Since every state has substantial authority to make its own sales tax laws, the rates, rules and compliance requirements vary substantially from place to place. Within that web of complexity, there is, thankfully, one basic certainty. When goods are sold between two different states, the transaction is taxable based on the customer’s state. This principle is known as “destination-based” sales tax on inter-state sales.
However, there are also “intra-state” sales, where the seller and the customer are in the same state. How is the appropriate local tax determined in that situation? The answer, as is most often the case in sales tax, is “It depends.”
Do your clients know which states utilize “origin-based” approaches and which continue to apply “destination-based” principles? Are they ready to apply the correct local tax in both scenarios? Do you as a practitioner sufficiently understand this distinction to identify if your clients have a sourcing challenge?
What’s the big deal in understanding origin-based sales tax rules?
First and foremost, we can take a few issues off the table. As noted above, inter-state sales are always taxed based on the destination location. Likewise, “over-the-counter” sales (where the buyer and seller are in the exact same location) are taxed where they occur.
It's important to understand that most states apply destination-based sourcing to intra-state sales. However, the complexity lies with intra-state sales occurring in those states that apply origin-based sourcing.
By now, you may be asking, what states utilize origin-based sourcing? Well, no reason to keep that secret. The following states continue to apply origin-based sales tax rules:
- California (for county and city tax; district tax applies at destination)
- Pennsylvania (for the two localities that have sales tax)
Across the world, we are seeing a trend towards destination-based taxation. This means that sellers face an expanded responsibility to account for tax rates and rules everywhere their customers are located. The above list hasn’t changed that much over the last few years.
However, there is one notable exception with New Mexico. When New Mexico passed legislation allowing the state to collect tax from remote sellers, it included, as part of the bill, a switch from origin- to destination-based taxation for intra-state sales. This switch took effect on July 1, 2021.
The appeal of making that switch seems obvious. Now, in New Mexico, most all sellers of delivered goods are collecting tax based on their customers’ locations. There is one set of sourcing rules and it applies to everyone consistently, making both tax administration and compliance a little easier. Why aren't the other origin-based states following suit? The answer often lies in local politics.
From a local government funding perspective, which jurisdiction’s local tax applies to a sale can be an incredibly important question. In fact, cities and towns may sometimes lower their sales tax rates and offer other incentives to entice local businesses to locate within their communities. At the same time, sellers are not above gaming the system.
In Illinois, companies would sometimes set up “sales offices” in low tax jurisdictions, so as to gain a tax advantage over their competitors through origin-sourcing. This prompted Illinois to ultimately change its rules so that local tax is not based on the location that is authorized to make or accept offers but is based on a number of factors that establish the proper location of the seller as it relates to sales tax.
A similar debate is happening in Texas where the Comptroller attempted to promulgate a rule that suggests a seller’s place of business, for the purpose of sales tax sourcing, cannot include online order processing centers. That rule was challenged by the city of Round Rock, which hosts the headquarters of a major U.S. technology company. The Comptroller and Round Rock have agreed to delay the enforcement of this new rule while the matter plays out in the local court system.
Location, location, location. How is location determined in an origin-based state?
Lastly, it’s important to understand that not all origin-states use the same rules. There are a variety of mechanisms that can be used to determine the “location of the seller” and no two origin states are exactly the same.
This can be especially challenging for sellers who have multiple business locations within an origin-based state. Depending on the rules, the item may be taxed based on the location from which the item is shipped. Alternatively, the state may look to apply tax based on the business location that “received” the order, or possibly where the order was “accepted” by the seller.
Take Texas, for example. Publication 94-105 specifies the general rule that tax is applied based on the “seller’s place of business” and then adds:
A "place of business" is a store, office or other location operated by the seller to sell taxable items where sales personnel receive three or more orders during the calendar year. These orders must come from persons other than employees, independent contractors, and people affiliated with the seller.
How should accountants and bookkeepers be prepared to support clients with sales tax rules?
As a trusted advisor, you should come armed with the following questions and an understanding of how it may impact the sales tax compliance requirements of your clients:
1) Do your clients do business in any state with origin-based local taxation?
2) In which of those states do they have a physical location?
3) Do they have multiple physical locations in any of those states?
4) How are those physical locations involved in the sales process?
5) Do they have solutions in place that recognize the relative locations involved in a given sale and utilize those locations to determine the proper tax to apply?
It’s not easy to keep pace with ever-evolving sales tax rules and regulations, especially as origin and destination intricacies may change. But implementing an adaptable software, built to keep pace with those changes, can help your clients stay compliant.