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Calculating sales tax for online stores

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Offline Phil

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Calculating sales tax for online stores
« March 01, 2017, 12:00:17 PM »
Most states (in the US) charge sales tax on purchases, and most of those are "destination based" (i.e., where the goods are delivered to the customer determines the particular sales tax rate). This worked fine for a long time, in the era of brick-and-mortar stores, and was OK for phone, fax, and mail orders, as there was time for some sales agent to look up (or confirm) the applicable sales tax rate. However, with web-based sales, the transaction has to be completed quickly, with no waiting for human intervention, and so tax rate calculations need to be automated, based on the shipping address given by the customer.

States where the seller has a "nexus" (some tangible presence) generally require the seller to collect the proper sales tax; otherwise, the customer is supposed to figure out the "use tax" (equivalent to the sales tax) and report and pay it with their income tax filing. The problem is that most people blow this off. Some well-intentioned ones might even jot down the information (only to misplace it before tax time), but most simply don't bother — their attitude is "I can get away with not paying tax, so I won't."  This gives an unfair competitive advantage to web-based sellers over local brick-and-mortar stores, because online prices (before explicit shipping costs) are 8 to 10% lower if sales tax isn't collected. This puts local stores out of business, as people come in only to "showroom" and kick the tires, and then go online to order for less (not paying sales tax).

What can be done about this situation? No one objects to paying less, even after explicit shipping costs are factored in (brick-and-mortar stores also have shipping costs, but they're hidden in the posted prices). Stores with a nexus in that state are at a disadvantage, too, as they have to collect sales tax. Note that even Amazon often doesn't collect the right amount, especially when selling through affiliates! The problem is that, particularly for destination-based rates, it can be a very complicated and error-prone activity to calculate the proper sales tax rate. Somehow you have to map the shipping address to the taxing jurisdiction, and you need to figure the correct tax rate class that applies for each item.

"Just use the ZIP Code" you might say (Postal Code for non-US readers). Well, ZIPs don't match up well to tax jurisdictions. For example, the state of New York has 81 tax jurisdictions (62 counties plus 19 cities authorized to levy their own sales tax), not counting the state itself or special districts such as the Metropolitan Commuter Transit District (which include entire counties). Some Post Offices cover parts of up to three counties, and some border towns are served by Post Offices across the state line! It's a mess to try to map a customer's ZIP Code to a tax jurisdiction, although it's simple enough that many store owners resort to that approach (even though the state explicitly warns them not to do so).

Ideally, it should be very simple for some out-of-state shop to figure the tax class and the rate (per tax jurisdiction) for any piece of merchandise, based on the customer address, and to remit the collected sales tax at the appropriate time. Betty's Birdhouse Boutique of Boise (Idaho) should have no problem automatically calculating the correct tax rate for a customer in Ulster County, New York, nor in remitting the collected tax with the push of a button. Unfortunately, it's complicated. Each state, and even counties and other tax jurisdictions within a state, has its own system of what is taxable at what rate. For example, in Texas, one county taxes single cans of soft drinks at a meal rate (full sales tax), and six-packs as groceries (no tax), while the neighboring county does just the opposite. This is especially bad with food and semi-food items, such as "junk food" and "snack food" taxes, and taxes on sugary soft drinks. New York has all sorts of special exemptions for sales tax, such as inexpensive clothing having no state sales tax, and each tax jurisdiction is left to decide whether to impose their portion of the tax (0 to 4.875%). States would need to agree on a small number of tax classes (categories), which means changing their brick-and-mortar policies, as well as to require collection and remitting of sales tax on out-of-state sales (which is not currently required, and no state has been willing to do, for fear of losing in-state businesses' out-of-state sales).

The biggest problem, by far, is mapping the customer's delivery address to the appropriate tax jurisdiction. Almost any change would require changes to rates charged by many brick-and-mortar stores. For example, ZIP Codes could become the official boundaries for tax jurisdictions, but ZIPs are subject to change as Post Offices open and close. At least, a state could provide a file listing ZIPs and which tax jurisdiction they fall into, today. It is possible to geo-locate an arbitrary street address/town/ZIP to a point on a map, and then check which county and city they fall into, but people don't provide consistent address formats (e.g., correct street names or locality names expected by Google Maps), and merchants would have to be prepared to deal with many "your address cannot be found" errors. It's also fairly expensive in server CPU cycles (whether the store's server or a third party mapping and lookup service) to geo-locate someone and then determine which polygon it is within. A state could simply adopt a statewide sales tax rate, and apportion the funds (or just those from non-local sales) in some agreed-upon manner. In New York, current rates range from 7.0 to 8.875%, so a simple distribution by population would bring complaints from higher tax counties that they're being short-changed. Counties with low rates would see their sales tax rise, and would complain that their residents are being overtaxed. No one will be happy, however you set the statewide sales tax rate.

Of course, the simplest solution is just to get rid of sales taxes! They are severely regressive (the poorest people pay the greatest percentage of their income in sales tax, compared to wealthier people) and no merchant enjoys having to collect, track, and remit sales tax. The problem is that this is a major income stream for states, counties, and cities; and that loss of revenue would have to be replaced by higher taxes (on income and wealth) elsewhere. At least, brick-and-mortar stores, and their many employees, would be on a level playing field with online stores, and tax evasion would be cut.

Much of this may apply outside of the US, with VAT and various provincial and national sales taxes.

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Offline Phil

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Re: Calculating sales tax for online stores
« Reply #1: March 24, 2017, 10:24:22 AM »
A further thought on using ZIP (Postal) codes to figure tax rate… a state could list its tax rates by ZIP code, and stores could remit by ZIP. Everybody knows their correct state and ZIP, and lookup would be quite simple. Then, the state apportions out the collected taxes (entered by ZIP and tax class) to the actual tax jurisdictions (cities and counties). For ZIP codes that cross county lines, taxes collected could be apportioned by population (and possibly weighted by different county tax rates). For ZIP codes that cross state lines, the first cut would be on the state name (selected from a drop-down list by the customer as part of shipping address entry).

If the current tax jurisdiction structure is retained (applying to brick-and-mortar stores), this won't be absolutely foolproof, as you could end up (in New York, for example), living in a county (tax jurisdiction) that does not charge sales tax on inexpensive clothing (thus the tax rate is 0%, as the state rate is 0%), but served by a Post Office (ZIP code) in a county that does (say, 4%). Customers will complain that they are being overcharged. A merchant could offer an escape hatch where the customer is shown what county is being used to calculate tax rates, and the customer can manually select the proper county. This override would have to be manually confirmed (by address lookup) before merchandise is shipped or released (for download), and if the customer is wrong, either cancel the order or demand further payment.

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Offline sciurius

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Re: Calculating sales tax for online stores
« Reply #2: March 24, 2017, 03:51:23 PM »
This problem may be unique to the USofA. In Europe, at least, VAT is fixed for the whole country. In the Netherlands, where I live, there are 3 VAT tariffs, 0, 6% and 21%, depending on the product/service.

When I was in the USofA (many years ago) I recall being surprised that the price tags on articles did not match the amount that I had to pay.

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Offline Phil

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Re: Calculating sales tax for online stores
« Reply #3: March 24, 2017, 06:49:39 PM »
Yeah, we're not a nation as much as we're an association of 50 feuding semi-autonomous republics, each setting many of their own policies. Within each state that charges sales tax (all but a handful), often each county (and cities within a county) can set its own rates (additions to the state rate). I think Canada has province-specific taxes, in addition to national taxes. The US has no national sales tax or VAT.

Sometimes you'll see prices listed (in a brick-and-mortar store) with sales tax, but that's rare. The custom has long been to list "plus tax". You can argue that really doesn't make sense, but that's the way we do it. Americans love a strong dose of anarchy and keeping as much power as possible local, but please don't tax us — just send money from elsewhere (Manna from Heaven).

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Offline Phil

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Re: Calculating sales tax for online stores
« Reply #4: August 10, 2018, 01:21:39 PM »
Just a note that in June of 2018, the SCOTUS (US Supreme Court) ruled that states may require merchants in other states to collect and remit sales taxes for products and services delivered into their states, even if the business has no nexus there (just customers). How this plays out and will be implemented is a big question, as the Constitution prohibits one state from "interfering" with commerce in another state. At a minimum, a consolidated and streamlined system (per my remarks above) will be needed, to

  • rationalize tax classes, so a merchant only has to decide what's what once
  • make it easy to figure out which set of rates to use, based on state and (optionally) ZIP Code
  • make it painless to report and remit collected taxes: one form, one payment, and you're done for the year, quarter, or month

I sent this to my congresscritters a while back, but haven't heard anything about it.
« Last Edit: August 18, 2018, 11:03:39 AM by Phil »