Time for everyone’s favorite topic: taxes!
Still with us? If you’ve just launched your new business and you’re ready to start making sales, you need to know whether you have to collect sales tax.
Knowing whether you need to charge sales tax is—no surprise!—pretty complex. Especially when sales tax laws make for dry reading and can differ from state to state.
Still, understanding your tax obligations is crucial for small businesses and retailers—and it doesn’t need to be quite as baffling as you might think.
Do I have to collect sales tax?
The answer to this question depends on various factors, like your business location and the type of goods or services you sell.
Much of the sales tax collection puzzle hinges on that second piece: what your business offers. Tax obligations differ between physical goods, services, and digital products.
If you sell physical goods, sales tax collection is more than likely required. There are only five states that don’t have a statewide sales tax:
- New Hampshire
If your business location is in one of the other 45 states and you sell physical goods, you’ll need to collect sales tax from customers. However, there are also exceptions based on the type of physical goods you sell.
Each state has its own unique list of taxable goods. In most cases, this can be found on your State Department’s website under the Department of Revenue (sometimes called the “Department of Taxation”).
Here are some common (but not universal) exceptions to state sales taxes:
- Food, particularly from grocery stores to be prepared in the home
- Prescription drugs
- Agricultural products, like seeds and animal food
- Products for resale, raw materials, or inventory that will be resold
These exceptions provide a general guideline, but you’ll need to thoroughly research your state’s individual tax laws, since they can be complex and detailed. For example, in Texas, “baked goods” such as doughnuts, bagels, and bread are exempt from sales tax. But, the law explicitly excludes items like pretzels, sandwiches, or pizza from that “baked goods” classification. It’s complicated out there for a humble baker!
For a long time, sales tax applied only to something called tangible personal property. TPP is a fancy term for a good that you can physically touch.
But because the line between goods and services has become increasingly blurred, many states do apply sales tax to services as well.
This is another area where your business location will play a large role. Although there are five states that don’t have sales tax, there are also four states where sales tax is applied to services by default:
- New Mexico
- South Dakota
- West Virginia
The remaining 41 states might require business owners to charge sales tax on services (although there are still plenty that don’t). Taxes will depend on the type of service they offer. Generally, services fall into one of the following six buckets:
Amusement/recreation: Providing admission to recreational activities, theme parks, and other forms of entertainment and enjoyment.
- Example: A small concert venue that showcases local music acts.
Business services: Providing services for other companies, rather than individual consumers.
- Example: An extermination service that specializes in eliminating pests from office buildings.
Personal services: Providing services to individual customers. Service-based businesses in this category typically fall into the personal grooming category.
- Example: A mom-and-pop barbershop.
Professional services: Providing services that require specialized expertise, training, and oftentimes a license.
- Example: A law firm specializing in intellectual property law.
Services to TPP: Providing services to improve or fix TPP.
- Example: A mechanic with their own small engine repair shop.
Services to real property: Providing services to improve or repair land or buildings.
- Example: A custodial company that cleans and completes small repairs for a variety of commercial buildings.
States will tax those categories differently or even not at all. For example, Alabama charges sales tax only for amusement and recreation services, while Virginia charges sales tax only for services to TPP.
Most charitable and religious organizations are exempt from sales tax. Check with an accountant or tax professional in your state to confirm whether your service-based business has a sales tax exemption.
In this digital age, sales tax laws get even trickier when talking about online sales of digital products. By this, we mean an intangible product that’s purchased and downloaded or accessed online.
This area is continuing to evolve, and several states haven’t yet clearly stated how sales tax is charged to digital products. Some states treat them exactly like tangible personal property, while others treat them as tax exempt.
Additionally, some states distinguish between software and digital products. Others tax differently depending on how the product is accessed (whether it’s downloaded to a personal device or accessed online).
There’s a lot of gray area here, but TaxJar has a helpful state-by-state breakdown of how digital products are taxed.
How much sales tax do I need to collect?
If you’re selling goods in one of the 45 states with sales tax, you’re responsible for collecting and filing these taxes with your state government. This is a moving target, as the state tax rates fluctuate monthly.
State tax rates range from 0% all the way up to 7.25%. To determine the exact tax rate for a specific address in your state, this sales tax calculator looks up sales tax rates by address.
You might also be responsible for local sales tax. This is based on the city, county, or jurisdiction that you or your customer resides in. How do you know if you should charge based on the location of your business or your customer? That depends on whether you operate in an origin-based state or a destination-based state:
- Origin-based state: Sales tax rate is based on where your business is located
- Destination-based state: Sales tax rate is based on where your buyer is located (provided you ship the item directly to their home)
Origin-based states include Arizona, California (except district taxes are based on destination), Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Virginia. All other states are destination-based, making it the more prevalent category by far.
What about out-of-state sales tax?
Considering there are 50 different states (each with their own complex tax laws), it’s no surprise that business owners are daunted by out-of-state sales taxes.
In general, out-of-state sellers (also called remote sellers) won’t need to collect taxes from their customers unless they have a nexus within that state. Literally translated as a “connection,” a nexus means that your business meets one or more of the following criteria:
- Your business has a physical location in that state.
- Some of your employees reside in and work in that state.
- Your business has property (including intangible property like trademarks, copyrights, and patents) in that state.
- Your employees regularly seek or perform business in that state (for example, you have an active salesperson in that state).
So, many online sellers can ship goods out of state without charging or collecting sales tax provided they don’t have a physical presence in that state.
However, a more recent court decision made this more complicated for sellers who are making a lot of sales to a certain state. Consider the South Dakota v. Wayfair decision in 2018,. The Supreme Court ruled that states can require businesses with no physical presence but substantial business in a state to charge sales tax. The ruling defined a “considerable amount of business” as more than 200 transactions or $100,000 worth of goods sold to that state.
There’s one more term you might come across as you research your state tax rates: use tax. This is a type of excise tax. The IRS defines use tax as a tax imposed on the sale of specific goods or services, or on certain uses. Use tax is often used for out-of-state purchases, but is generally not the seller’s responsibility. In most cases, the purchaser should declare and file this tax in their home state.
How do you handle the paperwork and filing?
Unfortunately, collecting sales tax isn’t quite as easy as tacking on an extra charge to your goods or services.
To legally collect sales tax, you need to get a seller’s permit or license from your state. In some states, you will obtain a seller’s permit on a state level. In others, you’ll also be required to obtain a license from your city, county, or jurisdiction.
To apply for a sales tax permit, visit your State Department’s website. Look for the “sales tax” or “sellers permit” (or license) application under the Department of Revenue. You’ll use that application to submit some basic information about your business, including your location, business type, and types of taxes you intend to collect.
As you collect sales tax, you’ll be required to remit it with a sales tax return to your state government on a regular basis. This may be required monthly, quarterly, or annually. How often you remit taxes will depend on how many sales you’re making, as higher sales volume means more frequent filing.
When your state gives you your seller’s permit, they should also let you know your filing frequency. At that same time, it’s wise to ask about your sales tax due date. Most states expect business owners to file their sales tax return by the 20th of the month following the taxable period, but this date can vary.
Don’t figure out sales tax on your own
It’s normal if the idea of managing your sales taxes is making you chew your nails. Figuring out all of the sales tax laws and details is intimidating.
The good news is that there are qualified tax professionals and accountants who can help you through this process without sweaty palms. Look for a tax accountant in your area or connect with other business owners to see if they can recommend someone.
Additionally, accounting software like QuickBooks will track and manage your sales tax information, reporting, and filing. QuickBooks automatically does all of the sales tax calculations, so you don’t have to worry about getting them wrong.
Sales tax will likely never be something you look forward to. But having the right help and resources in your corner will make the process a lot more painless.
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