Nothing in this world is certain except for death and taxes. So just pay your taxes and you’ll be fine. For many small business owners, that is much easier said than done. Taxes might be one of the only two certainties in life, it also brings a lot of questions with it. In this articles, we’ll demystify sales tax and everything that you need to know about it.
What is sales tax?
Sales tax is a tax that is paid by the end user of a product. However, while it is the end user who pays the tax, it is the seller who is responsible for collecting and filing it and forwarding the money to the appropriate state or local government.
What makes this whole process much more complex is the fact that every state has their own laws and regulations concerning sales tax. For example, these states don’t charge it at all;
- New Hampshire
Yet, many localities in Alaska have their own sales tax regulations. We cannot dive into all the differences and similarities but we can give you an idea of what information you need to collect on sales tax in your state or municipality. Find a general overview of sales tax rates per state here.
What is the difference between sales tax and VAT?
Sales tax and VAT (value-added-tax) are two different taxes. The difference can be a little confusing because both taxes have to be remitted by the seller but paid by the buyer. There are important differences, though.
As explained above, sales tax is only paid by the end user of the product. It’s only charged once. This is a whole different story when it comes to VAT. VAT applies to every sale in the supply chain, from the raw materials to the final product and every step in between.
This means that if you produce wood that is used to create tables and chairs, you add VAT to the price of the wood but no sales tax. If you sell the finished chair, you charge both VAT and sales tax.
Is the wood that you sell firewood used as fuel, on the other hand, it is considered an end product and you do have to charge sales tax as well as VAT. *
What are sales tax permits?
In order to collect sales tax from your customers, many states require you to obtain a sales tax permit. In most cases, you can easily apply online for this permit.
Once you have successfully obtained your permit, you are ready to start doing business in the applicable jurisdiction.
Do you want to expand to another jurisdiction, which can be state or county, you will need an additional tax permit and might have to file the taxes collected in this area separately. More on sales tax in different locations further on in this article.
Who needs to pay sales tax?
Sales tax should only be applied to the end product and only be paid by the end user. But raw materials are not the only products that are tax exempt. You should always check with your state an local government if these exemptions also apply in your jurisdiction, but these products are exempt from sales tax in most places.
- Raw materials: if what you sell will be used to create an end product and you don’t sell to consumers, you sell raw materials.
- Wholesale items: if you are a reseller or retailer who sells wholesale items, you will be tax exempt in most states.
- Education and non-profit: when you sell to non-profit, educational, government or religious organizations, your products are tax exempt.
- Occasional/casual sales: typically, you don’t have to collect sales tax on casual or occasional sales.
So, don’t worry if you sell your embroidered handkerchief on your local artisan market twice a year. The tax office won’t come after you asking for sales tax. Are your handkerchieves a bigger hit than expected and are you expanding to the weekly market? Then it’s probably time to get a sales tax permit and start collecting tax on your products.*
Check out our guide on the Common Small Business Tax Mistakes
Where do I pay sales tax?
Unfortunately, there are no all-encompassing, straightforward answers in sales tax. In most states, you are required to pay sales tax on a state level. However, this does not mean that you won’t also need to pay on a local level. Counties can charge sales tax as well as the states they’re in. If you operate your business in different counties across the state, this might mean you have to remit sales tax to all different counties plus the state.
If your state doesn’t charge sales tax, your county might.
You might be lucky enough to be operating your business in one of the 23 member states of the Streamlined Sales Tax Agreement. This Agreement aims to drastically simplify sales tax and modernize it at the same time. States who are part of the Agreement are committed to enforcing uniform laws across the state, implementing electronic tax filing systems, and having business owners pay taxes to one body of government rather than different counties and states, among other regulations.
These states are currently in the Agreement:
- New Jersey
- North Carolina
- North Dakota
- Rhode Island
- South Dakota
- West Virginia
Find more information about the Streamlined Sales Tax Agreement on the website of the Streamlined Sales Tax Governing Board.
The best way to find out where you need to pay sales tax is by consulting with a tax accountant. They are familiar with the tax landscape in your area and will be able to help you get set up.
The difference between online and brick-and-mortar
As if it wasn’t confusing enough, we have to distinguish between online and offline businesses. In the digital age, we are not limited to selling and buying locally, products easily cross state lines.
Do you need to keep track of all the places you send your products?
Generally speaking, you pay the sales tax in the state or county where your “nexus” is located. Nexus is a physical presence of your business. This can be:
- An office
- A warehouse
- A store
Or any other definition that can differ per state.
Not all online business can be categorized as having nexus. Do they not pay taxes?
Not yet. So far, this has been a loophole many online businesses take advantage of. Because they are not required to collect sales tax, they are able to offer lower prices than brick-and-mortar businesses.
In July 2018, the Supreme Court ruled in South Dakota vs Wayfair, Inc that no matter what the physical presence of a business, the state has the right to collect sales tax. For now, the new legislation only applies to South Dakota and only to businesses delivering a minimum of $100.000 worth of goods but it is likely to soon start affecting other states and businesses as well.
Do you want to start a dropshipping business without a physical presence? For now, you can happily conduct your business without having to pay sales tax. This might change soon so make sure you do stay on top of the changes in your area. We advise asking an accountant for help setting up your sales tax administration.*
Sales tax software and tools
Thanks to helpful software and nifty online tools we don’t have to do and know everything ourselves. Some of these tools are specially designed for eCommerce businesses and some are also relevant for brick-and-mortar companies. We have made a selection of some of the most popular tools and software on the market.
- TaxJar: This application is great for online businesses with Nexus in one or more states. You can have this tool produce return-ready reports or even auto-file your tax returns for you. TaXJar offers integrations with a large number of stores, website builders, payment systems, and tools which makes the whole administrative process a breeze. Plans start at $17 per month. More information on their website.
- Avalara: Avalara is a very complete solution to help you file your taxes. They don’t only support sales tax but also use tax and VAT, among others. This tool is very suitable for both online and offline businesses. Using Avalara you can automate much of the tax process including exemption certificates, filing, and returns. Avalara prices start at $50 per year. For more information, visit their website.
- Vertex: Vertex offers different solutions depending on your needs so whether you are just getting started, are growing rapidly or have a well-established business, Vertex has the right software to help you out. They integrate with Salesforce, Magento and Oracle among others. Request information about their pricing on their here.
What does nexus mean?
Having Nexus means having a physical presence in a state or county. If your business has an office, warehouse, employees or store in a location, it has established nexus.
When do I have to remit sales tax?
Most states require you to file sales tax every month or every quarter.
Do I have to charge sales tax on services?
Services never used to be taxed, taxes were meant for tangible products. With the shift into a service economy, this is changing. There are now four states that tax services by default:
- South Dakota
- New Mexico
- West Virginia
The other states might not tax services by default, some still tax certain services. This varies from state to state.
Is SaaS taxable?
SaaS, or Software as a Service, is a rising star in this digital age. Many online services have adopted this business model of cloud-based services that run on subscriptions. Being a combination of an online business and a service, it’s easy to lose track of the sales tax requirements for SaaS companies. As with most sales tax-related questions, the answer is: it all depends on the state. Some states consider SaaS to be a service, others see it as a tangible product. Where it is considered a service, it will be taxed as such which means fully or not at all, again, depending on the state.
Do I have to file tax returns even if I have made no sales?
Yes, if you have a sales tax permit and your products are taxable, you will always have to file your returns.
Steps to set up your sales tax administration
Sales tax can be overwhelming and it doesn’t help that the rules of the games vary from state to state. However, there are some steps you can take today to get your tax administration set up. Avoid sleepless nights, audit stress, unnecessary paperwork, and penalties; be prepared.
- Find an accountant: You really don’t have to do it all by yourself. An accountant will know the rules and regulations that apply to your specific situation, which saves you a lot of time trying to figure it all out by yourself. The right accountant can even save you money in the long run. They are likely to know some useful loopholes and they make sure you don’t get in trouble when you do get audited.
- Register for a permit: In most places, this can easily be done online. Check the website of the appropriate tax authorities and fill in the form. Do check what information they need before starting the application process to make it all go as smoothly as possible.
- Find the right software: Invest some time in finding the perfect software for your sales tax situation. Most of these solutions will take some getting used to and can be overwhelming at first but put in some time to familiarize yourself with all the features, it will pay off in the end.
As the saying goes, well begun is half done. This certainly applies to your sales tax administration. Spend the time to get yourself properly set up and you will thank yourself later.
The examples used in this article are general examples. Sales tax laws and regulations differ per state and local government. Always check with the appropriate tax authority which laws apply in your area before applying sales tax.