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Sales tax, which is a consumption tax levied on the sale of goods and services, is an important source of revenue for governments at the state and local levels.
While, in many instances, businesses are required to charge and collect sales tax from consumers, knowing when and how to charge sales tax can get complex. This is especially true in today’s environment of ever-evolving sales tax regulations.
Understanding the basic rules of sales and having the right tools and solutions in place can help businesses better navigate the complexities.
What is sales tax?
Sales tax is a tax imposed on the sale of goods and services. It is typically a percentage of the purchase price and is added to the final cost of the product or service. The rate of sales tax varies by location, with different states and localities having their own rates. In the United States, it is not a federal tax, but rather a state and local tax. Sales tax revenue is used to fund various government programs and services such as education, transportation, and healthcare.
Also, it’s a form of indirect tax, meaning that it is a tax that can be shifted to others.
Sales tax refers to when it’s added to the sales price of a good or service and is then charged by the retailer to the end consumer. The retailer then remits the retail sale’s collected tax to the government. Tax jurisdictions only receive tax revenue when a sale is made to the end consumer.
However, when buying supplies or materials that will be resold, businesses can issue resale certificates to sellers and are not liable for sales tax.
Sales tax varies by state
As noted earlier, sales tax can be an important source of revenue for governments at the state and local levels. This is a point where it can get confusing for businesses as local sales tax varies by state.
In fact, there are five states — Delaware, Montana, New Hampshire, Alaska, and Oregon — that do not levy a general state sales tax.
For the majority of states that do apply sales tax, the sales tax rate can vary within state lines. There are 38 states that allow local governments to impose their own general sales taxes, in addition to the state general sales tax. Alaska is an exception, as the state does not levy a statewide general sales tax but does allow local governments to impose their own general tax.
To further illustrate how sales tax rates can vary within state lines, consider the state of California. In Annapolis in Sonoma County the tax rate 8.5 percent. Meanwhile, Antelope in Sacramento County applies a tax rate of 7.75 percent. In Ashland, which is in Alameda County, the tax rate jumps up to 10.25 percent.
It should be noted that, oftentimes, items that are considered “essentials,” such as groceries or utilities, have a lower or no tax rate as a way to provide low-income tax relief.
Examples of sales tax
As previously stated, sales tax varies by state and even local governments can impose their own general sales taxes. This means that consumers can spend more or less money on the same item or service depending on the geographic location where they made the purchase.
Examples of items and goods that are commonly subject to sales tax include, but are not limited to:
Furniture
Restaurant food and drink
Cosmetics and toiletries
Computers
Giftware
Toys
Antiques
Clothing
Construction services
Metered parking
Hair cuts
Dry cleaning
How do you calculate sales tax?
When calculating the sales tax on a taxable item, the cost of the item is multiplied by the tax rate. To further illustrate, consider the following example:
In a state where the sales tax rate is six percent, the sales tax on a $10 book is 60 cents. The cost of the book to the consumer, after tax, is $10.60. The sales tax base is the total amount paid for all the goods and services subject to the tax. This is known as an ad valorem tax, which is a tax based on the price of the item sold.
What is nexus?
If you look up the word “nexus” in the dictionary you’ll see it is defined as a connection or link. Furthermore, the word comes from nectere, a Latin verb meaning “to bind.” Nexus refers to the connection between a business and a state or jurisdiction. Further fueling the complex sales tax nexus, which is the tie between a seller and a state that requires the seller to collect and remit sales tax to the state. Physical presence and economic nexus are the most common forms of nexus.
Physical presence nexus
Physical presence nexus refers to the type of nexus that is established when a business has a physical presence in a state. This could be because they have a physical location in the state, such as an office or warehouse, or because they have employees or make a certain amount of sales within the state.
In the context of sales tax and use tax, physical presence nexus is one of the most common ways that a business can be subject to tax laws in a particular state. However, it’s important to note that not all states require physical presence to establish nexus, and there are other types of nexus that can also apply.
Physical presence nexus can vary depending on the state, but usually physical nexus can be established by having, for instance, a manufacturing facility, warehouse, affiliate, or employee in a state.
In Washington state, for example, physical presence is a nexus standard that requires only more than the slightest presence. Such nexus-setting activities include, but are not limited to:
Having an employee working in the state.
Having real or tangible personal property in the state.
Having a stock of goods in Washington, including inventory held by a marketplace facilitator (i.e., a payment processing service provider, fulfillment service provider, etc.) or another third-party representative.
Providing services in Washington, such as accepting returns or providing product training, either by employees or other representatives.
Soliciting sales in Washington through employees or other representatives.
Meanwhile, in Michigan, physical presence can be created by the following:
Employees, agents, brokers, representatives, subcontractors, etc. working on behalf of the entity within Michigan.
The presence of property such as goods, offices, real estate, vehicles, etc. physically within Michigan.
When employees and representatives perform activities that can range from soliciting sales to providing services for any length of time.
Economic nexus
Then there’s economic nexus. As the name suggests, economic nexus is a sales tax nexus that is created when an economic activity occurs. Economic nexus refers to the type of nexus that is established based on a business’s economic activity within a state, rather than its physical presence. This means that even if a business does not have a physical location or employees in a state, they may still be required to collect and remit sales tax if they meet certain economic thresholds.
These thresholds are typically based on the number of sales or transactions that a business has within the state over a certain period of time. Economic nexus has become increasingly common in recent years, as more states have adopted laws requiring out-of-state businesses to collect and remit sales tax based on their economic activity within the state.
States usually have economic nexus thresholds in place and businesses may be required to register in that state and collect sales tax if they exceed the economic nexus threshold. This is regardless of where the business, warehouses, or employees are located.
The South Dakota v. Wayfair Supreme Court ruling marked a significant shift in tax law precedent and established a new definition for nexus.
Before Wayfair, nexus depended on a company’s “physical presence” in the state. However, as a result of the rulings, if a business sells goods in any state — even if they do not have a physical presence in that state (economic nexus) and the transaction is online only — it may now be obligated to register in that state and collect sales tax.
This means that, with nexus decided by different thresholds in different jurisdictions, businesses must follow nexus laws across all 50 states, rather than only those in which they have physical operations.
For companies that do business digitally, indirect tax software tools are especially important to ensure compliance with complex economic nexus laws and with states’ various sales tax requirements.
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What is excise tax?
Excise taxes are taxes that are imposed on specific goods, like alcohol, tobacco, and fuel, and are levied at the federal, state, and local levels. It is typically included in the price of the product and is paid by the manufacturer, importer, or retailer, who then passes the cost on to the consumer. Excise taxes are often used by governments to discourage the consumption or use of certain products, and the revenue generated from these taxes is usually earmarked for specific purposes, such as funding transportation infrastructure or public health initiatives.
Excise taxes can vary widely between different jurisdictions and can be subject to frequent changes, so it is important for businesses and individuals to stay informed and comply with applicable regulations.
Businesses often pay the excise tax and then pass the cost of the excise tax onto the buyer. They are typically not itemized on consumer receipts, which makes them less visible to the consumer compared with general sales taxes.
Excise taxes are often applied on a per-unit basis versus as a percentage of the purchase price like general sales tax. For example, excise taxes on fuel are levied in cents per gallon. And cigarette excise taxes are calculated in cents per pack.
What is VAT tax?
VAT tax, or value-added tax, is a type of consumption tax that is levied on the value added to goods and services at each stage of production and distribution. Unlike a sales tax, which is only applied at the final point of sale, VAT is applied at each stage of the supply chain and is ultimately paid by the end consumer.
VAT is used by many countries around the world as a way to generate revenue for the government and to shift the tax burden away from income and towards consumption. The rate of VAT can vary depending on the country and the type of goods or services being sold, and there are often exemptions and special rules for certain industries or types of transactions. VAT is a complex but important tax to understand for businesses and consumers alike.
So, among the differences between a VAT tax and sales tax, a VAT tax is collected a little bit at a time at each stage of the production process versus being collected in one lump sum when the final sale in the supply chain is reached, like general sales tax.
Manufacturers, distributors, suppliers, and retailers all collect VAT on taxable sales. Furthermore, manufacturers, distributors, suppliers, retailers, and end consumers all pay VAT on their purchases. To receive a credit for the VAT paid on their tax return, businesses must track and document the VAT they pay on purchases.
Similar to sales tax, the seller is the one responsible for collecting the tax and remitting it to the appropriate tax authority.
Sales tax vs. use tax
The main difference between sales tax and use tax is in the point of collection. Sales tax is collected by the seller at the time of the sale, while use tax is paid by the buyer when they use or consume a product or service purchased from an out-of-state vendor. Sales tax can be typically imposed on all sales made within a jurisdiction, while use tax is only imposed on purchases made from out-of-state vendors.
Use tax is intended to ensure that all purchases are subject to taxation regardless of whether they were made in-state or out-of-state. Both sales tax and use tax are important sources of revenue for state and local governments and are used to fund public services and infrastructure projects.
Sales tax and use tax, while both a form of indirect tax and a tax paid to the government on the purchases of goods or services, there are some notable differences between the two. Unlike sales tax, use tax refers to the tax imposed on the taxable goods and services that were not taxed at the point of sale.
Use tax most often occurs when a consumer orders goods from outside of the state (such as online) and the retailer (not having nexus, or presence, in the consumer’s state) does not have to charge sales tax on the purchase.
Ensuring compliance and keeping pace with changes related to sales tax can quickly become complicated for businesses. That’s why having the right tools and resources in place is essential to effectively navigate the complexities and better serve clients.
Summary
In conclusion, sales tax is a type of tax that is imposed on the sale of goods and services within a jurisdiction. It is typically collected by the seller and remitted to the state or local government, and the rate of sales tax can vary depending on the location and the type of product being sold. Sales tax is an important source of revenue for state and local governments, and it is used to fund a wide range of public services and infrastructure projects.
For businesses, understanding and complying with sales tax regulations is essential to avoid penalties and fines, and to maintain good relationships with customers. By staying informed and working with trusted advisors, businesses and individuals can navigate the complexities of sales tax and ensure that they remain in compliance with state and local tax laws.
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Learn the differences between sales tax and use tax
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