As a small business owner one of the toughest areas to truly understand and implement correctly is sales tax. With the proliferation of e-commerce, it’s become even more complicated for online retailers to understand what is and what is not taxable, which agency the collected sales tax should go to or even if sales tax should be collected at all.
In this article, we’ll break down this tricky subject into three areas:
- Sales Tax for Brick-and-Mortar Businesses
- Sales Tax for Online Businesses
- Sales Tax Exceptions
First, let’s define sales tax and how it is collected.
What Is Sales Tax?
Sales tax is a retail point-of-purchase charge that is paid by the purchaser and remitted by the seller to the applicable state and/or local tax collection agency. Currently, Alaska, Delaware, Montana, New Hampshire and Oregon are the only states that do not levy sales taxes.
What Is It Comprised of?
The tax itself is imposed solely by state governments, but county and local governments can supplement the state’s tax amount with their own add-on taxes. For example, let’s take Intuit’s U.S. headquarters, located in Mountain View, California. The city is located in Santa Clara County. As of this publication date, the city’s local sales tax is 8.75%, which is broken down as follows:
Since the city of Mountain View doesn’t impose an additional tax, the total rate is 8.75%. This is the rate a customer will pay on retail transactions in Mountain View.
How Is It Collected?
Businesses assess the tax on purchases, collect it and then pass it onto the appropriate agency within the required timeframe, typically monthly or quarterly. In many states, in order for a business to collect sales tax, it must have a sales tax permit. The Small Business Administration (SBA) offers a breakdown of sales tax permit requirements by state.
Sales Tax for Brick-and-Mortar Businesses
Generally speaking, any retail sale is subject to sales tax. This means that if you own a small business that sells widgets, any time you sell a widget to a retail customer, that customer is responsible for paying the necessary sales tax on the retail price. As the business owner, you are responsible for keeping track of the tax collected so that it can be reported to your state government.
There are of course exceptions to this rule. Notably, if your buyer’s intent is to resell the item, then he or she is not responsible for paying sales tax. In general, sales tax can only be levied against the final retail sale of an item, not a wholesale transaction.
So, if your widget company sells a pallet of widgets to a hardware store, the hardware store is not required to pay you sales tax on the purchase. When the hardware store sells the widgets to its customers, however, it will be required to collect sales tax.
Location, Location, Nexus?
As a brick-and-mortar business, it’s also important to note where you are responsible for paying sales tax. A state cannot simply demand that a business register for or collect sales tax unless the business has a physical presence in that state. This is known as a “nexus,” which is defined as:
- An office, store or other facility located in the state, or
- The business owner or its employees take orders, perform services or otherwise do business within the state’s borders
In short, if you have any type of physical presence in the state, an argument can be made that you have established a nexus, and thus are subject to the state’s sales tax laws.
Sales Tax for Online Businesses
This is one of the trickier aspects of sales tax collection for small businesses. One key aspect for online retailers is this: wherever you are located (or have a nexus), you must collect sales tax on sales made to residents of that state.
For example, let’s say that you operate an online store and have office space in New York. Any sales you make to anyone within New York are subject to New York’s state sales tax. Any sales made to people outside of New York are not subject to sales tax.
Obviously, this is a pretty major loophole in state tax law, especially since online shopping is such big business. As a result, many states that charge sales tax also have a complementary “use” tax law that requires you to pay your state the equivalent state tax on any purchases made online or through a catalog. This “use” tax can be assessed against businesses that purchase goods and services online and individual consumers who purchase goods and services online.
Sales Tax Exceptions
There are exceptions to every rule and sales tax is no different. Here are the most common exceptions where a sales tax won’t apply.
1. Items Necessary for Daily Life
Some states recognize that there are certain products that people must purchase in order to survive. Therefore, items like food, clothing and prescription medicines are often exempt from the state sales tax. In some states, they are not exempted entirely, but a lower tax rate is assessed.
2. Selling to Tax-Exempt Buyers
According to federal 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.
3. Items Used for Public Good
Some states exempt items that it believes encourage 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 is normally also true of sale of machinery or equipment used in manufacturing. Raw materials purchased by a business with the intent to manufacture or make something else that will be sold may also be exempt.
4. Frequency of Sale
For the most part, states exempt any sales from tax that are defined as occasional, casual or isolated. A primary example of this is your neighborhood’s annual garage sale.
But if a person is in the business of making regular, taxable retail sales, (i.e. one that resembles a regular business or sole proprietorship) then the state may deny the exemption to him or her. The inverse can also be true, as some states allow exemptions to retailers if the sale is not made in the regular course of their business.
5. Exemptions Based on Relationship Between Buyer and Seller
If you primarily sell your products to another business that in turn sells the product to a consumer, you are not responsible for assessing a sales tax on the original purchase. However, if you are a business that sells products or services for use by other businesses, than those sales typically are subject to sales tax.
Understanding the intricacies of sales tax law is not easy. As a small business owner, it’s imperative that you are aware of your responsibilities to avoid any type of penalty for failure to pay the appropriate sales tax. Use the information above as a guide, and consult an accountant with sales tax experience for more detailed requirements.
To dive deeper into small business taxes, read our article on 10 things that can cause a tax audit.