The Factors Making U.S. Sales Taxes More Complicated
You have probably have heard: the U.S. sales tax system is so complicated, especially compared to our Canadian system. Why is that? The simplest reason is the number of government bodies who can levy sales taxes in the U.S. However, there are actually three dimensions if we dig deeper.
Dimension 1: Higher Number of States in the U.S.A.
The U.S.A. has a population of 331.9 million people (2021) while Canada has only 38.25 million people (2021). The U.S. population is roughly eight times larger than the Canadian one. The U.S. consists of 50 states and Washington D.C. while Canada has only 10 provinces and 3 territories. Again, the American system is larger.
Different state/provincial governments set up different tax rules, such as what products/services are subject to sales tax and, of course, how much the tax rates are. Therefore, there are 51 sets of rules in the U.S. compared to only 13 sets of rules in Canada. Furthermore, Alberta and 3 Canadian territories have the same set of rules, which is “GST only”. As a result, Canada is outnumbered by the ratio of 5 to1.
The greater number of states means a taxpayer needs to file sales tax returns to more tax offices. In addition, each department has a different name for the tax form and a different way to fill it out. It takes time to learn each state’s tax rules.
Dimension 2: More Levels of Government Involved in the U.S.A.
If the X-Axis is the number of states or provinces, then the U.S. also has a taller Y-Axis; in other words, more levels of local government who can levy sales taxes.
In Canada we have only two levels: the federal sales tax (GST) and the provincial sales tax (PST/QST/HST). Within the same province, the combined sales tax rate stays the same.
The U.S. doesn’t have a federal sales tax but many local governments within the state can levy sales taxes. This includes the counties, the cities, the school boards or the transit authorities. As a result, even within the same state, different tax rates can apply to different communities. This is the major reason why the U.S. sales tax is so complicated.
There are so many different municipal taxes in Illinois that the Illinoi Department of Revenue has to divide the state into 1,545 geographic areas for the purpose of calculating sales tax.
Dimension 3: Higher Filing Frequencies
In Canada, most small businesses file sales tax returns on an annual or quarterly basis; only big businesses need to file every month. In the U.S. most states will require a Canadian eCommerce business to file monthly. That’s at least 3 times more frequently than the Canadian system.
Not only the state Department of Revenue requires taxpayers to file more frequently, it also requires the taxpayers to file it sooner. In Canada, for the monthly filers, the due date is usually the end of the following month. In other words, Canadian businesses have about 30 days to prepare the tax return. In the U.S, the due date is the 20th of the following month. That short timeline is definitely adding a lot stresses to business owners, unless they have an automated system to help them with the sales tax filing and remittance.
This is the Z-Axis and the American way is more difficult as well.
Summary
So now we have all 3 dimensions. Let’s calculate the increase in complexity by multiplying all of them:
- X = 5 (number of states)
- Y = 3 (levels of government setting sales tax rate)
- Z = 3 (filing frequency)
That’s 5 * 3 * 3 = 45! Yes, we could say the U.S. sales tax is FORTY-FIVE times more complicated than the Canadian counterpart! Is there any wonder why many eCommerce merchants are stressed out by the sales tax in the U.S?
The Factors Making U.S. Sales Taxes Easier
We have to be fair. The sales taxes are not always more difficult in the U.S. There are three areas in which the U.S. sales tax system is actually simpler than the Canadian system. Therefore, the U.S. sales tax system is not really 45 times more complicated.
Factor 1: No Input Tax Credit (ITC)
Under the Canadian GST/HST system, most businesses need to collect GST/HST from their customers but are allowed to offset the final tax bill by the GST/HST paid to their suppliers. (The GST/HST paid is called Input Tax Credit, or ITC). In Canada, we need to enter the tax code on both sales and purchases.
In contrast, the U.S. sales tax only applies to the final party who consumes the product, or the consumers. Other businesses in the middle of the supply chain don’t have to collect sales taxes, nor can they claim sales taxes paid as a credit.
Factor 2: Physical Goods Only
The Canadian GST applies to both goods and services (that’s why we call it GST, Goods and Services Tax). In the U.S., services are usually exempt from sales tax; only physical goods are taxable. As a result, most service-based businesses in the States don’t have to deal with sales taxes at all.
Factor 3: Variances Among the States
Not all the States have a complicated sales tax system. Some states only have a single rate throughout the state; some states have no sales taxes at all.
What Should I Do as an eCommerce Entrepreneur?
First of all, relax! You won’t be immediately required to collect sales tax from all States. Every state has a threshold for mandatory registration and it takes time to reach the threshold. You should investigate your tax obligations (called “nexus” in the U.S.) one state by one state. Luckily, Shopify automatically monitors your tax liabilities and notify you when your store approaches the threshold. If you haven’t received any notification, you are probably all right.
However, if you have several stores on Shopify or you have other channels, such as Amazon or Esty, you may reach the threshold before Shopify realizes that. This is because Shopify doesn’t aggregate all sales data from your stores when determining nexus. You shall use more diligence if that’s the case.
Once you’re getting close to the registration threshold or you have other reasons to believe that you may have to collect U.S. sales tax, it’s time to contact us for a diagnostics. Always stay proactive and resolve the issues before they arise!
Presented by eComGuru Accounting Services Inc., U.S. sales tax expert for Canadian Shopify merchants.
Leave a Reply