The basics of selling digital goods and services to Americans
If you’ve ever sold goods or services in the United States, you know just how difficult it can be to navigate the country’s complex web of ever-changing tax laws, rates, and regulatory powers at the federal, state, and, in many cases, local levels, too. This has made tax compliance for foreign businesses transacting in the U.S. sometimes feel like an uphill battle.
As opposed to many other countries around the world, there is no uniform sales tax in the U.S. It varies state by state. Some states don’t even charge it at all. And making things even more complicated, there are also instances where sales tax rates can and will vary based on the types of goods sold. Therefore, it almost goes without saying that before you start selling goods and services in the U.S., be sure to do your due diligence upfront to understand the unique sales tax regulations that apply to every state in which you do business.
Given the complexity of the American sales tax landscape — and its many “exceptions to the rule” — it’s virtually impossible to become a U.S. sales tax pro overnight. Even Americans themselves will tell you the same. That’s why we’ve created this quick guide to help you understand the ins and outs of sales tax laws in the U.S. Our goal here is to help you avoid the most common pitfalls that can lead to non-compliance, which, in the long run, can be more problematic for your business than simply taking the time to get it right from the very start.
Economic nexus laws by state
as of December 16, 2019
According to Avalara
A very brief history of sales tax regulation in the U.S.
For years, businesses having no physical presence in a given state, where existing state-level tax laws applied, could not be forced to collect or pay sales tax on customer transactions made via mail, phone, or internet. Not only did this eliminate a potentially large tax burden on vendors and retailers, but it also gave consumers a financial incentive to purchase goods and services remotely, even if the savings amounted to only a few mere dollars.
The vast majority of these transactions involved the sale of physical goods (i.e. books, CD’s, furniture, clothes, etc.) that were packed, weighed, shipped, and delivered to physical addresses. Fast forward to the present day, however, where the pendulum has swung in the digital direction: many goods and services can now be fulfilled in real-time and at a massive scale digitally. It was only a matter of time until cross-state sales tax laws caught up.
Then, in 2018, the United States Supreme Court, in the case of South Dakota vs. Wayfair, changed this dynamic entirely. In an effort to help states avoid losing billions of dollars in potential tax revenue, while still protecting the interests of small businesses, the Court’s decision declared that out-of-state vendors doing either $100,000 in total sales or fulfilling at least 200 different transactions shipped to addresses within any given state would be required to collect and pay that state’s sales tax.
While this set a baseline for how this law could be implemented and enforced across the U.S., it should come as no surprise that it has its state-level variations as well. This is referred to as sales tax or economic nexus and defined as “the connection between a seller and a state that requires the seller to register, collect, and remit sales tax on sales made in the state. Certain business activities, such as having a physical presence in a jurisdiction or reaching a sales threshold may establish nexus with the state.”
>> Here’s a great resource that clearly outlines sales tax nexus laws across all 50 states. <<
Selling digital goods and services in the U.S. today
As an ISV, resellers can do a lot to help you achieve your revenue goals, increase your market share, and tap new channels of customers. The key is educating your resellers on how a SaaS model works in their favor—and then providing incentives that motivate them to sell your product. Here are three incentive strategies to consider:
Renewal commissions. This is a common arrangement within indirect SaaS sales and one that encourages resellers to help maintain the user relationship. In addition to an upfront commission, vendors may offer resellers a percentage of renewals for the first and second generation. An automated reconciliation system can help ensure that generational commissions don’t cause problems with your accounting.
Upfront commissions. Offering resellers an upfront commission on a SaaS sale can sweeten the deal, especially if they're in the process of transitioning to more subscription sales. Upfront commissions are typically paid once the first invoice has been received versus waiting for subscription payments from the customer.
Lifetime value incentives. ISVs can also get creative, creating incentive structures that reward resellers based on the anticipated lifetime value of the customer. Keep in mind that doing so requires strong analytics on the vendor side, and a good amount of trust between the ISV and reseller.
SIMPLIFY YOUR RESELLER MANAGEMENT
Although this case above set a new precedent, whereby states could now impose sales tax on non-local businesses at their own discretion, the application of this law on digital goods and services has been anything but uniform across all 50 states.
For starters, there are only 27 states that currently tax digital products, including:
- Online data processing services
- Downloadable software
- Downloadable books (i.e. Books and Kindle)
- Downloadable music and digital audio files (i.e. iTunes and podcasts)
- Downloadable movies ad digital video (i.e. Netflix and Amazon Prime)
- Other downloadable electronic goods
Now, to add another layer of complexity to this, the definition of what constitutes digital goods and services varies across states, regardless of whether they impose sales tax on those products or not. These definitions are roughly broken into the following three categories:
- States that leverage a custom definition: These states use the general categories above as a starting point but have customized those categories in their own, unique ways. These states include: Arkansas, Connecticut, Georgia, Illinois, Iowa, Kansas, Louisiana, Maine, Michigan, Minnesota, Mississippi, North Carolina, Ohio, Oklahoma, Texas and West Virginia.
- States that leverage a standard definition: These states use a single definition for digital goods and services as defined by the Streamlined Sales Tax Project (SSTP). These states include: Indiana, Kentucky, Nebraska, New Jersey, Nevada, North Dakota, Rhode Island, Tennessee, Vermont, Washington, Wisconsin and Wyoming.
- States that do not define digital goods in any way: Alabama, Arizona, California, Colorado, Florida, Hawaii, Idaho, Maryland, Massachusetts, Missouri, New Mexico, New York, Pennsylvania, South Carolina, South Dakota, Utah, Virginia, Washington DC.
How High Are Sales Taxes in Your State ?
Combined State & Average Local Sales Tax Rates, July 1 2019
According to Tax Foundation
All these rules apply to both businesses operating within the U.S. and foreign businesses interested in selling to American consumers. It’s also worth noting — not that we’re trying to make this even more tedious than it already is — that the U.S. is home to more than 12,000 sales tax jurisdictions. This alone makes selling in the U.S. incredibly complicated for virtually any business, whether they have a physical presence in any of the 50 states or not.
Now, if you love the idea and challenge of untangling this complex web of sales tax laws all on your own, you can integrate your online sales efforts with third-party partners like Avalara, Tax Jar, Tax Cloud, or Drake Software. These are viable options for businesses that prefer taking a hands-on approach for collecting and paying state-by-state sales tax. We don’t necessarily recommend this, as this can leave room for error and other unexpected surprises.
For the rest of you who would rather leave the “heavy lifting” to the professionals — and for good reason — Nexway can serve as your Merchant of Record, a trusted partner able to handle all aspects of tax compliance and other international regulatory laws on your behalf, in the U.S. and in over 140 countries around the world.
We have years of experience serving as the online presence for global brands and businesses of all shapes and sizes. We know how to work through the complexities of international tax laws and calculate accurate taxes and duties on all the products you sell. This includes automatically adjusting fees on the product page, shopping cart, and checkout flow based on the country or state in which a consumer is shopping to ensure that all relevant taxes and duties are reflected correctly. We are also experts in A/B testing to help you identify what display configurations increase conversion the most in every market you operate. In short, we focus on the details, so you can focus on growing your business.
To learn more about how Nexway can help you navigate the intricacies of U.S. sales tax regulations (and beyond!), contact our Team today.
The Nexway Team