As soon as you land in the US you will be subject to taxation, and tax-related questions will increasingly become a consideration in many of your commercial decisions. Whilst it may have become a cliché that trading in the US is like trading in 50 separate markets, this couldn’t be more the case when thinking about tax.
US taxation can be roughly divided into:
Sales tax is a pass-through tax similar to VAT in the UK in that a merchant must collect this from customers and then pay this to the State Revenue Department or in some instances, a city or district department. Sales tax is payable in all but five States. These taxes vary from 0 to 16 per cent. Much like VAT, some goods and services are exempt but predictably this also varies between States. Most businesses offering “services” do not look to pay sales tax but where tangible goods or software are involved, you should expect to include sales tax as part of your pricing. You should contact the Revenue Department in any States you operate in or use a specialist advisor to understand what level of tax is applicable.
From companies we have spoken to, sales tax can be the most difficult to manage as there are so many variables.
Where many companies operate in multiple States, it is crucial to understand whether your economic connection to a State will trigger sales tax. If this connection is deemed substantial enough, a business is said to have “nexus” in a given State.
Simple triggers which could typically create a nexus include:
- Having a physical location in the State;
- Having resident employees in the State; and
- Having employees who regularly solicit business in the State.
More complex triggers which may create a nexus include:
- Having affiliates which may contribute traffic or sales to your business (click-through nexus);
- Having staff working from home in a State;
- Having a server farm in a State; and
- Holding inventory in a State.
Nexus can be enforced by State authorities and may involve a nexus questionnaire in order to scrutinise your judgement around whether nexus has been established. These checks may also be triggered by audits conducted on your suppliers or other businesses in your value chain.
The rate at which sales tax must be charged is also linked to whether a given State is an At Destination State or At Origin State. Most States are taxed at destination. This means that the location of the customer defines the tax rate to be paid rather than the location of the merchant.
If you are an ecommerce business looking to do business in the US, you are strongly advised to work out whether you have established click-through nexus or affiliate nexus. Given the ongoing legal challenges around the Amazon Tax, this could have an impact on many marketplace businesses.
For sales tax, liability is with the seller, so if you did not collect sufficient sales tax from your customers, you will still be expected to pay the full amount. As a result, this could result in a large cost to the business given the average sales tax rate of 10 per cent. You must also apply for a permit to collect sales tax ahead of collecting it. Failure to do so is deemed criminal fraud.
Many ecommerce companies choose to use automated solution to manage their sales tax such as TaxJar or Avalara which operates as a plug-in and will ensure that you are observing detailed sales tax rates and boundaries which may be as granular as city level.
Franchise tax is paid to the State and reflects the privilege to operate in a given geography. In addition to this, whichever State you are incorporated in will typically expect franchise tax. For example, if a company is incorporated in Delaware but has factories in Florida and New York, it would be expected to pay franchise tax in all three States. Failure to pay franchise tax can result in a business being prevented trading in a given State.
The calculation of franchise tax varies significantly between States. In Delaware it is linked to the total number of authorised shares up to a maximum cap of $180k, whereas in Alabama it is a graduated tax of 0.175 per cent. on income over $2.5 million up to a maximum cap of $15k.
A State level tax is paid on all tangible property and some States also include a tax on intangible property. This tax has increasingly shifted from being a State level tax to a district or city level.
Tax part three – Reporting, Team, & Key Challenges can he found here
Where to go next
- Check out our Dropbox for a range of additional resources;
- Sales tax;
- Sales tax agencies in each State;
- A great sales tax map with State by State information by TaxJar;
- Sales tax rates by State;
- What products are subject to Sales Tax?
- What is nexus?
- What is a click-through nexus?
- An example of the potential complexity in deciding when Sales Tax should be applied – excerpt from Connecticut Department of Revenue Services guidelines;
- Where does click-through nexus apply?
- Details of States with click through nexus;
- Introduction to sales tax for ecommerce;
- Origin and Destination tax States;
- Franchise Tax calculation methodology by State;
- Given the specialist and technical nature of these topics, speaking to accountants and advisors such as those below is strongly suggested:
- Eric Collins, Frank Hirth;
- Bradley Smallberg, Schissel Smallberg;
- Don Dismuke, Dixon Hughes Goodman
- Greg Capitalino, Kranz Associates; and
- Michael Hamilton, KPMG.
Thanks in particular to John and Kevin at Antidote, Keith at Graze, Katherine at Semafone, Eric at Frank Hirth, Bradley at Schissel Smallberg and Greg at Kranz Associates for your help in researching this topic.
This blog and those in this series are aimed at helping entrepreneurs learn about the US market, what it takes to start here, and ultimately what it takes to succeed here. Many of the topics (if not all) are complex and it is best to view these blogs as a basic introduction from which you the entrepreneur must triangulate to your own specific set of circumstances – and invariably it will be sensible and appropriate to seek third party professional advice.