What e-retailers need to know about the online sales tax

Web retailers that have never collected sales tax outside their home states face the very real prospect of a whole new way of doing business online.

Paul Demery

Web retailers that have never collected sales tax outside their home states face the very real prospect of a whole new way of doing business online.

Shedding light on how to succeed in e-commerce comes naturally to Corey Frons, who launched his own e-commerce site more than a decade ago and over the years has managed several sites selling jewelry, consumer electronics, and health and beauty products. And as CEO of eBulb Inc. since the fall of 2011, he has steered web-only BulbAmerica.com as its sales have surged from less than $5 million in 2010 to nearly $13 million in 2012. That puts the retailer at No. 604 among the top 1,000 e-retailers ranked by Internet Retailer. The web, Frons says, never ceases to amaze. "It's great to see people willing to order something as simple as lighting online," he says. "The fact that we could grow so much in 2011 and 2012 is huge."

Frons has used his broad web retailing expertise to perfect BulbAmerica's operations and how it serves customers. From building a base of some 35,000 types of unique bulbs on a highly customized web site running on eBay Inc.'s Magento software, to perfecting the retailer's packaging materials and shipping processes, BulbAmerica has strived to keep its customers happy while running a tight ship. "It's all a balancing act, operating on a tightrope," he says confidently.

But one thing that troubles him is the prospect of having to collect sales tax across nearly the entire country. Like many online merchants, BulbAmerica now collects sales tax in only one or a few states. That's all BulbAmerica and other web-only retailers are required to do by existing law, which leaves them free from collecting sales tax in most of the 45 states, plus the District of Columbia, where sales tax is charged. Current federal law exempts retailers from collecting tax in states where they have no physical presence, or nexus in legal terms, such as stores and distribution centers.

That could well change in the next year or so. A bill that the U.S. Senate has already approved, the Marketplace Fairness Act, would authorize those 45 states and the District of Columbia to force more online retailers to collect sales tax, whether or not they have nexus. That has Frons and many other web merchants worried. "It's a new headache I'd rather not have," Frons says.

And what a headache, he and other web retailers say. Being forced to collect tax, they contend, will remove what has been one of their key advantages over retail chains—the ability to promote tax-free products—while the process of collecting sales tax for more than 10,000 taxing jurisdictions and remitting it to states will greatly add to their operating costs. And with tax collection duties come possible audits by state revenue departments, another time-consuming process that retailers fear could lead to fines if they make a mistake calculating and remitting tax.

"Unlike Wal-Mart, Amazon.com and other big retailers, we do not have armies of accountants and tax attorneys to deal with costly and time-consuming audits from every state," says Ben Kirshner, CEO of Coffee Serv Inc., which operates CoffeeForLess.com, No. 495 in the Internet Retailer 2013 Top 500 Guide with $19 million in 2012 web sales. A tax expert with connections to state revenue departments and the major retailers' tax departments says privately that while major retailers tend to have large tax and accounting staffs, they usually have only a few people dedicated to sales tax matters.

Kirshner and other retailers say they're no strangers to costly tax audits, and that makes the idea of possibly having to contend with even more of them mind-boggling. "In our state we have experienced audits that took us many days to deal with and cost us thousands of dollars in accounting and bookkeeping time," Kirshner says. Adds Kevin Hickey, CEO of Online Stores Inc.: "A state tax auditor was on site for four weeks and took up hundreds of hours of accounting and I.T. time, running reports and printing thousands of invoices. We had to jump through hoops, document everything—it was a nightmare."

The biggest unknown for e-retailers at this stage, however, may be to what degree charging sales tax will scare away online customers unaccustomed to seeing it at checkout. Many online retailers play up the message "No Sales Tax" or something similar on their home pages and product pages, but that will have to come to an abrupt end for many of these retailers if the Marketplace Fairness bill becomes law. The bill passed the Senate in May by a vote of 69 to 27 and is now in the House. The Senate version exempts retailers with less than $1 million in sales across all states where they have no physical presence.

"When an online shopper is putting in a credit card number, she wants to see trust logos, shipping information, etcetera," Frons says. "If all of a sudden, instead of seeing a total price of $100 and free shipping, she now sees an $8 tax added on, she's likely to think twice about it. I think the bounce rate in checkout pages will rise. It will be bad for e-commerce." Statewide sales tax rates, including local rates, ranged from 4.35% in Hawaii to 9.44% in Tennessee as of January 1, for a nationwide average of 7.0%, according to the Tax Foundation, an independent research organization.

The actual impact of collecting tax on online sales, however, is difficult to determine. A 2011 study of more than 34,000 online consumers by Forrester Research Inc. and Bizrate Insights found that only 8% of online shoppers say sales tax by itself makes a big difference in whether they buy online. But an April survey of 3,196 online consumers by comScore Inc. found that 54% said they'd be "less likely" to buy online with sales tax, while 42% said sales tax would have no effect on their online shopping.

Some retailers say they've considered how they might change promotional offers to counteract any negative effect of new sales tax charges. But e-retailers interviewed by Internet Retailer say they could not offer extra discounts for long at a time when they're already competing on price and offers like free shipping. "It will have to be business as usual," Kirshner says.

E-retailers could benefit in some respects by the passage of the federal sales tax law, by allowing them to take advantage of services they might have shunned to avoid collecting sales tax. Eric Best, CEO of Mercent Corp., which helps online retailers sell through e-marketplaces like Amazon.com and eBay.com, says many of his clients have discussed how they might start using services, such as third-party warehousing and fulfillment services and affiliate networks that can create nexus for users.

"We expect our clients will become much more aggressive at adding Fulfillment by Amazon, Fulfillment by Sears, Google Express Shopping and affiliate networks," Best says. "Merchants that don't add these services could be left behind."

For larger web merchants like off-price mass merchant Overstock.com Inc., with more than $1 billion in sales, the removal of nexus as a basis for collecting sales tax will open the door to building more distribution facilities across the United States. "We're careful about where we create a physical presence today, because we don't want to create a tax nexus," executive chairman Jonathan Johnson says. "But if you have to collect tax everywhere, then it can make more sense to locate warehouses in other states so shipping times and costs are shorter and lower." He declines to comment more about potential plans for new distribution warehouses by Overstock, which for now operates distribution centers in Kentucky near Cincinnati, and its home base of Salt Lake City.

Amazon.com Inc., meanwhile, has been expanding its number of distribution centers across the United States, with more than 40 in place and plans to add another five by year-end, an Amazon spokeswoman says. It collects sales tax in eight states, and has agreements to begin collecting tax in other states including New Jersey, Texas and California.

Aside from the impact sales tax may have on customer activity, however, is the chore and overall cost of collecting sales tax. This includes mapping all of a retailer's products to the right tax classifications for each state, filing monthly tax returns to each state, and remitting to each state the collected tax revenue, also monthly. "I don't think tax collection will decrease sales," Kirshner says, "but the cost to comply with the law will crush us."

Kirshner estimates that the first year of complying with a nationwide sales tax collection law will cost his company $20,000 or more to modify product databases to associate each product with the proper tax codes, train employees how to use new tax software to comply with each state's tax code, and set up new tax collection software and integrate it with his online shopping cart, order management system and accounting software.

Scott Peterson, a former state tax official who is director of government affairs at Avalara Inc., a provider of sales tax software, says such costs tend to be highest for retailers with highly customized e-commerce technology built in-house.

Joshua Wood, Co-Founder of Ozbo.com, a web-only retailer selling products ranging from auto parts to groceries to pet supplies and No. 450 in the 2013 Top 500 Guide, says retailers with broad product ranges face a particularly large challenge. "The effect of a sales tax depends on what you're selling and your number of SKUs," he says. "We have many categories, including food, clothing and equine products, so we'll have to organize all our data into what's taxable and what's not taxable in each state. We could spend $40,000 to $50,000 in the first year between software and labor."

Even the largest web retailers also feel the pain, says Johnson of Overstock, ranked No. 31 in the 2013 Top 500 Guide. Overstock deployed sales tax collection software in early 2011 from Sabrix Inc., whose software has since been folded into the OneSource Indirect Tax software line from Thomson Reuters. Overstock currently collects sales tax in its home state of Utah, as well as Kentucky, Colorado, Oklahoma and North Carolina.

Johnson won't say what price Overstock paid for the licensed software, but noted it was "not significant" when compared with the extensive resources required to make it work. "We threw 20 to 30 software developers on it, and we spent 9,412 person-hours to complete the installation and testing of the software," he says. Thomson Reuters says that retailers generally take between two and six months to deploy its sales tax software, using personnel from multiple teams including information technology departments and tax managers. It says it also offers an Internet-hosted version that cuts up to 20% off the implementation time.

One of the most difficult and time-consuming parts of implementing sales tax software is connecting each product category, and in some cases individual product SKUs, to the correct classification in a tax software application for each state. That's largely a matter of pulling down data menus for each product category as well as for some individual SKUs.

Once a retailer connects its product database in that way, the software, at least theoretically, is designed to handle the rest. Tax software vendors say they are set up to get constant updates of sales tax rules from each state with a sales tax law, covering all the local jurisdictions within each state.

Robb McCarter, director of e-commerce at e-retailer Edwin Watts Golf Shops LLC, who has been involved with e-commerce technology since the late 1990s, says sales tax software's functionality and accuracy has improved over the past several years. "There can always be a fly in the ointment anywhere, but we trust the vendors to keep their software up to date," he says. The retailer uses sales tax software from Avalara to manage sales tax collection in its physical stores, while relying on CyberSource Corp. software in its UniteU e-commerce platform for managing sales tax collection on its e-commerce site.

Edwin Watts currently collects sales tax for online orders in the 16 states where it operates its chain of 88 golf shops. But as the Florida-based retailer opens stores in additional states, as it recently did in Utah, it has not found it difficult to extend its tax collection software to automatically calculate sales tax for transactions, McCarter says. "No matter what state we have a store in, to collect sales tax we just punch in that city and county tax code," he says.

Sales tax software from most vendors that provide it—including Avalara, FedTax, Exactor, AccurateTax and CCH—also include services for remitting tax revenue on behalf of retailers to states and for preparing tax return forms that show the amount of tax collected and remitted. The software companies say they're also prepared to represent any client retailers that get audited for tax collection by states, to prove that their software collected and remitted the correct amounts. "As long as a retailer gives us accurate sales transaction data and doesn't commit fraud by trying to hide sales volumes, the retailer is off the hook in audits," says Charles Collins, vice president of legal affairs for Taxware LLC.

The cost of sales tax software can range widely. Avalara says its software starts at "a few hundred dollars" per year for small retailers. CCH, a unit of Wolters Kluwer N.V., offers a web-hosted Sales Tax SaaS product for a startup fee ranging from about $2,000 to $5,000, depending on a retailer's size, plus an annual subscription fee ranging from about $3,000 to about $20,000, depending on a retailer's transaction volume, says product manager Cory Barwick. The software typically takes 30 to 60 days to get up and running, he adds.

CCH has about 200 clients running that software, including some doing as little as about $100,000 a year in sales, Barwick says, adding that the software is designed to handle retailers with sales of up to $50 million or more. CCH also offers licensed software suitable for larger companies, he adds.

Under the Marketplace Fairness Act, retailers may have to pay none of that cost—or only a part of it, depending on what's in any bill that finally passes.

E-retailers unaccustomed to widespread sales tax collection, meanwhile, have at least a few more months to plan how sales tax will fit into their way of doing business.