How Does Sales Tax Work in E-commerce?

Sales tax in e-commerce is one of those topics that can confuse even the most experienced online sellers. Unlike traditional retail, where the rules are relatively straightforward, e-commerce sales often cross multiple states, countries, and tax jurisdictions. 

For online entrepreneurs in the UK, USA, or other global markets, understanding sales tax in e-commerce is no longer optional, it’s a requirement if you want to stay compliant and profitable.

In this article, I’ll walk you through exactly how sales tax works in the world of e-commerce, why it matters, and how you can manage it effectively.

What Is Sales Tax in E-commerce?

Sales tax in e-commerce refers to the tax collected on goods or services sold online, similar to how traditional stores charge VAT or GST. The difference is that e-commerce sellers often sell across regions, meaning they may be responsible for collecting and remitting sales tax in multiple jurisdictions.

For example, if you are selling from the UK to customers in the United States, you might be subject to U.S. sales tax rules depending on where your buyers live. In contrast, within the UK, VAT applies, and businesses must charge it on most goods and services once their annual turnover passes the threshold (£90,000 in 2025).

Why Is Sales Tax in E-commerce Complicated?

The complexity lies in nexus, a tax law concept that determines whether your business has a sufficient connection to a state or country to be requiring to collect sales tax there. In traditional retail, nexus was usually tied to physical presence, such as owning a store or warehouse.

However, since the 2018 U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc., economic nexus has become a standard. This means that if you generate a certain level of sales or transactions in a state, you may need to collect and remit tax—even if you have no physical location there.

In practice, this means that an e-commerce seller using platforms like Shopify, Amazon FBA, or Etsy may have multiple sales tax obligations, depending on the location of their customers.

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How Does Sales Tax Work in the UK and Europe?

For sellers in the UK and across Europe, Value Added Tax (VAT) takes the place of sales tax. The rules differ, but the principle remains the same: VAT is collected at the point of sale and remitted to tax authorities.

• In the UK, VAT applies at a standard rate of 20%.
• Small businesses with an annual turnover under the threshold can apply for VAT exemption.
• If you sell digital products to EU customers, you may need to register for the VAT One-Stop Shop (OSS) to simplify reporting across multiple countries.

For international e-commerce sellers shipping goods into the UK, customs duties and VAT may apply at the border, making compliance even more critical.

How Does Sales Tax Work in the USA for E-commerce?

In the United States, sales tax is handled at the state level, not the federal level. Each state has its own rules, rates, and thresholds.

For example:

• California has a statewide base rate of 7.25%, but local districts can impose additional rates.
• Texas applies a 6.25% base rate, plus up to 2% added by local jurisdictions.
• Delaware, Montana, New Hampshire, and Oregon do not have a sales tax at all.

This patchwork system means that U.S.-based e-commerce sellers or international sellers shipping into the U.S. must carefully track the location of their customers and determine whether they have triggered economic nexus.

Digital Products vs. Physical Products

One of the biggest questions for e-commerce entrepreneurs is whether digital products are taxed the same way as physical products. The answer depends on where you sell.

• In the UK, most digital services are subject to VAT.
• In the USA, some states tax digital products (e.g., New York taxes downloadable software), while others do not.
• Globally, countries like Australia and Canada also impose GST/HST on digital goods.

This is especially important for entrepreneurs selling courses, e-books, Lightroom presets, or software online. If you ignore these rules, you risk penalties or back taxes.

The Role of Marketplaces in Sales Tax Compliance

If you sell on large marketplaces like Amazon, eBay, or Etsy, you may get some relief. Many jurisdictions now require the marketplace facilitator to handle sales tax collection on behalf of sellers.

For example:

• Amazon automatically collects and remits sales tax in most U.S. states for third-party sellers.
• Etsy and eBay also withhold applicable taxes and remit them directly to the relevant authorities.

While this removes a significant burden, sellers must still keep records, ensure accurate reporting, and register in certain cases.

Common Mistakes E-commerce Sellers Make

From my experience working with e-commerce traders in the UK and abroad, the most common mistakes are:

1. Ignoring small thresholds: Many sellers think their revenue is too low to matter. However, some U.S. states have thresholds as low as $100,000 in sales or 200 transactions annually.
2. Assuming marketplaces cover everything: Even if Amazon or Shopify collects taxes, you may still need to file returns.
3. Not tracking digital sales: Sellers of digital goods often overlook the fact that VAT or GST may be applicable across borders.

Avoiding these mistakes will help you stay compliant and build trust with your customers.

Tools That Simplify Sales Tax in E-commerce

Fortunately, technology has made managing sales tax easier. Several tools integrate directly with e-commerce platforms to automate compliance:

• TaxJar: Provides automated tax calculations and reporting for U.S. sellers.
• Avalara: A global tax compliance tool that handles sales tax, VAT, and GST.
• Shopify Tax: For sellers using Shopify, this built-in feature automatically calculates sales tax at checkout.

Using these tools reduces errors, saves time, and ensures that you don’t overlook your tax responsibilities.

How Sales Tax Impacts Profitability

Understanding sales tax isn’t just about staying compliant—it directly affects your profit margins. If you fail to collect tax, you may end up paying it out of your own pocket later.

For example, if you sell a product for £100 and forget to add VAT, you’ll still owe £20 in tax to HMRC. That instantly eats into your margin. Similarly, in the U.S., failing to collect state sales tax can lead to fines, interest, and legal action.

Planning your pricing strategy around tax obligations ensures your margins remain healthy.

The Future of Sales Tax in E-commerce

The trend is clear; tax authorities worldwide are tightening their grip on e-commerce. With the rise of cross-border transactions and digital services, regulators are expanding their reach.

In 2025, we can expect:

• More countries are introducing digital services taxes.
• Better enforcement of cross-border VAT and GST rules.
• Marketplaces are playing an even bigger role in compliance.

As an e-commerce seller, staying proactive is key. If you understand how sales tax in e-commerce works today, you’ll be better prepared for the changes ahead.

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Final Thoughts

So, how does sales tax work in e-commerce? It depends on where you sell, what you sell, and how you sell it. For UK and EU sellers, VAT rules dominate, while U.S. sellers must navigate a patchwork of state-level sales tax laws. Add digital goods into the mix, and the complexity grows even further.

The good news is that with the right knowledge, tools, and planning, you can stay compliant and protect your profits. Whether you’re selling handmade crafts on Etsy, books on Amazon, or digital presets through your own website, sales tax must be part of your strategy.

As an e-commerce expert with a decade of experience, my advice is simple: don’t ignore sales tax. Embrace it, manage it, and treat it as a natural part of your business operations. That way, you’ll not only avoid headaches but also position yourself for sustainable growth in 2025 and beyond.