Sales taxes stay a bit aside from the pull of business taxes that apply to small businesses. Only those businesses that sell taxable products or provide taxable services are liable to sales tax. And if you are one of them, you probably know how complicated the system is and how much time and effort it might take you to stay tax compliant. From widening or shortening the base of taxable products and services at times to determining which state’s tax rates apply to you if you sell online to many more details to consider. Sometimes, sales taxes look like a large puzzle that you have to gather into a single picture. (And the picture changes from time to time).
So let’s break down this puzzle and take a closer look at the most significant pieces. Hopefully, it will help systemize and simplify your dealing with sales taxes in terms of collecting, filing, and paying them.
What is a sales tax, and why it’s so complicated?
Let’s start with a simple definition. Sales tax is a tax imposed by the government on goods or services you sell or provide to consumers. Usually, it’s a seller or service provider that needs to collect the taxes and pass them on to the government. Sounds pretty clear, doesn’t it?
So what’s the all thing fuss about it?
The thing is, the simplicity ends on the definition. In real life, almost every word in it leaves you asking questions.
- Which of the products I sell are taxable?
- Is the service that I provide liable to taxes?
- What tax rates are applicable if I sell interstate?
- Whom do I pay those taxes?
- What are the sales tax payment due dates?
And almost every answer starts with it depends. And actually, it does.
The biggest thing that complicates the matter is that there’s no single federal sales tax. Sales taxes are governed at the state level, and sometimes, at a locality level. So tax laws, regulations, and even rates can differ greatly depending on the state you sell in.
Just let me share some figures to give you a little bit more clear view o the problem:
- 45 states and the District of Columbia impose sales tax;
- 5 states don’t have sales taxes, namely Alaska, Delaware, Montana, New Hampshire, and Oregon;
- 38 states allow local communities, counties, and cities to impose their sales taxes (Alaska, which doesn’t have a state sales tax, however, is included in this list)
So, in total, about 13 000 sales tax jurisdictions have their tax rates and regulations. Can you just imagine this?
On top of that, it is your responsibility as a business owner to keep an eye on any changes that state or local tax authorities introduce at times.
All this makes sales taxes one of the most complicated things that small business sellers face. And to light the way through this kind of maze, there are steps to follow to understand, prepare and file sales taxes. Here they are:
1. Understand where to collect and pay sales taxes
First thing first, you need to define where you can charge taxes and need to report them. Speaking the tax language, you need to know your sales tax nexus.
In a nutshell, tax nexus stands for the relation of your business to the state that permits you to charge sales taxes and obliges you to report them. Nexus can be represented either by the physical presence of your business or some types of business activities.
Let’s take a more detailed look at how it works.
Imagine you have a brick-and-mortar shop in, let’s say, Maryland. So, it will be your nexus, and thus, Maryland sales tax regulations and rates will apply to your business. Pretty clear so far.
Apart from a store, which is the simplest example, there’s a couple of more physical presence circumstances under which nexus may occur. They comprise having an office, a warehouse, or any other inventory storage. In many states, having a salesperson or another representative (a contractor, an employee, etc.) that work for your business in a client-facing role is quite enough to create your physical presence. Just bear in mind that in the latter case, the requirements may differ from state to state.
Economic nexus is a more interesting and complicated occurrence. A business might not be physically present in a location. But if it receives payments for its products or services from that location, it can be enough reason to fall under the local sales tax obligations.
This rule applies to online sellers and e-commerce businesses, which is quite obvious, but also to any company or service provider whose annual gross amount of payments received from a certain area reaches the threshold of over 200 transactions or $100,000 in sales.
In some states, the definition of nexus was expanded to encompass the affiliate nexus and click-through nexus. The first one occurs when a related or commonly owned company provides services on behalf of a business that is not physically present in the area. And the click-through nexus occurs when a business performs sales through the referrals that receive a commission.
2. Understand what’s taxable and sales tax rates
Knowing which state’s sales tax regulations apply to you, it’s only logical to find out which products and services are liable to sales taxes in this state (and this locality)and which fall under sales tax exemption.
The good news is, there are some types of products that generally are liable to sales taxes almost everywhere. Those include tangible personal property and services at large.
Tangible personal property is quite a wide definition that comprises most of the usually sold items, like pieces of furniture, tableware, jewelry, books, toothpaste – you’ve got the idea. In most states, services (like dry cleaning, lawmaking, barbershops, etc.) are also subject to sales taxes. There are some exemptions, of course. However, the general trend is expanding the list of taxable services rather than shrinking it.
Product categories that usually are exempt from sales taxes in most cases include grocery, closing, religious books, magazines, prescription medicines, etc.
However, there are some reservations to be considered. Thus in many states, some beverages and also prepared food are usually liable to sales taxes. Non-prescribed medicines fall under the same category, as well as luxury closing.
The taxability of digital products is still subject to discussion. By digital products, we mean audiovisual works, like movies, music videos or news shows, audio works, like songs and other music and sound recordings, and also digital books. Different states have different approaches to such products in terms of applying sales taxes to them.
There’s not the full list, of course, of taxable and non-taxable products, and the best way to distinguish between them correctly is to turn directly to the state or local tax agency.
3. Get your sales tax permit from the local tax authorities
Getting a sales tax permit is an important step. This permit is obligatory to every business that is going to collect sales taxes from customers. Without it, you can be blamed for tax fraud, and the consequences may seriously affect your business.
Where to get your sales tax permit?
Businesses should register with the State Department of Revenue (or another taxing authority eligible to handle such registrations) to obtain a sales tax permit.
Before registration, you will require to gather the necessary documents, the set of which may differ state-to-state. Usually, those requirements can be found on the official website of the issuing authority, along with the rules that regulate the collection and remittance of sales taxes. Please bear in mind that in some cases, you’ll need additional permits and licenses.
Once approved, you’ll receive your sales tax permit number. Now you can officially charge your buyers or customers taxes on top of the products or services they bought from you.
4. Ensure you collect sales taxes to report them to the tax authorities
Once you have your valid sales tax permit, your next step is to begin collecting sales tax from your buyers.
States generally require online sellers to collect sales tax in one of two ways:
- Origin-based sales tax collection
- Destination-based sales tax collection
This concept is also commonly referred to as “sales tax sourcing.”
Origin-based sale tax collection. Online sellers who are based in states with origin-based sales tax sourcing are required to collect sales tax at the seller’s business location.
If your business is based in an origin-based state like Texas, you would determine the sales tax rate at your home, warehouse, store or other headquarters. Then, charge all your buyers in Texas that single sales tax rate.
This type of sales tax collection is simple. You’re only required to know and charge a single sales tax rate to all buyers in the state.
Destination-based sales tax collection. Online sellers who are based in states with destination-based sales tax sourcing are required to charge the sales tax rate at the buyer’s “ship to” address.
As a seller, you are required to calculate and charge the state, county, city and other local sales tax rates where your buyer is located. Most states have destination-based sales tax collection.
The above examples only apply when selling to buyers in a state where your business is based. If you have nexus in a state for another reason — such as having an employee there or attending a tradeshow there — then charging sales tax is different.
In most cases — with the exception of California, Arizona and New Mexico — if you are selling to a buyer outside the state where your business is based, you would charge that buyer the sales tax rate at their “ship to” location.
5. Finally, file your sales tax returns and pay them on time
When preparing to file a state sales tax return, you need to determine how much sales tax you collected from buyers in not only the entire state, but in each county, city and other special taxing district.
Why? States rely on sales tax dollars to pay for infrastructure, public safety and other budget items. But they won’t know which city or other local area to allocate those funds unless you break down your transactions for them.
In a small number of states, like origin-based states or states that only have a single statewide sales tax rate, filing sales tax isn’t very difficult. But, in most cases, breaking all your transactions down manually is a time-consuming chore, especially if you are a high-volume seller or you sell on multiple channels.
And here is where you can use your accounting and tax preparation software to make this process much fuster and, which is even more significant, much more accurate. And the more accurate you tax report is, the easier it will be for you to file your sales taxes.
Now, you can proceed with filing.
Most states allow you to file sales tax online, and some require it. The best way to understand which option you can choose, you can consult with the local tax authorities.
Summing up, you can see that though there are complications, dealing with sales taxes and sales tax returns should not necessarily be a pain for small businesses. While there can be several peculiarities that depend on where you collect taxes, knowing what to do, where to look for explanations, and using necessary tools can save a lot of time and effort on collecting, calculating, and reporting sales taxes.
Do you pay sales taxes? What helps you stay on top of them? Feel free to share your thoughts in the comments!