When a consumer or business buys almost anything, it has a sales tax on it. Every state has its own tax rate. Additionally, each county in each state can also add a percentage on top of the state’s sales tax. If you are a business buying something for resale or an ingredient or materials to make something for resale, you do not have to pay sales and use tax on most items, but you must have a tax certificate from the state.
The government imposes a consumption tax on goods and services. The sales tax is not included in the price of the item or service but added to at the point of sale. The taxpayer/retailer collects the tax and forwards it to the state’s department of revenue. Every business must collect the tax amount in its jurisdiction, pursuant to the laws of the business’s jurisdiction.
When running a business, the owner must know when to collect sales and use taxes and how much to collect on each sale.
Types of taxes
A business that provides goods and services should know the terms associated with its sales tax liability.
A use tax is a sales tax that a customer purchasing goods from a state other than his or her home state pays. The tax amount is the percentage that the person pays in his home state. For example, if a consumer lives in Tennessee and purchases something from California, he pays Tennessee tax on the product he purchases. However, if the purchase is not taxed in his home state, he does not pay taxes and does not include the purchase in his use return.
The retailer collects the use tax and files a use tax return. Use tax rates might be different from your state’s tax rates. Tax filers should always check on the various use tax rates when conducting business with out-of-state customers.
Every state has laws that determine taxable goods. In many jurisdictions, many grocery items are not taxable. Some jurisdictions even have different tax rates for different items. For example, a grocery store might tax groceries at one rate and cleaning products at another rate.
In many jurisdictions, businesses do not have to collect tax for certain services. If the service is combined with items, the items are still taxable. For example, depending on its location, an auto repair shop might not charge tax on labor but must charge tax on parts.
The first income tax was levied in 1894 and was known as the Wilson-Gorman Tariff. However, Charles Pollock sued, stating the tax was unconstitutional. The Supreme Court found in favor of Pollock (Pollock v. Farmers’ Loan and Trust Company, 157 US 429 (1895) because the Tariff was a direct tax on property owners and not apportioned among the states, which is unconstitutional.
In 1913, the U.S. Constitution was ratified to include that Congress could levy taxes on any income “without apportionment among the several states, and without regard to any census or enumeration.” The Sixteenth Amendment then passed, which overturned the ruling in Pollock and reinstated the federal income tax.
Since then, changes have been made, and now we pay income tax under Title 26 of the United States Code (26 U.S.C.). Everyone is subject to income tax, including businesses. The amount of income tax you pay is based on the amount of income you have.
Local sales tax
A local sales tax is an extra percentage a city or county implements. It is added to the state sales tax. Thus, if the state’s tax is 7 percent, and the county you live in levies a 2-percent tax, your total tax is 9 percent. All retailers in the county must collect 9 percent on every taxable sale.
State sales tax
The state levies a sales tax on goods and services. Retailers in all jurisdictions must collect this tax at a minimum. Depending on state and local laws, counties and cities can also add sales tax to the state tax. The local taxes are paid to the local jurisdiction, and the retailer pays the state tax to the state.
On top of income taxes, businesses must also pay self-employment taxes to cover Social Security and Medicare. In most cases, those who work for themselves pay self-employment tax as it is not collected elsewhere. If a business makes more than $400 from self-employment income or more than $108.28 in wages from a church, it must pay self-employment taxes. Ministers and members of religious orders are exempt from the self-employment tax.
Social Security and Medicare taxes
Additionally, a business must pay Social Security and Medicare taxes, federal income withholding tax, and federal unemployment tax if you have employees. Most of these taxes are deducted from the employee’s paycheck, though the employer pays a percentage of the Social Security and Medicare taxes.
Those who operate certain kinds of businesses must also pay an excise tax, including those who:
- Manufacture or sell certain products,
- Use certain types of equipment,
- Offer certain services, and
- Use various products or facilities.
The excise tax has many categories of taxes, including:
- Environmental, fuel, air transportation, communications, and the first retail sale of tractors, heavy trucks, and trailers.
- Certain trucks, buses, and truck tractors with a taxable gross weight of 55,000 pounds or more if those items are used on public highways.
- Gambling and lottery activities.
- Motor fuel.
Sales tax is governed by several jurisdictions, including state, county, and city. In some aspects, federal laws also govern the tax, such as when a company sells goods and services to the federal government.
Sales tax is not the only tax a business pays – it has federal income taxes it must also pay. All businesses except partnerships must file an annual income tax return. Partnerships must file an information return. Everyone, including businesses, must file income tax as it is earned. In most cases, individuals and businesses must estimate the income taxes due and pay them quarterly. Those who do not pay quarterly taxes pay a penalty for “late taxes” when filing income taxes.
Businesses also pay state and local taxes. These taxes depend on the jurisdiction and the type of industry. For example, someone handling oil, gas, or hazardous chemicals pay a local tax on the disposal of these types of items.
Types of taxes businesses might pay include:
- Income tax.
- Self-employment tax.
- Excise taxes.
- Property tax on business property (real estate).
- Payroll taxes.
- State income taxes, where applicable.
- Gross receipts taxes, where applicable.
- Dividend taxes on corporate shareholders.
- Sales and use taxes.
- Agricultural land taxes.
- Amusement tax (for amusement parks).
- Securities transaction taxes.
- Tobacco and alcohol taxes.
- Stamp taxes.
- Vehicle license tax.
- Land value tax.
Not all jurisdictions require all of these taxes, and not all types of industries require all of these taxes. Check with a local attorney to determine which taxes a particular business needs to pay before starting a business.
Sales tax exemptions
Every state has exemptions for sales tax. Common exemptions include medicine and food. If a jurisdiction does not have a complete exemption, it taxes the items at lower rates. Additionally, depending on the state or local jurisdiction, some sales transactions are exempt from the tax. The jurisdiction bases these exemptions on the type of property, the purchaser’s identity, and what the property will be used for.
Type of property sold
Most states exempt certain commodities that people need to survive, such as food, medical devices, and medications. Some states exempt clothing, while others charge a lower or full sales tax rate. Some states also have a partial tax on certain food items, such as grocery ingredients like flour or meat, while boxed dinners, candy, and soda are fully taxed.
Depending on the industry you are in, you might sell one or more of these items and could have more than one tax rate, depending on your business’s jurisdiction.
Type of purchaser
While most sales tax is based on state law, federal law has its fingers in the pot. A state cannot impose a tax on property sold to the federal government and some of its agencies. In some states, a city, county, or other local jurisdiction cannot impose a sales tax on goods and services sold to the state.
For example, a business that makes non-stick bandages might sell to the U.S. government for use by VA hospitals and on-base hospitals, and doctor’s offices. These items would be non-taxable, but the same items sold to a private medical establishment would be taxable.
Type of use
Certain industries, such as industrial processing, agriculture, and manufacturing, are exempt from paying sales tax. A state with a heavy farm presence might not charge farmers a tax on goods needed to produce the farmed products, including machinery and other equipment used for harvesting or otherwise used on the farm.
Additionally, most states allow products that are used for resale to fall under tax exemption laws. Because the state assesses the taxes on the retail sale, it would double tax an item if the retailer bought it to make something for resale.
For example, a small business makes hats for resale. That business would be able to purchase the products used to make the hats without paying sales tax. However, that business must pay the tax when it sells its hats.
Proving the right to exemption
The purchaser of a service or product must prove that his or her purchase is exempt from sales tax. The state issues tax certificates to those exempt from paying the tax. Some states also issue a certificate that shows that a business pays sales tax directly to the state rather than through individual purchases at retailers. The certificate allows those purchasing items for resale to buy those items tax-free. They must, however, charge tax when they resell the items.
A business can apply for a sales tax credit if:
- It overpaid sales tax.
- It paid tax on certain transactions by mistake.
- It collected sales tax from customers but returned the tax to the customer.
The credit reduces the next tax payment you make.
What is a tax nexus?
First, a nexus is a relationship between at least two entities. Since we are talking about sales taxes, the nexus is the relationship / presence between your business and the state, county and / or city that collects the tax. These jurisdictions cannot tax you without that relationship. The nexus is the presence you have in a certain jurisdiction.
The U.S. Constitution creates the tax nexus in the due process clause, which requires a connection, and the commerce clause, which “requires a substantial presence.” A nexus also describes the degree of the business present in a state.
Generally, having a tax nexus means that a business maintains an office, employs workers, and / or stores products and supplies in a warehouse in the state.
For federal tax purposes, you have a nexus if:
- The business’s income comes from sources in a state,
- The business leases or owns property in the state,
- The business has capital assets in the state, and / or
- The business has employees engaged in activities that are more than “mere solicitation” in the state.
For sales tax nexus, the rules aren’t as stringent. A business must have a physical location, have employees that are residents of the state working for it, own property – real or intangible – in the state, or have employees who solicit business (salespeople) in the state.
Adding online transactions has made “nexus” more complicated. Because the “old” way required a business to have a physical presence, people buying goods online often got away without paying sales tax. The states were losing a lot of revenue because online businesses did not meet the physical presence requirement to have a tax nexus within a state.
In June 2018, the Supreme Court ruled that states had a right to collect sales taxes from online sellers in S. Dakota v. Wayfair. A business no longer needs a physical presence in the state if it sells products online.
The states that have sales taxes set up procedures to allow businesses to collect the taxes from online sales. Some states have a minimum number of transactions or amounts per year that bar collecting sales tax.
In other words, if an online business generates less than a certain amount or number of transactions per year, it does not have to pay tax on those transactions.
Online sales nexuses
To determine whether a business has an online sales nexus, it will need to review the rules for its state. Common ways the states determine whether businesses should charge sales tax for online sales include:
- Considering a click-through as a direct connection between the seller and buyer, such as through a referral link.
- Through affiliate programs, such as Amazon’s affiliate program.
- You sell over a certain amount or have a certain number of transactions. For example, Idaho has a minimum sales nexus of $100,000 per year.
Sales tax rates
Every state has its own sales tax rate. Additionally, counties and cities could add a small percentage to the state’s tax rate. A business should familiarize itself with all local and state sales tax laws, including the differing tax for certain products. State and local sales tax might fluctuate frequently, so check constantly to ensure that the business charges enough tax to cover the tax due on its tax forms.
Calculating sales tax
When calculating sales tax revenue, a business might have different taxes for different items. For example, some states charge one percentage for clothing and material goods and another rate for groceries. Always review the tax rates for your state, county, and city.
Sales made in the store might have a different tax rate than online sales. In-state sales might have a different rate than out-of-state sales. Make sure you know the rules for all retail sales of goods and services.
How to collect sales tax
Set up point of sale software to add the requisite sales tax to each item scanned. This way, you and your employees won’t have to remember which items have different tax percentages.
If a business does not have a point of sale and calculates everything by hand, it will have to know the appropriate amount, figure the percentage and add it to the sales price. Some states do not allow you to incorporate the sales tax in the price of the service or product, so be careful of selling items or services “all-inclusive” and figuring out the tax later.
Filing sales tax returns
State laws tell a business how often it must file sales tax returns. Many states require that you file them monthly.
Tax return due dates
Check your state’s laws for tax return due dates. Some states require them to be postmarked by the due date, and some want the returns processed by the due dates. If your state allows electronic filing, that is the best way as you can send payment electronically, and it is marked as received as soon as the state receives the return.
Yes. Check with your state laws to find out if you sell any product or service that is exempt. Otherwise, almost everything is taxable.
File your sales tax when your state tells you it is due. Many states require that you file sales taxes every month.
No. Some states allow exemptions for certain items. Be sure to check your state’s laws for items and services that are exempt from sales tax.
You must complete and file a sales tax return that includes all taxable sales.
Most products and services are taxable, though retail sales tax depends on state and local laws. However, if a business purchases goods for resale, it must have an exemption certificate to not pay double sales tax. Paying taxes on an item when a business purchases it, then paying taxes on it again when it sells the item or a product created with the item is double taxation.
Add up the sales tax you collected from your customers. This is the amount of tax the business owes. If the business did not charge tax on a taxable item, it must also include the tax on that item, even though it did not collect it from the customer.
You must charge sales tax as dictated by state and local laws.
It depends on the type of business they have. Some businesses are required to pay additional taxes because of products they work with or services they provide.
If a state, county, or city requires it, a business must obtain a seller’s permit or license. Sometimes, the business might have to pay for a state license, a county license, and a city license.