Sales Tax 101 - The Complete Overview

As a consumer, you’re accustomed to paying more than the sticker price on most goods you buy, but you probably don’t think much about sales taxes beyond grumbling at your receipt.

As a business owner selling ANY tangible items, and sometimes even digital products, for better or worse, you cannot ignore it any longer. 

Both the law and the financial success of your business require you to understand how sales taxes will affect your operations This article is the first part of an extended series on sales taxes that aims to help you get exactly the information you need.

What is Sales Tax exactly?

Sales Tax is imposed by local and state governments as a major source of revenue to fund government initiatives. 

1. WHO pays it? Sales tax is a tax paid by the END CONSUMER of TANGIBLE PRODUCTS.

2. HOW do they pay it? Consumers pay sales taxes to the business that is selling them tangible goods. 

3. WHAT happens to the money? The collecting business is required to file periodic sales tax returns, remitting the tax to the appropriate city, county, or state government. These locales are referred to as “taxing jurisdictions.”

4. WHICH jurisdictions apply to my business? Your annual sales volume and nexus determine where you have sales tax requirements. Continue reading below for clarity on the term “nexus.”

5. WHEN is sales tax filed by my business? Each jurisdiction will determine separately whether you are required to file on a monthly, quarterly, or annualized basis. The thresholds for this decision are almost always based on your yearly sales volume. 

Each state has its own rules and regulations, resulting in a convoluted and confusing mess that can cost thousands to untangle if you are not proactive about managing this for your business. 

Defining the “End Consumer”

Under most definitions, the sales tax payer is your customer who buys a product for personal use, without intending to resell it. The end consumer is usually an individual purchasing goods for personal or household use. Businesses that buy items for use within their operations, rather than for resale, are also considered end consumers in this context.

For example, when a retail store sells clothes to a customer for personal use, that customer is the end consumer. On the other hand, if the same retail store sells clothes to another business in a wholesale transaction, the buyer is NOT an end consumer and should not be charged sales tax. 

To reiterate -  the consumers, AKA Your Retail Customers, are the ones being taxed here, not you as a business. Rather, it is the businesses’ responsibility to collect the correct amount and file the returns by the due date including submitting the payment for the tax you collected. 

Don’t you just LOVE how the government has delegated this responsibility to you as a business owner? 

We certainly do not love it, even as accountants, but we are here to help you navigate these responsibilities. 

It is in your best interest to make sure you're collecting the full amount from your customers as soon as possible. The only way in which you as a business owner will become responsible for sales tax liabilities is if you fail to collect and remit the full amount from your customers. You would also become liable for penalties and interest if you fail to file and pay the tax due. 

Business owners will often adopt a perception that their business and income are being taxed, in addition to all the taxes they already pay.  The good news is - if your collection efforts are maintained, you shouldn’t pay a penny more than what is collected.

Sales Tax Versus Use Tax

It's important to note the distinction between Sales Tax and Use Tax, which are often reported on the same form.

• Sales Tax is a tax charged to the end-use customer when a sale is made, as required by the city or state. It is your responsibility as a business to correctly collect and remit sales tax from your end-use customers in any location where you have a Nexus (see next section).
  

• Use Tax has the same intent, but is charged to a business or individual when they purchase a tangible product for use or consumption in a different state, and they did not pay sales tax on that purchase. Most often, this is because the seller does not have a Nexus in the home state of the buyer.

For example, if your Colorado-based company buys a machine from a Texas-based company, you might owe Use Tax in your home state of Colorado. Review your purchasing receipts to determine whether sales tax was originally collected.

Both business and individual consumers are responsible for maintaining records of purchases where sales tax was or was not paid to determine the requirement for payment of use tax.

Now that you understand the core differences, we won't discuss Use Tax any further in this article. Sales tax is much more likely to trigger violations, penalties, and interest. We recommend prioritizing getting it right.

What is a Sales Tax Nexus

A sales tax nexus is used to determine whether a business has compliance requirements in a particular jurisdiction.

There are two subtypes of nexus - physical & economic - which are broken down below-

Physical Nexus: The business has a physical presence in the jurisdiction. That presence could be in the form of-

• They own, rent, or otherwise operate from a physical location in the jurisdiction. This includes an office, retail storefront, production house, storage facility, etc. Even storing inventory at your Uncle Jack’s house will trigger a physical nexus.

• An employee or other agent works inside the jurisdiction - this often creates serious compliance issues for remote, distributed teams 

• 3rd party fulfillment services operate in the jurisdiction

• Salespersons are active in the area or exhibiting at trade shows

As you can see, it’s not only your headquarters location that determines your physical nexus.

Economic Nexus: The business has surpassed an economic threshold in the jurisdiction. 

Economic thresholds are determined by each jurisdiction according to any of a variety of factors, including-

• a dollar amount of taxable sales, often between $100,000 to $500,000 in a period

• the number of individual sales totaling $200 or more in a year

• collection of any amount of sales tax from customers in the jurisdiction, regardless of other factors

Fulfilling any of these criteria can result in a nexus being generated and an obligation to collect and remit sales taxes. 

As you can see, it can be difficult to understand how these concepts apply to your business. If your business is selling tangible products, we highly recommend working with an accountant, like us, who intimately understands the sales tax environment. 

If you are still trying to navigate this yourself, Avalara is a technology company providing sales tax compliance products and their articles are useful in navigating these complex nexus questions. For example, they have broken down each state's unique economic nexus requirements. 

Okay, I have a State nexus - what’s next?

Similar to the nexus situation, each state has its laws on taxable products and services, so review your local laws to understand how they apply to your business. 

First - determine which of your sales are susceptible to sales tax: 

Products: Generally, sales tax applies to almost anything tangible that can be bought or sold, and even digital products in some states, like CA and CO. 

Services: Services are traditionally exempt, but occasionally the state and the general public have different ideas about what constitutes a service and what doesn’t. For example, SAAS models (software as a service) are often susceptible to sales tax requirements. 

Additionally, tangible products delivered in association with a service are still susceptible to sales taxes. For example, home remodel companies often provide both goods and services. The goods they install ARE taxed, while the services are not. This is because:

• The Client is the end user of the part, & 

• The Contractor has a physical nexus at the job site (physical location) 

• The parts are sold to the client as an integral part of the sale (taxable physical product) 

In most states, service providers who deliver tangible goods should itemize their bills in order to apply sales tax only to the physical items. 

What sales are Exempt?

Since sales taxes can only be collected on retail sales to the end consumer, some of your sales may be Exempt from sales tax if they do not fit this criteria. Common examples of exempt sales are when your customers use the products in manufacturing their end product OR resell the products unchanged.

For a particular sale to be exempt, your customer must provide, and you must keep on record, a copy of a document called a “Wholesale Certificate” or “Reseller’s Certificate”. In some states, like Colorado, this is the same document as their sales tax license, but in other states, additional documentation is required. This document shifts the responsibility for sales tax collection from your business to theirs. 

How much sales tax should I charge to my customers?

You only charge sales tax to customers inside your nexus state(s).

The amount of sales tax you charge your customers depends on whether your nexus state(s) follows destination-based or origin-based sales tax rules. 

In a destination-based state, the sales tax rate is determined by the location where the customer receives the goods. This means if you’re shipping products to customers in different areas, you need to apply the sales tax rate of the customer's location. Conversely, in an origin-based state, the sales tax rate is based on the location of the seller. So, if your business is located in such a state, you charge your local sales tax rate regardless of where the customer is.

For example, if you run an online store based in a destination-based state like California and you ship a product to a customer in Los Angeles, you must charge the sales tax rate applicable in Los Angeles. On the other hand, if your business is located in an origin-based state like Texas, you would charge the sales tax rate based on your business location, even if the product is shipped to another city within Texas.

Most states are destination-based. There are only 12 origin-based states as of this writing in July 2024: 

• Arizona

• California (considered a "mixed sourcing state" as city, county and state sales taxes are origin-based, but certain district sales taxes - supplementary local taxes - are destination-based)

• Illinois

• Mississippi

• Missouri

• New Mexico

• Ohio

• Pennsylvania

• Tennessee

• Texas

• Utah

• Virginia

For more information on this concept of destination-based vs origin-based sales, read more from Avalara here.

How do I charge sales tax to my customers?

Ecommerce platforms like Shopify and WooCommerce have ever-growing capabilities to manage your sales tax collection automatically when set up correctly. Square and other merchant providers also have similar capabilities that can be implemented in physical sales locations. 

These platforms do have limitations and we recommend the use of TaxJar for destination-based sales tax collection.

They offer both automated collection and auto-file or manual filing based on your needs.

Conclusion

Navigating the incredibly complex world of sales taxes can be daunting, but understanding the basics is the first step toward compliance and financial success. If you feel overwhelmed or need expert assistance managing your sales tax obligations, don’t hesitate to reach out to us at hello@sonderaccounting.com. Our team is here to help you simplify the process and ensure your business stays on track.