An Online Sales Tax Overview

Key Takeaways

• Online purchases are often subject to sales tax, collected by the seller.
• The 2018 Wayfair ruling let states tax sellers with economic nexus, not just physical presence.
• Nexus, physical or economic, is what creates a duty to collect tax in a state.
• When a seller doesn't collect, the buyer may owe an equivalent use tax.

How online sales tax works

Sales tax is a tax that states, and many local governments, charge on retail purchases, and online sales are increasingly no exception. The mechanics are the same as in a physical store: the seller collects the tax from the buyer at checkout and then remits it to the state. The buyer pays it, but the seller is responsible for collecting and forwarding it.

Online sales tax is complicated because the United States has thousands of taxing jurisdictions, each with its own rates and rules. A seller shipping nationwide may have to charge different rates depending on where the buyer lives, and the rules about *when* an out-of-state seller must collect at all have changed significantly in recent years.

For most of e-commerce's history, many online purchases effectively escaped sales tax because sellers without a physical presence in a state weren't required to collect it. That changed with a landmark 2018 Supreme Court decision, which reshaped the landscape and is the key to understanding today's rules, covered in the next section.

For consumers, the upshot is that sales tax now appears on far more online orders than it used to. For sellers, it means navigating a patchwork of state requirements. Either way, understanding how online sales tax works helps both sides avoid surprises. You can compute the tax on any purchase with the Sales Tax Calculator.

The Wayfair decision and economic nexus

The pivotal event in online sales tax was the 2018 Supreme Court case South Dakota v. Wayfair. Before it, states could generally only require sellers with a physical presence (a store, office, or warehouse) to collect sales tax. Online retailers without such a presence often weren't obligated to collect, giving them a price advantage over local brick-and-mortar stores, and leaving state and local sales-tax rates^[1] unevenly applied across the web.

The Wayfair ruling overturned that physical-presence rule. It held that states could require sellers to collect sales tax based on their economic activity in the state, even with no physical footprint there. This concept, known as economic nexus, fundamentally expanded which sellers states could reach, and it quickly reshaped how online sales tax works across the country.

In the wake of Wayfair, nearly every state with a sales tax adopted economic-nexus rules, typically setting a threshold of sales revenue or number of transactions into the state. Once an out-of-state seller crosses that threshold, it must register, collect, and remit that state's sales tax, regardless of where the seller is located.

The practical effect was sweeping. Online sellers that once collected tax in only one or two states suddenly faced potential obligations in dozens, and consumers saw sales tax added to many more of their online purchases. Economic nexus is why online sales tax is so much more pervasive than it was a decade ago.

What is nexus?

Nexus is the connection between a seller and a state that's sufficient to require the seller to collect that state's sales tax. It's the linchpin concept in all of sales tax: without nexus in a state, a seller generally has no duty to collect there; with it, the obligation kicks in. After Wayfair, nexus comes in two main forms.

Physical nexus is the traditional kind: a tangible connection to a state such as an office, a store, a warehouse, inventory stored there, or employees working there. Physical presence has always created a duty to collect that state's sales tax, and it remains a clear trigger. If you have people or property in a state, you almost certainly have nexus there.

Economic nexus is the post-Wayfair addition. It's created purely by economic activity, exceeding a state's threshold of sales or transactions, without any physical presence at all. The thresholds vary by state, but once a seller's sales into a state cross the line, economic nexus exists and the collection obligation follows, even if the seller has never set foot there.

The combination means a seller can owe sales tax in a state through either route. A business might have physical nexus in its home state and economic nexus in many others where its online sales are large enough. Mapping where you have each kind of nexus is the foundational step for any seller trying to stay compliant with sales tax obligations.

Use tax: the buyer's side

Sales tax has a lesser-known counterpart that falls on the buyer: use tax^[2]. When a seller doesn't collect sales tax on a taxable purchase, for instance, an out-of-state seller with no nexus in your state, you, the buyer, often still owe an equivalent use tax to your home state. Use tax is essentially the mirror image of sales tax.

The purpose of use tax is to close the loophole that would otherwise exist. Without it, people could dodge sales tax simply by buying from out-of-state sellers who don't collect. Use tax ensures that the tax is owed regardless of where you bought something, leveling the playing field between in-state and out-of-state purchases and protecting states' revenue.

In practice, use tax has long been widely under-reported by individuals, who often don't realize they owe it or simply don't pay. Many states include a line on their income-tax returns for reporting use tax on untaxed purchases, but compliance among consumers remains low. Wayfair has reduced the issue by pushing more collection onto sellers, but use tax still applies where sellers don't collect.

Businesses, however, are held to use tax much more rigorously. Companies are expected to track and remit use tax on taxable items they buy without paying sales tax, and they can be audited. So while individuals frequently overlook use tax, businesses ignore it at their peril: it's a real obligation that tax authorities actively enforce on the commercial side.

What sellers need to do

For online sellers, compliance starts with figuring out where they have nexus, both physical and economic. That means identifying every state where they have a physical presence and every state where their sales exceed the economic-nexus threshold. This nexus map determines where the seller is obligated to register, collect, and remit, and it's the essential first step.

Once nexus is established in a state, the seller must register with that state's tax authority, charge the correct sales tax rate on taxable sales to customers there (accounting for local rates as well as the state rate), and file returns and remit the collected tax on the required schedule. Each state has its own registration, rates, and filing cadence, which is what makes multistate compliance demanding.

Because doing this manually across many states is burdensome, many sellers turn to automated sales-tax software that calculates the right rate for each transaction and helps with filing. Others sell through large marketplaces that act as 'marketplace facilitators,' collecting and remitting sales tax on the seller's behalf under laws that most states have enacted. These tools have made compliance far more manageable.

The stakes are real: failing to collect and remit where required can leave a seller liable for the uncollected tax, plus penalties and interest. So even small online sellers should understand their nexus footprint and put a system in place (whether software, a marketplace facilitator, or professional help) to stay compliant as their sales grow into new states.

A worked example and common mistakes

Consider a small online store based in Texas that sells products nationwide. In a given year, it sells $150,000 worth of goods to customers in California. If that figure exceeds California's economic-nexus threshold, the store must register with California, collect California sales tax on its sales to California customers, and file returns there, even though it has no office, warehouse, or employees in the state.

Now suppose the same store sells only $5,000 into a different state with a $100,000 threshold. Below that threshold, it generally has no obligation to collect that state's sales tax, because it lacks both physical and economic nexus there. The example shows how a single seller can be required to collect in some states but not others, depending entirely on where its sales cross each state's line.

This patchwork is precisely where sellers and buyers go wrong. Sellers sometimes assume online sales are tax-free or ignore economic nexus until an audit forces the issue, while buyers forget they may owe use tax when a seller doesn't collect. Applying a single tax rate everywhere, rather than the correct state and local rate, is another frequent error.

Keep these common mistakes in mind:

• Assuming online sales are tax-free: the Wayfair ruling largely ended that.
• Ignoring economic nexus: you can owe tax in states you've never physically visited.
• Forgetting use tax: buyers may owe it when the seller doesn't collect.
• Applying one rate everywhere: rates vary by state and locality.

Frequently Asked Questions

Do I have to pay sales tax on online purchases?

Usually yes. Since the Wayfair ruling, most online sellers collect sales tax based on where you live, and if they don't, you may owe use tax to your state.

What is economic nexus?

A sales-tax obligation triggered by selling more than a state's threshold of sales or transactions there, even without any physical presence in the state.

What is use tax?

A tax the buyer owes their home state when a seller doesn't collect sales tax, the counterpart to sales tax, designed to close that gap.

Do small online sellers have to collect sales tax everywhere?

Only in states where they have nexus. Below a state's economic-nexus threshold, an out-of-state seller generally isn't required to collect there.

What is a marketplace facilitator?

A large platform that collects and remits sales tax on behalf of the sellers using it, under laws most states have enacted, simplifying compliance for those sellers.