Understanding Sales Tax and Use Tax: A Guide for eCommerce and Software Companies

When transactions fly at the speed of a few clicks and swift downloads, navigating the terrain of taxation can be a perplexing journey. And thanks to the subtle differences and nuanced regulations that exist around sales tax and use tax, we know compliance can sometimes feel like deciphering a cryptic code.

In the world of eCommerce and digital software sales, understanding the difference between sales tax and use tax, and how they both affect your business, is paramount. 

So let’s simplify things a little and show you you can manage your compliance with ease. 

A brief introduction to sales tax and use tax

In the landscape of commerce taxation, there are two fundamental pillars: sales tax and use tax. While often used interchangeably, these fiscal components are in fact worlds apart when it comes to their application and their influences on business operations.

What is Sales Tax?

Fundamentally, sales tax is a levy imposed by state governments on the sale of goods and certain services. When a consumer purchases a taxable item, such as a tangible product or a taxable service, the seller collects the applicable sales tax and remits it to the state treasury. The rate of sales tax varies across jurisdictions, with some states imposing additional local taxes on top of the state rate.

What is Use Tax?

On the other hand, use tax emerges as a counterpart to sales tax, designed to capture revenue from transactions where sales tax has not been collected at the point of sale. Essentially, use tax applies when a buyer purchases goods from out-of-state vendors or makes taxable purchases without paying sales tax, such as through online retailers. In these instances, the buyer is responsible for remitting the equivalent use tax directly to the state.

While the responsibility of sales tax remittance is typically imposed on the seller, use tax places the onus on the purchaser to ensure compliance. This subtle yet crucial distinction shapes the compliance landscape for businesses operating in the digital sphere.

And in June 2018, the world of use tax and its impact on online business transactions shifted drastically.

How South Dakota v. Wayfair changed the world of use tax

In the annals of tax law, few cases have had as profound an impact on the digital commerce world as South Dakota v. Wayfair. This landmark Supreme Court decision, handed down in June 2018, sent shockwaves through the eCommerce landscape, reshaping the terrain of taxation for businesses across the nation.

At the heart of the case lay South Dakota’s enactment of Senate Bill 106, which sought to require certain out-of-state sellers to collect and remit sales tax on transactions made within the state, regardless of whether the seller had a physical presence in South Dakota. This departure from the traditional physical presence nexus standard established by the Supreme Court in Quill Corp. v. North Dakota (1992) signaled a seismic shift in the interpretation of interstate commerce laws.

In a pivotal 5-4 ruling, the Supreme Court overturned the precedent set by Quill. Instead, the Court upheld South Dakota’s economic nexus law, which established thresholds for remote sellers based on their sales volume or transaction count within the state. This watershed moment effectively paved the way for states to enact economic nexus laws, thereby expanding their authority to compel out-of-state sellers to collect and remit sales tax.

The ramifications of the Wayfair decision reverberated far beyond the borders of South Dakota, fundamentally altering the compliance landscape for eCommerce and software enterprises. Suddenly, businesses found themselves grappling with a patchwork of economic nexus laws enacted by states eager to capture revenue from online transactions. Companies that could once hand over tax responsibilities to their clients through use tax now had to start collecting sales tax on behalf of the states in which they had an economic nexus. 

In essence, the Wayfair decision served as a catalyst for change, propelling eCommerce and software companies into a new era of taxation. As the regulatory landscape continues to evolve, businesses must remain vigilant in their compliance efforts, staying abreast of legislative developments and leveraging technology to navigate the complexities of modern taxation.

How does use tax affect your eCommerce business? 

When borders are non existing and transactions can cross geographical boundaries with ease, the specter of use tax looms large, casting its shadow over businesses large and small. But how does use tax impact the operations of eCommerce businesses?

To grasp the significance of use tax in the context of eCommerce, it’s essential to first comprehend its fundamental nature. Use tax, as we’ve previously explored, arises when sales tax is not collected at the point of sale, typically in transactions involving out-of-state vendors or online purchases. In essence, it serves as a mechanism to ensure that purchases subject to sales tax are not unfairly advantaged by circumventing taxation.

Implications for eCommerce: For eCommerce businesses, use tax exerts a twofold influence, affecting both their roles as sellers and buyers within the digital marketplace.

As sellers, eCommerce companies can only fall back on the application of use tax for out-of-state transactions if they do not have an economic nexus in that state. As soon as an economic nexus is triggered, you need to start collecting and remitting sales tax.

Conversely, eCommerce businesses also find themselves on the receiving end of use tax obligations when procuring goods or services for business operations. Whether purchasing inventory from out-of-state vendors or acquiring software licenses for internal use, these transactions may trigger use tax liabilities that must be diligently accounted for and remitted to the appropriate tax authorities.

In another example, if an eCommerce business ends up using its inventory for its own use, such as lightbulbs or staff uniforms, they need to pay use tax on the inventory that is no longer used for resale. 

How does use tax affect you as an online software seller? 

Software vendors occupy a unique position, offering digital products and services that often transcend the traditional boundaries of taxation laws. Yet, amid the digital deluge of bytes and code, use tax has become a mainstay in software sales.

Unlike tangible products, which are subject to sales tax based on their physical location, digital software presents a distinct challenge, blurring the lines of jurisdiction and taxation.

When selling software to customers located outside of the seller’s home state, use tax obligations may be triggered if the seller does not collect sales tax at the point of sale. In such cases, the burden falls on the purchaser to remit the equivalent use tax to their respective state authorities.

But the moment a software seller establishes an economic nexus in a state, they have to adhere to the sales tax regulations of that state and tax their products accordingly if the state sees software as taxable goods. 

If a company buys software for resale, and ends up using the software in its own operations, they need to pay use tax on those licenses that have been activated the same way a consumer would have to. 

Compliance strategies for eCommerce and software companies

So how do you avoid the pitfalls of use tax and sales tax? 

Stay Informed

The regulatory environment surrounding sales tax and use tax is constantly evolving, with new legislation and court rulings shaping the compliance landscape. eCommerce and software companies must stay abreast of these developments, monitoring changes to tax laws, thresholds, and nexus criteria in jurisdictions where they conduct business.

Conduct Nexus Assessments

Nexus, the connection between a business and a taxing jurisdiction that triggers tax obligations, is a critical consideration for eCommerce and software companies. Conducting regular nexus assessments helps businesses identify where they have established economic or physical presence, thereby determining their tax obligations in each jurisdiction.

Implement Sales Tax Automation Software

Leveraging sales tax automation software can streamline compliance efforts and reduce the burden of manual tax calculations and reporting. These sophisticated platforms automate sales tax collection, calculation, and remittance, ensuring accuracy and efficiency in tax management processes.

Maintain Accurate Records 

Robust record-keeping is essential for demonstrating compliance with tax laws and regulations. eCommerce and software companies should maintain detailed records of sales transactions, including customer information, sales tax collected, and exemption certificates, to facilitate accurate reporting and auditing. They must also maintain detailed inventory records that track which inventory has been used during the course of operations. 

Educate Employees

Compliance with sales tax and use tax regulations requires a collective effort from all members of the organization. Providing training and education to employees involved in sales, finance, and operations ensures that everyone understands their roles and responsibilities in maintaining tax compliance.

Monitor Marketplace Activities

For eCommerce companies selling through online marketplaces, monitoring marketplace activities and marketplace rules is crucial for identifying potential tax obligations. Many marketplaces offer tools and resources to help sellers navigate tax compliance requirements, including sales tax collection and remittance services, but once you’ve triggered an economic nexus, the ultimate responsibility for compliance still remains with you. 

Consider Outsourcing Sales Tax Support 

Navigating the complexities of sales tax and use tax compliance can be daunting, especially for businesses operating in multiple jurisdictions. That’s why the guidance and advice of sales tax experts can be key when navigating complex compliance ecosystems. 

Streamlining sales tax management through technology that retains the personal touch

eCommerce transactions and online software sales offer consumers and businesses something that’s often lacking in this fast-paced world: a sense of simplicity. But the complexity of use tax and sales tax responsibilities can rob you of the same simplicity you’re offering to the world. 

That’s why Complyt brings back that sense of simplicity to your compliance journey. Our sales tax automation software makes compliance simple with real-time nexus monitoring, sales tax calculations, automatic remittance, and detailed record-keeping. 

But we also provide you with something else that’s so often missing in digital transactions: a human touch. Our team of sales tax experts are always ready to assist you with your sales tax and use tax questions, to help you understand and avoid the pitfalls of your unique tax ecosystem, and to help you set up the most efficient and impactful compliance platform possible.