- Sales tax for brick-and-mortar businesses
- Sales tax for online businesses
- Sales tax exemptions
What is sales tax?Sales tax is a retail point-of-purchase charge that is paid by the customer, then passed on to the state or local taxing authority by the seller. Imagine buying a pack of gum from a convenience store. When you buy the gum, the sales tax is lumped into your total. The convenience store must now take the tax collected and pay it to the taxing authority.In the United States, there is no federal-level sales tax. Instead, it’s set at the local or state level, and the amount of tax varies from state to state. For instance, sales tax on a pack of gum would be different in Louisiana than in Florida or Georgia. Currently, there are only five states in the United States that do not levy state-level sales tax:
- New Hampshire
What is sales tax comprised of?The tax itself is imposed primarily by state governments. However, county and local governments can supplement the state’s tax amount with their own local tax. For example, let’s take a look at Intuit’s U.S. headquarters, located in Mountain View, California. Mountain View is part of Santa Clara County. As of writing this, the city’s total sales tax is 9.00%, which is broken down as follows:
- California’s State Tax of 6.25%
- Santa Clara County’s Cumulative Taxes of 2.75%
What is sales tax comprised of?Businesses assess the tax on purchases, collect it, and then pass it on to the appropriate agency within the required timeframe. Timeframes, or “filing frequencies,” can vary, but they typically occur either monthly or quarterly. In many states, businesses must have a permit to collect sales tax. The Small Business Administration (SBA) offers a breakdown of sales tax permit requirements by state. You can also check with your state’s department of revenue.
Sales tax for brick-and-mortar businessesGenerally speaking, any retail sale may be subject to sales tax. This means that if you own a small business that sells clothing, any time you sell an article of clothing to a retail customer, that customer is responsible for paying the necessary sales tax amount on the retail price. As the business owner, you’re responsible for keeping track of the tax you collect so that you can report it to your local and state governments.There are, of course, exceptions to this rule. Notably, sales tax is only applicable at the final point-of-sale from a business to a consumer. So sales tax can only be levied against the final retail sale of an item, not against a wholesale transaction.For example, if you’re a clothing manufacturer who sells shirts to a local retail store, the retail store is not required to pay sales tax when they purchase the shirts from you. But when the retail store turns around and sells that clothing to a customer, the retail store must collect sales tax and pay it to the appropriate agency.As a brick-and-mortar business, it’s also important to note where you’re responsible for paying sales tax. A state cannot demand that a company register to collect sales tax unless the business has a physical presence in that state. Having a physical presence in a state is known as a “nexus,” which is defined as:
- An office, store, or other facility located in the state
- A business where the business owner or their employees take orders, perform services, or otherwise do business within the state’s borders
Sales tax for online businessesOnline transactions are trickier when it comes to sales tax collection for small businesses, especially in this past year. There are three main reasons this area is so challenging.
- Wherever you have established nexus (the connection between a seller and a state), you must collect sales tax on sales made to residents in that state.For example, let’s say that you operate an online store and have office space in New York. Because of the physical store location, any sales you make to anyone within New York State are subject to New York’s state sales tax rate.
- Many states that charge sales tax also have a complementary “use” tax law. In these states, you have to pay use tax on any purchases made online or through a catalog where sales tax was not charged. The use tax rate is often the same as the sales tax rate, but the requirement to report use tax is on the purchaser, not the seller.
- In June 2018, the U.S. Supreme Court upheld a South Dakota law which reversed the long-standing physical presence requirement for nexus. Now, sellers with an economic presence in states where they sell online have nexus and are required to collect sales tax and pay it to the state. Many of the states’ new laws mirror the law upheld in Wayfair and impose this collection requirement when sellers have $100,000 in sales or 200 transactions into a state.
Sales tax exemptionsThere are exemptions to sales tax laws. Here are the most common exemptions where sales tax won’t apply.
Items necessary for daily lifeSome states recognize there are certain products that people must purchase to survive. Therefore, things like food, clothing, and prescription medicines are often exempt from state sales tax. Some states may not completely exempt these items but may instead assess a lower tax rate.
Selling to tax-exempt buyersAccording to U.S. law, states cannot charge sales tax on any sales made to the federal government or its agencies. In most states, this is also true for sales made to the state and its agencies, or to cities, counties, or local jurisdictions. Non-profit, religious, and educational organizations are also exempt from sales tax in a lot of states.
Items used for public goodSome states exempt items that it believes encourages activities that contribute to the public good, such as industrial development or pollution control.For example, in many states where farming is the primary industry, the sale of products or equipment used to produce food for human or animal consumption are sales tax-exempt. This may also be the case with the sale of manufacturing equipment. Raw materials purchased by a business in order to manufacture or make something else that will be sold may also be exempt.
Frequency of saleFor the most part, states offer tax exemptions on sales that are defined as occasional, casual, or isolated. A primary example of this is your neighborhood’s annual garage sale. If the sale is not made in the ordinary course of business, it may not be subject to sales tax.But if a person is in the business of making regular, taxable retail sales, (i.e., sales that resemble a regular company or sole proprietorship) then the state may deny the exemption to him or her. The ordinary course of business typically stands for anything that is “usual” or “necessary.”
Exclusions based on the relationship between the buyer and sellerIf you sell your products to another company who then resells the products to a consumer, you are not responsible for assessing a sales tax on the original sale. However, if you are a business that sells products or services that another company will use themselves and not resell, then those sales are typically subject to sales tax.Take, for instance, a company who manufacturers industrial light fixtures. If they sell lights to a home improvement store for the purpose of selling to consumers, the manufacturer does not have to collect sales tax from the home improvement store. However, if that home improvement store instead purchases the light fixtures to hang in their stores, then the manufacturer would be required to collect sales tax because the home improvement store becomes the final consumer.
Sales and use tax audits?Sales and use tax audits can be overwhelming for small business owners, requiring them to invest a lot of time and money. Each state has different requirements for what may trigger a sales and use tax audit. For instance, states may choose companies based on certain factors, like the company’s:
- Sales volume
- Complexity of its tax returns