? States are finding new ways to force businesses to levy a user tax by targeting businesses doing business on the Internet. Take the case of Isabel Rubinas, a small business owner from Glen Ellyn, Ill., Who runs her online business, Lollipop Seeds, from her kitchen table. Most of its orders are processed through an Amazon program called Fulfilled by Amazon. To Rubinas’s surprise, the California Department of Tax and Fee Administration debited $ 2,700 from his bank account for use taxes owed on online sales to California residents. Rubinas sued the state of California in federal court in Illinois, but the court dismissed her claim saying she must sue in state court of California. The court acknowledged that Rubinas will have to spend more time and money pursuing his case in California, but that did not prevent the court from dismissing the case.
California law imposes tax remittance obligations on online businesses. It requires online retailers to “collect tax from buyer, file return and remit tax.” Failure to pay will result in a levy on the business owner’s bank account, as Rubinas learned the hard way. California is just one example. There are 43 other states that have already started forcing outside businesses to collect and remit user taxes resulting from sales to their residents via the Internet.
Illinois, on the other hand, does not impose the burden of remitting taxes on online retailers. In other words, the tax responsibility lies with the customers who buy products online. Therefore, from a tax standpoint, there is still a difference between running an online business and a physical store in Illinois. The physical store must collect sales tax at the time of purchase, while the online business can sell their product – regardless of tax remittance obligations – if the customer resides in Illinois. Wisconsin tax laws, on the other hand, mirror the California tax system. Therefore, once an Illinois business makes an online sale to a resident of Wisconsin, the company is required to collect and remit the Wisconsin purchase tax. It’s important to know that tax obligations change depending on whether products are sold online, where inventory is held, and perhaps more importantly, what state the customer resides in.
The lesson for business owners is clear. Failure to understand the tax and remittance obligations in different states can lead to unexpected tax liability. Each state’s tax authorities expect online businesses to understand the rules and pay on time. Otherwise, they will go directly after the business owner’s back account to collect what is owed.