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Do You Have to Pay Sales Tax on Internet Purchases?

Whether you have to pay sales tax on internet purchases is a common question in a world where consumers buy everything from clothes to food to cars online.

Some people view the internet as the prime place to start selling items that are free from the bonds of sales tax. Indeed, many online retailers often lure customers in by advertising that any purchases made will be free from sales tax. However, like many things that just sound too good to be true, there are often cases when sales over the internet are indeed subject to state sales taxes. For instance, some states require that whenever you purchase an item online that is not subject to sales tax, you must report that sale to the state tax agency and pay sales tax on it. However, not every state does this.

Sales Tax on Internet Purchase Depends on Where the Buyer is Located

Generally speaking, if an online retailer maintains a physical presence in a state that charges a sales tax on most purchases, then that online retailer must charge sales tax on any items that are sold to customers within the home state. However, if the online retailer is selling an item to a customer outside of its home state, then it is not required to collect sales tax from that customer.

Here is an example. Suppose that Pete, who lives and works in California, likes to buy all of his cooking oils and spices for his restaurant over the internet. He normally orders from Restaurant Supplies Unlimited, a company that is headquartered and has its warehouse in Nevada. Because Pete orders his supplies for his restaurant from a vendor that is outside of California, Restaurant Supplies Unlimited does not have to charge Pete a sales tax.

However, now suppose that Restaurant Supplies Unlimited has opened a warehouse in California to better supply their regular customers there. Now, because Pete's order will be taken and shipped from California, he must be charged sales tax on his order.

How Do Large Websites Avoid Sales Tax on Internet Sales?

You may be wondering how it is that large websites that have stores located in many states avoid putting sales tax on the purchases made over the internet. They do this by establishing subsidiaries that are solely responsible for the internet part of the business model.

Picture it this way: the store that you buy an item from online may be a different legal entity from the corresponding brick and mortar store that is in your local shopping mall. Because that particular online store does not have an actual physical presence within your state, it does not need to charge you sales tax. This is a highly controversial practice that will probably be legislated in the future as many brick and mortar stores that do not have online counterparts are losing sales to the tax-free internet shops.

However, this issue becomes even more complicated when the online retailer allows a customer to make returns to a brick and mortar store that is technically a separate legal entity. Consumers will buy an item online that is free from sales tax, but are then able to return those purchased items to brick and mortar stores.

Consumers May Be Required to Report and Pay Sales or Use Taxes

For consumers that order tax-free items online, but live in states that charge a sales tax, they are technically required to report that purchase to their state tax agency and pay the sales tax directly to the agency. When consumers are required to do so, it is often called a "use" tax.

The sole difference between a sales tax and a use tax is the person that ends up giving the money to the state government. When it is a sales tax, the retailer is the one handing over the money, while a use tax is handed over directly by the consumer. However, collecting use taxes on small purchases often costs more than simply letting the consumer not pay the use tax. Instead, state tax agencies try to focus more on collecting use taxes for big ticket items that are purchased online with no sales tax, such as cars and boats.

However, there are a number of states that have stepped up their enforcement of their use tax laws and are now trying to make their state residents pay the taxes that should be paid. However, these states are still hampered by limited resources as well as the complexities involved with tracking down minor purchases and demanding that a use tax be paid.

It is worthwhile to keep in mind that state governments are missing out on a substantial chunk of money when it comes to uncollected use taxes. It is not too hard to imagine the federal government stepping in at some point to pass legislation regarding use taxes.

Is the Tax-Free Future for the Internet Bright?

It is a hard question to answer. There have been many steps taken that all attempt to close off the tax free shopping that occurs every day on the internet. For example, in 2002, many state governments came together to fight against the tax-free internet shopping trend. They formed together and made the Streamlined Sales and Use Tax Agreement (SSUTA), also known as the Streamlined Sales Tax Project (SSTP). As of 2005, there were 44 states that participated in SSTP. Under the SSTP, online retailers can voluntarily decide to pay sales tax on internet sales to the states that their customers reside in. Online retailers that decide to participate are granted immunity from assessment for uncollected state sales taxes.

Next Steps
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