As a small business owner, one of your responsibilities is to collect, track, and remit sales tax. How do you know when you need to collect sales tax? What recordkeeping is required? When and how is sales tax remitted to your state(s)? Did you know that there are several types of sales tax?
Yup … there’s a lot to know about sales tax! Let’s break it down.
Types of sales tax
Can you name four types of sales tax? The most common terms are sales tax, use tax, excise tax, … and … value-added tax (VAT) which is common in other countries. (If you listed the last one, VAT, give yourself extra points!)
#1) Sales tax collected at point of sale — This is the tax of sales that we are most familiar with. Each state has its own rules about which items or services are taxed and what percentage sales tax is charged in that state and/or community. Not all states charge tax sales, and some states have origin vs. destination sales tax.
As a consumer, you clearly see on your receipt the amount of sales tax that has been added to the purchase price. As a business owner, you need to track the sales tax you collect and remit it to your state(s).
#2) Use tax — Most states collect both sales tax and use tax at the same rate. Use tax is a type of sales taxation imposed when you purchase an item out of state for use in your home state — and you did not pay sales tax for the item.
For example, let’s say you buy a television online, and you are not charged sales tax. Let’s also say that if you had purchased the television at a local store, you would have been charged sales tax. Your home state does not want to miss out on that income. So if you are using the television in your home state, you are expected to pay a use tax. The use tax will be the same amount as the sales tax would have been at your local store.
This is another situation where you will want to check the laws for your state.
#3) Excise tax — Similar to state sales taxation, excise tax is added to the price of goods or services and paid by the consumer. However, excise tax is paid as a part of the sale price without showing up on the receipt.
When excise tax is applied to things like gambling, alcohol, or tobacco products, they are commonly referred to as “sin taxes.”
Excise tax can be required by federal or state governments. See IRS Form 720 for more information.
#4) Value-added tax (VAT) — Unlike traditional state sales tax, which is collected from the ultimate consumer by the vendor, VAT is added on and paid to the government at each step of production. So each business along the manufacturing and distribution chain collects a portion of the tax on the product. VAT has been recommended by American economists as a way to collect tax sales more consistently with minimal fraud.
When is sales tax required?
Almost all goods and services are required to have sales tax added to them when they are sold. There are exceptions, such as those outlined in our article What Is a Sales Tax Holiday. Each state has its own laws. Your decision whether to collect sales tax will depend on the laws of the state where you made the sale. While some states charge sales tax on an item, other states may not.
The sales tax rate may also change from city to city, with some cities electing to increase the sales tax as a way of funding different public projects.
Items that are typically exempt from sales tax
Generally speaking, these items are tax-exempt:
- Food – Sales tax is not applicable for food items in some states, while other states like Virginia and Arkansas apply a high percentage of sales tax on foods. Some states tax food that is sold for consumption on the premises (as in restaurants), but do not tax food that is sold only for off-premises consumption (such as groceries or carryout orders).
- Medicine – Almost no state charges tax for prescription medication, but non-prescription drugs are usually taxed.
- Agricultural products (e.g., animal feed, seed).
- Raw materials.
- Materials that will be resold and not used by the customer.
Sales tax exemptions. Some purchases are exempt from sales taxation when being made by a diplomat or made on behalf of a non-profit organization (like a church or school).
Sales tax for services. Some services are taxable; some are not.
Each state has its own rules for exemptions and services, so as the seller, you need to check with the state where the sale is made.
Sales tax holidays
Many states have implemented sales tax holidays. These holidays are dates designated by a state on which the taxation of sales for specific items is waived. For example, your state’s holiday might waive the tax on school supplies and/or clothing sales before school starts in the fall.
Why do you want to watch for sales tax holidays? First, you don’t want to collect tax from your customers if the purchase should be untaxed. In addition, you could use the sales tax holiday as an incentive to bring more customers into your store.
The Federation of Tax Administrators (FTA) maintains a state-by-state list of sales tax holidays. You can also find sales tax holiday information on your state website.
Remitting sales taxes
In theory, paying sales tax to the state falls on the shoulders of the buyers. However, it is next to impossible to expect all buyers to pay sales taxes directly to the government on every purchase they make.
Hence, the government has made it easy for the consumer to pay tax indirectly through the sellers themselves. The seller puts a calculated percentage on each and every taxable item or service and makes the consumers pay the extra price at the time of purchase. The seller is then responsible for remitting sales tax to the government.
Paperwork needed for taxes
Every seller must get a license from the state in which they are operating in order to collect sales tax from buyers.
The seller logs each transaction where tax is collected in his/her records and reports the totals on the correct tax return forms.
Businesses may have to remit their tax of sales monthly, quarterly, or even annually. It often depends on how many sales you make and how much income you have.
Paying tax for sales in multiple states
If your business makes sales in more than one state, you might be required to pay sales tax in multiple states — especially if your business has established call centers, sales representatives, employees, and/or a definite address for the company in each state. You will need to check each state’s sales taxation regulations.
Conversely, if your business has no physical presence in a state, then the U.S. Supreme Court has ruled that there is no need to pay sales tax for sales made in that state.
Sales tax nexus refers to your company’s physical presence in a specific area and your resulting requirement to pay sales tax in that locale.
Paying tax for sales over the Internet
Sales tax for sales taking place via the Internet has been argued for some time in congress. The concern is that if no tax is collected for Internet sales, it puts small businesses at a disadvantage. As of this posting, vendors on the Internet do collect a tax on sales. Of course, there are exceptions!
According to the Marketplace Fairness Act of 2015 …
Sellers with annual gross receipts in total U.S. remote sales exceeding $1 million must collect and remit sales and use taxes with respect to remote sales.
The supporters and opposition continue to argue, so, for the most up-to-date information, see the Marketplace Fairness website.
Calculating sales tax rates
There are two rates that can be included in the sales tax: they are the state sales tax rate and the district sales tax rate, which includes city and county taxes. Customers have to pay both. Some districts do not have any sales tax, which means the customer only has to pay the state tax.
As mentioned above (repeatedly!), you will need to check your state website for accurate information about sales tax rates and regulations. There are a lot of regulations! For example, the state of Ohio dedicates more than 30 pages to the topic of sales tax in their guide for new businesses!
You also will want to consider software that will help you track your sales tax collections and remittances. You never know when you might get audited. As with all taxes, an audit can be a real time-eater and penalties for errors can be scary steep.
Patriot’s small business accounting software is an easy and accurate way to keep all your money records organized. We have great customer service and affordable prices. Start your free trial today!