Even though the state-wide base rate for California online sales tax is 7.25%, like with the rest of California’s complicated tax laws as they relate to online transactions, it's not that simple.
There are a few key points that every online business owner should know when it comes to California internet sales tax.
And this is where we come in…
In the past two years, e-commerce sales have skyrocketed, with global e-commerce as a percentage of retail sales rising as follows:
Analysts from Morgan Stanley project a steady growth within the next 5 years, with an estimated 27% increase in online retail sales by 2026.
As a result, businesses have found increasingly innovative ways to capitalize on the convenience of online shopping.
Many companies have transitioned to provide services remotely, updating and investing in attention-grabbing digital ads and heightened online presence.
However, these massive spikes in ecommerce have been met with a rollout of new legislation to address the regulation and taxing of online sellers.
The California Department of Tax and Fee Administration published several new guidelines on navigating online marketplaces, required licenses and permits, as well as how internet sales are taxed to build on the already-present California sales tax laws.
Before navigating the CA online sales tax requirements below, if you fall under any of the categories that classify you as exempt from California internet sales tax, your life is much easier.
While the list of exemptions from the CDTFA is somewhat comprehensive, it’s worth checking out if you fall under any of the following services:
Museums & public arts
Nonprofit, religious & educational
Manufactured housing & buildings
Once you know whether you're exempt or liable for CA online sales tax, you then need to understand the nexus.
As a new or prospective online business owner looking to attract customers in the third most populous state in the U.S., you may have reservations about what all this means for collecting sales tax in California.
The amount boils down to two California sales tax nexus elements for your business:
Physical presence nexus
The physical presence nexus, like the name suggests, occurs when a seller uses an office space or distribution center that is geographically located within the state of California.
Even for online sellers that conduct business primarily through digital means, having a physical place to store any physical items sold on the internet falls under the physical presence nexus and is, thus, affected by the state’s sales tax.
Even if your business does not have a physical location in California, its operations may still fall under the definition of an economic nexus.
In California, if you complete more than $500,000 worth of transactions to buyers located within the state, then you have satisfied the economic nexus element and the state will collect taxes on any of those sales from California customers.
Now you know the two nexus and how they work, we can apply the California online sales tax rate...
We now have to apply the appropriate online sales tax in California, especially if your business is registered outside the state of California.
There are two types of sales tax rates relevant to online sales:
Origin-based: Sales tax rate is collected based on where the seller is located.
Destination-based: Sales tax rate is based on where the buyer is located.
Keep in mind that the destination-based system can be extremely tricky to navigate. In contrast, as a seller in a destination-based system, you’ll have to sift through hundreds of different tax jurisdictions within other states and modify your taxes accordingly.
But which is California?
Fortunately, the CA online sales tax is the less confusing origin-based category of tax rates.
So, as an online seller based in California, the only tax rate you will have to worry about is California’s.
The issue is, like many of California’s laws, its origin-based tax rate is unique because it takes on a “modified” version of the origin-based sales tax. This means that remote sellers in California must charge a cumulative rate that takes into account the following local tax rates of the customer’s location:
In other words, California’s online sales tax, while mostly origin-based, is technically a hybrid of origin and destination-based.
Out of the four parts to the equation, three come from the home state (California state, county, and city). In California, these are combined and come out to 7.25%.
The last prong of the equation, the district tax rate, is a bit more complicated. These rates are tacked on to that 7.25% depending on where your customer is located.
To better understand how this would apply in a real-world situation, think about who you, a California online business owner, are selling to.
If you are based in Los Angeles and you sell a pair of shoes to a customer in San Francisco through your website, you would be taxed based on your own city (Los Angeles), county, or state applicable rate.
However, say you are based in Los Angeles and you sell a different pair of shoes to an online customer who is based in Utah. In this case, any district sales taxes will be based on Utah’s tax code. If that district rate is 3.5%, then the total tax rate for the transaction would be 10.75% (7.25 + 3.5).
If you’re a business, you’ll need to pay California use tax if you made a purchase from out-of-state sellers.
This only applies if both of the following are true:
Of course, there are exemptions to this rule, such as:
Food for human consumption
Electronic downloads (software, games & music) without physical storage media.
For the complete details on this, check out the CDTFA guidance on use tax.
In addition to sales taxes, online retailers may also be accountable for income taxes. Most recently, California’s Tax Board announced in a memorandum a reinterpretation of a federal law that had largely prevented out-of-state retailers from being taxed by the state of California.
For context, the federal law on the taxation of out of state businesses, Public Law 86-272, enacted in 1959, prohibits states and local governments from taxing the income of online businesses if their only activity within the state is soliciting sales of “tangible personal property.”
That said, given the rapid increase in online retail, California decided to broaden their interpretation of what constitutes “business activity” to include any interaction out of state businesses may have through a website or app that is accessed within the customer’s state.
To solidify its authority on this new interpretation, the California Tax Board cites a well-known U.S. Supreme Court ruling, South Dakota v. Wayfair, Inc., stating that while the case did not explicitly reference virtual contacts or online services, the court’s analysis in the Wayfair case is relevant to online business activities.
The Tax Board’s memorandum addresses different situations where online business operations may or may not be protected under Public Law 86-272.
The key difference typically lies in how much contact the online seller does with customers based in California.
For example, if the seller merely has a static website and no other services to sell its products, then the seller is shielded from income taxes.
Likewise, if the seller provides a frequently asked questions (FAQ) brochure or web page to the customer or simply places cookies on the customers’ computers for solicitation of sales, they are also shielded from being taxed.
According to the Tax Board, all of these activities are entirely “ancillary” or indirect to solicitation but do not constitute actual solicitation.
However, taking each of these hypothetical scenarios one step further removes the protection of the Public Law.
For example, instead of selling websites from a static website, an online seller offers remote repair and product upgrades to a customer in California. This would not be ancillary to solicitation, because this interaction is substantially more direct and interactive.
Similarly, if, instead of offering a list of frequently asked questions, a seller offers post-sale assistance through a live electronic chat, this would similarly rise to the level of business activity that would be susceptible to income taxes.
Depending on the type of business entity, the amount of income tax for e-commerce businesses will vary:
Corporation (other than a bank or financial services entity): 8.84%.
Banks and financial institutions: 10.84%.
S-corporation banks and financial entities: 3.5%.
Ultimately, while the laws on internet sales tax in California are complex and rapidly changing, there are ways to navigate the process to minimize the amount of taxes you’ll have to pay.
The key elements boil down to the:
type of nexus your business falls under
location of your business and its customers
types of business activities affected by income taxes
Lastly, if you are thinking about starting an ecommerce business in California, pay close attention to the type of business entity and the industry under which you want to register.
The sales tax online in California you’ll be liable for will be significantly more or less, depending on what you decide
What Next? Registering for Sales Tax Online in California
If you’re not exempt for California online sales tax and are aware of your physical and economic nexus, registration and obtaining a seller’s permit is simple:
You’ll then need to file your sales tax return & remit any payable tax accordingly. This can be either monthly, quarterly, every 6 months or annually, depending on your personal circumstance.
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