Understanding Sales Tax for Your Small Business
This article discusses the following:
- Understanding how sales tax works
- Sales tax exemptions
- Sales tax nexus
- Use tax
- Excise Tax
- The benefits of charging sales tax
- How small businesses handle sales tax
- Filing your business’s sales tax return
- How much sales tax to charge
- When to charge for online sales
- Goods and services that typically have a sales tax
Many small business owners find collecting, reporting, and paying sales tax a daunting and time-consuming process, particularly for new entrepreneurs who aren’t familiar with sales tax laws and procedures.
The complexities surrounding sales tax are even more challenging when you have a business that sells taxable products or services across various state lines or has an online business.
But sales tax, like other small business taxes, doesn’t have to be rocket science. In this article, we’ll help you understand the basics of sales tax for small businesses so you can navigate the process easier.
Understanding How Sales Tax Works
Sales tax is a different type of tax than federal income tax or self-employment tax. While federal income taxes are remitted to the IRS, sales tax is paid to a local or state taxing authority.
Sales tax is an amount levied on a transaction of a taxable good or service. It is calculated based on a percentage that the applicable taxing agency designates, and the consumer or buyer pays it as part of the transaction. However, it’s the responsibility of a small business owner to submit the sales taxes that their business collects to the appropriate tax agency.
Forty-five states in the U.S., Puerto Rico, and the District of Columbia impose some kind of general sales tax. Alaska, Delaware, Montana, New Hampshire, and Oregon are the only states that don’t charge sales tax.
In addition to the states that charge sales taxes, 38 states have local sales tax ordinances on top of the state sales tax rates. Adding confusion to the matter, Alaska and Montana allow individual local areas to charge sales tax, even though they don’t participate in a state-level sales tax program.
Understanding the sales tax laws within your individual state and local jurisdictions is essential. You’ll also want to learn your state’s sales tax rate in order for your business to charge the right amount for any taxable goods sold or services performed.
Many business owners find that hiring a tax professional like a CPA is a wise strategy in helping them to understand and meet compliance laws surrounding sales tax, rather than trying to stay on top of taxes and regulations themselves.
Sales tax exemptions
A sales tax exemption is an authorization that excuses specific organizations from paying sales tax, either in part or altogether.
Some states allow exemptions on certain types of products, services, or points of sale, but this varies from state to state.
Many states in the U.S. exempt sales tax from being charged on professional services like physician visits and essential items such as medicine and food
For example, Massachusetts excludes groceries from being charged sales tax. But 13 states still charge sales tax on food items.
Also, most states still levy sales tax on clothing purchases, but eight states either limit or exempt them from being assessed the tax. For instance, New York caps clothing exemptions at $110.
Some items are exempt by nearly every state, such as sales to:
- government agencies
- religious, nonprofit, charitable, or educational organizations
- certain industries, such as the agriculture and industrial processing industries
Wholesale items for resale are also usually exempt from sales tax, as are raw materials used as ingredients in products manufactured into things sold later. However, when a buyer claims an exemption, sales tax laws require that they present you with the necessary certification to prove their eligibility for a sales tax waiver.
Again, every state has its own laws regarding sales tax exemptions. It’s highly recommended that small business owners become familiar with exemption laws in their state.
Sales tax nexus
Traditionally, a sales tax nexus was defined as the state where a business had a physical presence. Your business’s sales tax nexus will always apply in the state where you operate your business and where you reside. But the traditional small business model has changed for many entrepreneurs, and the term nexus has evolved along with it.
A 2018 Supreme Court decision challenged the sales tax landscape and redefined a business’s sales tax obligations when selling or doing business outside of its tax jurisdictions.
The case involved the state of South Dakota and the home-goods e-commerce enterprise, Wayfair. The court ruled in South Dakota’s favor, allowing the state to impose sales taxes on remote sellers outside of their taxable jurisdiction when exceeding predetermined transaction and sales thresholds.
The case laid the foundation for other states to follow suit and enact sales tax laws on remote or online businesses, essentially extending the nexus beyond state lines in certain circumstances. The nexus is usually applied when the business’s sales exceed the economic nexus determined by the state, usually involving transaction or monetary thresholds or limitations.
In other words, if you are doing business in multiple states, or are selling online, there’s a good chance you might have to pay taxes in those states.
Use tax is a type of sales tax applied to purchases outside of a buyer’s taxing jurisdiction but used within the purchaser’s state. Use taxes work in two ways: in one situation, the seller reports the sales tax; in the other, the consumer reports it.
In the first case, a seller or retailer use tax applies when a vendor sells a taxable good or service outside the state where they are registered to collect sales tax. Instead of filing the use tax on their regular sales tax return, the seller or vendor files a separate return known as a seller use tax return. The rate calculated for the tax is generally the same as the seller’s sales tax rate.
In the second scenario, a consumer use tax is assessed on the purchaser when a vendor doesn’t collect a vendor use or sales tax. In this case, a buyer is ultimately responsible for remitting the tax to their tax agency.
An excise tax is a type of sales tax that only applies to certain products like alcohol, tobacco, and gasoline.
While the tax calculation for a sales tax is based on a percentage of a purchase price, an excise tax is usually calculated on a per-unit basis and added to the sales price, not as an after-transaction tax. But excise taxes are sometimes levied after sales tax, which results in a consumer paying a tax on a tax.
How can small businesses handle sales tax properly?
First, you’ll want to determine if your business’s products or services are taxable by law. To discover your sales tax obligations and if your type of business is required to collect and pay sales tax, contact a CPA or your state’s taxing agency. In most states, this is a state-level Department of Revenue.
You’ll need to register your business with the agency to obtain a sales tax or seller’s permit. The permit is free in many states, but your state may charge a small fee.
When applying for your sales tax permit, your state office will likely require your Employer Identification Number in addition to other pertinent information related to your business.
You’ll want to calculate the sales tax rate on taxable transactions then collect the tax on each transaction while documenting it on receipts and invoices.
Filing your business’s sales tax return
Each state has a set frequency when sales taxes are due and must be filed and remitted. Some states require that a business pay the taxes monthly, while others require quarterly sales tax filings or another timeframe.
Many states require small businesses to file a state sales tax return, even when a company hasn’t collected taxes during a particular timeframe.
The sales tax return and the amount owed by your business should be submitted to your state’s taxing agency.
Each state has different rules regarding sales tax filings. Some have a more simplified process, whereas others want more detailed information with a breakdown of your business’s sales tax. Some states also require specific forms for different companies. Thankfully, most states accept electronic filings and don’t require you to mail in your forms anymore.
You’ll also need to include information on your return about your tax-exempt buyers and customers who didn’t pay a sales tax.
Accurate bookkeeping regarding sales taxes is vital for your small business. An efficient system of maintaining records, documenting taxes collected, and a history of tax payments is crucial to avoid difficulty retrieving the documentation you need if a tax agency questions your business’s compliance.
Last, always remember to file a sales tax return by the due date. Neglecting to do so can result in penalties for your business. Even worse than that, the state can revoke your sales tax license, and in many cases, your business’s ability to operate within the law.
How much sales tax should I charge?
The Sales Tax Institute website lists sales tax rates for each state if you want a general idea, but it’s always best to confirm which rate to charge through your local and state taxing authorities.
Let’s say you find out that the local sales tax rate is 8%. You would simply add 8% to all taxable transactions.
For instance, if someone purchases $100 in goods, you’d multiply that by 8% ($8.00) and add that to the price of the goods. The total you would have to collect from the customer is $108, with $8.00 in sales tax paid to the taxing agency when you file a sales tax return.
Can I get a sales tax credit if I refund a customer?
In most cases, if you have already received payment and submitted the sales tax to the taxing agency, you can apply for a tax credit to go towards your next return. You can also apply for a tax credit if you later discover that you’ve overpaid sales taxes on a previous return.
Should I charge sales tax for online sales and, if so, how much?
Online businesses and sales and services originating from the Internet make it more challenging to determine the sales tax rules that apply to your business. This is especially true if you do business with a consumer in another state.
In addition to the state sales tax, some states require small businesses to collect sales taxes based on where the item is shipped. If this is the case, you’ll need to determine the sales tax rate in your buyer’s jurisdiction.
When you consider there are more than 10,000 sales tax jurisdictions in the U.S., it can get complicated. Thankfully, most online businesses use e-commerce platforms and shopping carts that calculate how much sales tax you need to charge based on the delivery address. The sales tax is then added to the total for the buyer to pay.
Examples of Taxable Goods and Services
As previously indicated, the goods and services subject to sales tax will vary from state to state and county to county as each has its own laws regarding exemptions and taxable transactions.
But here are some basic examples where sales tax may be applicable:
Taxable goods include tangible personal property such as:
- Building/construction materials
- Other retail items
Services that may be taxable include:
- Personal services such as dry cleaning and grooming services
- Maintenance services such as plumbing work, electrical work, auto repairs, inspection services, lawn maintenance, and snow removal
- Business services such as marketing, advertising, and consulting
There are many states where services like those listed above are not taxable. You’ll need to determine your state’s requirements concerning each if your small business includes any of them in their scope of duties.
How are sales taxes used?
After all this talk about taxes, it’s helpful to end on a more positive note and look at why we pay sales tax. After all, it’s not just a scheme to make people pay more for goods and services.
Revenue from sales tax is typically used to pay for public services and infrastructure, schools, public safety employees and services, and more.
For instance, schools use sales tax revenue to pay teacher salaries, buy textbooks, and build newer schools. Firefighter and police salaries and emergency vehicles are also funded through sales tax revenue received at the local level. Sales tax monies also pay for maintaining roads, highways, and other local infrastructure.
Understanding your state’s sales tax laws and having an organized and efficient system to streamline your business’s sales tax process is an essential component of operating your small business profitably.
Point-of-sale sales tax software or a tax service can make things easier for you and your business to deal with your sales tax obligations.
Before doing anything, though, contact your local and state tax revenue departments as well as any state you do business in. It’s always best to learn firsthand what the laws regarding state sales tax are in your state.
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