A Complete Guide to Sales Tax
No matter how large or small your business is, sales tax is an important and sometimes frustrating topic to master. Even if you only operate in one state, the myriad statewide and local rates and regulations can create challenges to staying compliant, and those are only magnified when you’re selling in multiple states. Of course, staying compliant is essential to the continued health and success of your business, and it is possible if you have the right information and tools at your disposal.
- What Is Sales Tax?
- States Without Sales Tax
- When Sales Tax Applies
- Understanding Nexus
- Challenges to Quill and the Evolution of Economic Nexus
- Sales Tax Rates
- Product Classification
- Exemption Certificates
- Understanding Sourcing
- Collection and Remittance
- Streamlined Sales and Use Tax Agreement
- Filing Returns and Making Payments
- Sales Tax Holidays
- Sales Tax In Your Online Store
- International Sales Tax
What Is Sales Tax?
Unless you live in one of the few states that doesn’t have one, you’ve likely been paying sales tax your whole life, but you may never have stopped to think about what it actually is. Essentially, sales tax is a tax on consumption, and as such, it’s typically levied on the end consumer of a good or service. However, it’s the responsibility of the retailer selling that good or service to calculate the sales tax at the appropriate rate, charge sales tax to (and collect it from) the customer at the point of sale, and then remit it to the state.
States Without Sales Tax
There are five states that don’t have a general statewide sales tax, although they do sometimes impose taxes on specific items or allow local jurisdictions to levy their own. Those states are Alaska, Oregon, New Hampshire, Delaware and Montana (commonly referred to as the NOMAD states, from their initials). Of course, because sales tax is such a major source of revenue for states, those that don’t impose sales tax compensate in other ways.
For instance, New Hampshire has property taxes that are among the nation’s highest, and taxes on the extraction of natural resources combined with income taxes help cover the gap in Montana. Oregon has one of the highest income tax rates in the country, which means that, even though its residents don’t pay sales tax, they do shoulder quite a heavy tax burden.
When Sales Tax Applies
Since sales tax is only supposed to apply to the final sale of an item, goods purchased for the production of something to be sold later, or simply to be resold directly themselves, are not subject to sales tax. In order to avoid paying the sales tax, however, the purchaser must obtain a retail exemption certificate. The process for doing this may vary somewhat from state to state, but the underlying structure of the tax laws are generally quite similar.
Some states have variations on sales tax that are actually taxes on the seller, but that get passed on to the consumer, and so are effectively the same as a traditional sales tax. Arizona, for example, has a transaction privilege tax that is levied on all businesses making retail sales in the state. Similarly, Hawaii has a gross receipts tax that applies to all sales made in the state, but that is also technically charged to the seller rather than the purchaser.
While in most instances these variations function the same way a traditional sales tax does, they can have implications for online and remote sales in particular. Online sellers, of course, always have to be mindful of their sales tax responsibility in the same way brick-and-mortar stores do, but the key to knowing whether you are required to collect and remit sales tax for purchases made by customers in a given state is understanding each state’s sales tax nexus requirements.
Quill Corp v. North Dakota
One of the major obstacles to the imposition of sales tax on online sales made by out-of-state retailers is the Supreme Court decision handed down in the 1992 case of Quill Corp v North Dakota. This case began with a decision by North Dakota to try and collect sales tax from the Quill Corporation, which was an office supply company based out-of-state. The basis for claiming the right to tax their sales, the state argued, was the fact that some North Dakota customers were using Quill’s proprietary software accessed through use of a physical disc to place their orders, and so that software constituted a physical presence in the state and created a nexus.
The Supreme Court rejected that argument, stating that an actual physical presence was required to establish nexus, and that asking out-of-state retailers to navigate the myriad state and local tax rates and regulations placed an undue burden on those businesses. It did, however, specifically point to the ability of Congress to pass legislation redefining the requirements for nexus, allowing them to effectively overrule the decision to rectify the situation.
On the most basic level, the term nexus as it applies to sales tax describes a substantial connection between the business doing the selling and the state the purchaser resides in. This connection is what gives the state in question the right to compel the collection and remittance of the tax by the business. According to most federal guidelines, that connection must be physical in some way, and most states have described it in their sales tax laws in roughly similar terms.
Although specific details can vary, sales tax nexus can be triggered in most states by:
- The presence of a physical store or office in the state
- Goods stored in a warehouse in the state
- The presence of employees or independent contractors who work within the state for a minimum number of days per year
- The delivery of goods to customers in the state in a vehicle owned by the seller
- The sale of goods or services to customers in a state with economic nexus laws, if your sales reach or exceed the state’s thresholds
- Having certain relations with someone advertising on your behalf, such as affiliates or multi-level marketing businesses
For many smaller online retailers, these conditions won’t be met in many states. However, using fulfillment by Amazon for purchases can lead to a nexus condition for a seller if there is an Amazon warehouse in the state where their goods are stored.
Amazon itself has, after fighting against paying local sales tax for several years, begun voluntarily collecting and remitting sales tax on purchases by customers in every state that has one, whether or not the company actually has a physical presence there. It’s also important to note that if you sell through multiple channels and meet the nexus conditions through one of those channels, it creates a nexus for you on sales you make through all channels.
That decision by one of the largest online retailers reflects a growing recognition that states are working hard to find a way to collect sales tax on online purchases. That’s largely because sales tax revenue is something that states depend on to pay for any number of programs and services, and so losing that revenue to untaxed online sales has become a major problem in many areas as those sales have grown to represent a larger and larger percentage of retail sales as a whole.
Indiana’s Economic Nexus Law
One example of an economic nexus law is one currently in effect in Indiana. It states that a seller is required to collect and remit sales tax to the state if they make sales of tangible personal property to customers in Indiana the gross receipts of which total $100,000 or more in a year, or that are made in 200 or more discrete transaction. These purchases may result in physical products being delivered into the state or digital products that are transferred electronically to customers in the state.
Challenges to Quill and the Evolution of Economic Nexus
Despite several false starts, Congress was never able to pass any type of legislation related to out-of-state and online retailers, and with the rise of the internet and online selling, the issue of revenue lost to out-of-state sellers has only gotten worse for states. In 2016, the state of South Dakota sent notices to its four largest out-of-state retailers demanding that they register to collect and remit sales tax. Three refused, citing the Quill decision, and South Dakota sued. The lawsuit eventually made its way to the Supreme Court, where it became known as the South Dakota v. Wayfair, Inc. case. In a 5-4 decision, the Supreme Court overturned the Quill decision.
This didn’t directly pave the way for states to begin forcing out-of-state sellers to collect and remit sales tax, however. It simply opened the door to that possibility, as there was no longer a national case preventing it. Since then, many states have implemented what has become known as economic nexus laws. These laws generally require that retailers who make a certain dollar amount in sales to customers within the state, and/or a minimum number of transactions to those customers, begin to collect sales tax.
This trend has made it important for retailers to know these economic nexus thresholds, whether they meet/exceed them, and when they become responsible for collecting that sales tax and filing returns within each state that has economic nexus laws.
Sales Tax Rates
For any given location, there is generally a single sales tax rate for most goods. That sales tax rate is the sum of multiple rates by different taxing authorities that the location is subject to. For example, the state may charge 5%, the county 1%, the city another 1%, and a local shopping district its own 0.5%. Add those up and you would have a total sales tax rate of 7.5% for the majority of goods sold at that location.
Sometimes, specific types of products have different tax rates, or they may be completely exempt from sales tax, at that same location. Groceries, medical supplies, and feminine products are some examples. See the next section about Product Classification for additional details.
If you need to find the total sales tax rate, as well as all individual rates, for a given address, you can use our sales tax calculator.
The sales tax laws in most states specify which items are taxable and which are not. For instance, most states don’t tax groceries, but they do tax prepared foods. Both prescription and over-the-counter medicines are exempted in some states, as are certain types of medical equipment and supplies. Specific products are then assigned to these broad categories to make it clear exactly what is taxable and at what rate.
In general, states will have one tax rate that applies to anything covered under sales tax law at the state level, and so everything taxed will be taxed at that rate. There are a few exceptions to that rule, though. For instance, some states do tax groceries, but do so at a lower rate than other taxable items including prepared foods. One example of this is Arkansas, where groceries are taxed at a statewide rate of 3%, while the regular sales tax rate for the state is 6.5%.
Other states leave some classes of items exempt as long as the total price of each individual item is below a certain threshold. That’s true of clothing in Massachusetts, as these products are exempt as long as they cost less than $175 each. For items costing over $175, only the excess amount is taxed. Likewise, clothing under $110 is exempt from New York City and New York State sales tax, but items over that amount are considered luxury goods and are taxed.
These are only a few examples. There are numerous tax classes (or product classifications) across the states that have sales tax. Retailers need to accurately identify not only what they sell, but also how and to whom they are selling. Professional guidance from a sales tax professional is often recommended.
Because the sales tax rules can be so specific in their classification of taxable and non-taxable items, and because those classifications are often slightly different from one state to the next, it’s important to make sure all of the products in your online shop are classified properly. This is far from the only reason to institute these classifications, as they are useful for marketing purposes, as well as for improving your customers’ overall shopping experience.
Some buyers are exempt from sales tax on otherwise taxable purchases. This may be because they have a non-profit status, such as a church or school, where the law exempts them from sales tax. Or, they may have a resale certificate for certain items they purchase at wholesale to then re-sale to their customers, where they will collect sales tax from the end buyer. Resale and Exemption Certificates are issued by state governments and can be used to request a sales tax exemption status from your vendor. If you accept sales tax exemption certificates, you should do your due diligence to authenticate the certificate and to request a new one when the existing one is nearing its expiration date.
California’s Modified Origin Sourcing
California is also a mostly origin-based state, but there are some exceptions. In California sales taxes to be collected and remitted at the state, county and city level are origin-based, while taxes at the district level are calculated based on the destination of the shipment.
Just knowing what’s taxable and what’s not in a particular state isn’t always enough to determine the appropriate sales tax rate to charge. That’s because, particularly when you’re shipping an item to another part of a state, you need to know what that state’s regulations are concerning sourcing.
Sourcing refers to the point at which sales tax is to be assessed. The two primary types of sourcing are origin or destination-based, although there are exceptions to that rule as well.
In this context, sourcing refers to whether the tax rate at the product’s final destination should be applied, or whether it’s the rate at the origin of the shipment that’s in effect. While the state-wide rate for each state is always the same, most states allow local jurisdictions to impose their own sales taxes as well. These can often include county, city, school district, and other special jurisdictions, so that the applicable rate at a given location is the total of all of those rates combined with the state rate.
Check this list of origins, TN is in the process of changing to destination and TX is actually a modified where it’s destination-based then origin up to the 8.25 limit.
The 11 origin-based states are Arizona, California, Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Texas, Utah and Virginia. If you are based in one of these states and make a sale to a customer in that state, you will charge them the rate in effect at your business location or wherever the shipment originated. (Texas is actually quite a bit more complicated, something we’re not going to go into here.)
If you are an out-of-state retailer selling into one of these states in which you also have nexus, however, the rate you charge will be the rate in effect at the delivery destination. This is because the shipment did not originate within the state, and so no applicable origin-based rate exists.
Collection and Remittance
Before you begin collecting sales tax in a given state, you’ll have to register with that state and receive a permit. The process for registering can vary somewhat from one state to the next, although most now allow you to register online and tend to require similar categories of information.
When you register, you’ll usually be assigned a filing frequency by the state based on your estimated total tax liability per month. That will determine when you file your sales tax return and remit your payment to the state, and some common filing frequencies are monthly, quarterly or annually.
Over time, your filing frequency may change due to changes in your sales volume. While some states allow you to judge for yourself when to file your tax based on your estimated tax liability, other states only allow changes in filing frequency to be initiated by the department responsible for collecting the payments. It is helpful to pay attention to sales tax due dates, in order to avoid penalties and interest for late filings.
Streamlined Sales and Use Tax Agreement
Particularly if you sell to customers nationwide, or at least in a large number of states, you may want to take advantage of the registration process available through the Streamlined Sales and Use Tax Agreement (SSUTA) website. There are 24 full member states that are party to this agreement, and you can register for a sales tax permit for all of them at once through the SSUTA. These member states are Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming.
Filing Returns and Making Payments
Regardless of your specific filing frequency, you must always collect the sales tax on each purchase from the customer at the time the sale is completed. These sales tax payments should to be accounted for separately, as you need to remit them in full to the state. Depending on the requirements each state has for the amount of information that must be included on your return, you will also have to keep records of where a shipment went, what the total cost of the shipped goods was, the shipping method, what sales tax rate was used, and what the total sales tax collected was.
When the time comes to file your return, you can usually fill out a paper form and mail it in along with your payment, or you can create an account to file and pay online. For most states, this online filing is easily done through their Department of Finance or Department of Taxation website, and it is increasingly the preferred method. Payments are always due at the time of filing.
If you do file or pay late, you will likely incur a penalty. The specific amount of the penalty will vary from state to state, although it’s common to charge a percentage of the total tax due for every 30 days the payment or return is delinquent. Interest also accrues on overdue balances, and repeated late filing or payment can ultimately result in the revocation of your sales tax permit.
Most states require you to file a sales tax return as long as you hold a valid sales tax permit, whether or not you have made a taxable sale in a given filing period. These are known as zero returns, and you can incur penalties for not filing them as well even if you own no actual taxes at the time. Even though these penalties are usually relatively minor it’s worth filing your zero returns on time to make sure your account is always in good standing with the state.
Sales Tax Holidays
A number of states hold sales tax holidays at least once per year, and a few, like Louisiana and Texas, have up to three. These generally pertain only to a specific type or category of item. For instance, back-to-school sales tax holidays exempt things like clothing, footwear, backpacks, and school supplies to help make it easier for families to prepare for the upcoming school year. These tend to occur towards the end of the summer, often over two or three days on a weekend.
Second Amendment sales tax holidays exist in several states as well, and these leave items like firearms, ammunition, and related supplies free from sales tax during the specified time frame. A few states, including Texas and Louisiana, have a sales tax holiday once a year geared towards disaster preparedness when things like portable generators, short-wave radios, and hurricane shutters are exempt from sales tax. In some states, specified items are also exempt from local sales tax during the holiday, while other states allow those local jurisdictions to determine for themselves whether or not they will participate.
If you sell items that may qualify for a state sales tax holiday, you must make sure to track those sales separately and not charge your customers sales tax on purchases made during the holiday. The states will often have guidelines you can follow when filing your sales tax returns for the period that includes the sales tax holiday so that you can properly track the sales you made while accounting for the lack of sales tax revenue related to those sales.
Sales Tax in Your Online Store
Managing sales tax in your online store, particularly if you sell to customers in multiple states, can be a challenge. Most online selling platforms include a tool to allow you to add sales tax to each sale you make, but if you sell through multiple platforms, keeping track of the data from each of these can be a hassle as well.
The most efficient way to manage your sales tax collection and remittance successfully and efficiently is to use a sales tax software program that can integrate with all of your online selling platforms, allowing you to keep all of your data centrally located. These software tools also facilitate the filing of your returns, and they ensure that you’re always charging sales tax at the appropriate rate no matter where your customer is located.
However, no software will work well for you unless you have your products classified into the types of categories that states use to delineate which products are taxable and which are not. Different states and localities also sometimes tax certain items at different rates, and so proper classification is essential to ensuring that you are always collecting sales tax at the proper rate.
International Sales Tax
This information presented here refers to sales tax in the United States. Other countries may handle sales tax differently. For example, Canada has three types of sales taxes: Harmonized Sales Tax (HST), Provincial Sales Tax (PST), and Goods and Services Tax (GST). Each province has some combination of these, but not all three. In the United Kingdom, the sales tax is called a Value Added Tax, or VAT.
Although managing sales tax in your online store may seem like a daunting task, the truth is that you can make it just another part of your business if you take the proper steps and plan appropriately. Keeping your sales tax account in each state in good standing is essential to your ability to continue to sell to customers there, and so ensuring sales tax compliance is worth the investment it may take up front to set up a system that works for you.
Another thing to keep in mind about sales tax is that the landscape is constantly changing. The court cases currently being litigated will eventually end in decisions that may impact just about everyone who sells online when it comes to where you will be considered to have nexus and so be compelled to collect and remit sales tax. Staying up-to-date on these developments is important, but it’s just part of understanding the general trend towards more universal collection of sales tax from online sellers.