Refunds and your sales tax compliance

It seems like a simple part of selling online. You sell an item to a customer, they decide for whatever reason to return it, and you give them a refund. Simple.

Except when sales tax becomes involved. 

One in every five …

What are the odds your online company will have to deal with returns and make refunds? Pretty likely: At least one in every five products ordered online are returned, versus maybe one in 10 bought in a brick-and-mortar store. Clothing and shoes are the most returned product category, followed by electronics. One in four products come back just because a buyer changed their mind.

But do you get back the already charged state or local sales tax on returned products? Yes, you have to refund the right amount of that, too. Here is where it gets complicated:

• How much did you charge the customer in sales tax?
• Where was the sale made (and did it incur sales tax based on destination or origin)?
• When was the return made?
• What was returned?
• What extra charges were involved in the return?
• Have you already filed your sales tax return based on the original amount of sales tax charged?

General sales tax refund rules, specific states

Almost all the states (and the District of Columbia) that impose a sales tax generally allow retailers to deduct or exclude sales tax refunds for returned goods from taxable sales. Some states – Connecticut, Massachusetts, Michigan, Rhode Island and D.C., for example – impose a time limit, usually 90 days but up to 120 days or even 180 days in Michigan and Massachusetts for certain items. If you refund the full price, then you’re entitled to take a credit with the state for the full sales tax you returned to the customer.

To do so if you’ve already filed your sales tax return, you’ll have to amend the return – more complicated in some states than in others. In Texas, for example, you take a credit on a future return using

The full sales tax refund treatment for returns can be straightforward compared with those of partial refunds. A New York case demonstrated this when a merchant asked the state tax department for an opinion on how much sales tax may be subject to a refund or credit when a customer returns merchandise but receives less than the original purchase price as a refund.

How much of the sales tax goes back to the customer and how much is the subject of a state tax credit for the merchant? This merchant’s new return policy allowed customers only a partial refund after 60 days, a reflection of the value of the merchandise (fashionable clothing) decreasing proportionately to the passage of time after the initial sale.

“Since the sales tax initially collected is based upon the amount of the original transaction that gave the customer the use and /or possession of the merchandise, the customer is entitled to a refund of sales tax only to the extent the original transaction is undone,” New York opined. “If [the merchant] retains a percentage of the original sales price, the sales tax collected on that retained amount must be remitted to the State and is not subject to a refund or credit.”

At issue too in the New York case was yet another wrinkle in returns, refunds and sales tax: a restocking charge.

Restocking is generally considered a service and as such wouldn’t incur sales tax in many states. In California, for instance, “to qualify for a returned merchandise deduction, the retailer must refund the full retail selling price less any restocking charges. The charge for restocking returned merchandise is a charge for service and is not subject to tax. The retailer must refund the full sales tax reimbursement, not merely the tax on the net amount of the credit after the restocking charge.”

These are just a few examples of how sales tax refunds can be complicated and open your company to cost and risk, especially if you try to track and calculate refund-related sales tax issues manually.

If you want to explore further how to effectively handle sales tax in the context of returns and refunds, check out our resources and insights. Discover the best practices to streamline this process and ensure compliance with state regulations. Start learning today!

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