No matter where in the world you do business, understanding how sales tax impacts your business is important. The concept of tax on goods or services sold at retail is widespread and more than 160 countries have some form of sales tax.
There is no national sales tax in the US, but 45 states and many municipalities have a sales tax. If you have any kind of retail sales, you will need to comply with rules on sales taxes in the state where the sale was made, and collect and remit the appropriate tax amount.
What is a sales tax?
A sales tax is a consumption tax imposed by state or local governments on the sale of goods or services consumers pay when making a purchase. It is the responsibility of a business to collect sales tax and remit payment to the government when the business has some form of connection to the jurisdiction.
How does sales tax work?
A sales tax is a form of consumption tax collected when someone spends money on a product or service. Sales taxes raise revenue for local and state governments. Many purchases are subject to sales tax. However, some states and municipalities have exemptions on products such as groceries, prescription medications, or clothing of certain types or up to a certain value.
When consumers pay a sales tax, they pay a percentage of the purchase in addition to the purchase cost. Consumers pay this additional cost to the retailer, and the retailer collects it to pay the government at regular intervals. Because consumers don’t pay the sales tax directly to the government, sales tax is considered an indirect tax.
When are businesses exempt from sales tax?
Sales tax is not required if the business does not have a nexus, or connection, with a jurisdiction. However, a 2018 Supreme Court case, South Dakota v. Wayfair, made it easier to establish a nexus. A business establishes a connection if it has a physical presence in a state. This physical presence can be an office or warehouse, or having a sales representative or contractor in the state. A business may also have a nexus based on the number of transactions or amount of sales derived from a particular state. Each state has its own rules defining an economic nexus.
Businesses that purchase materials to make the product they sell are exempt from paying sales tax if they have a resale certificate. For example, a business owner who sells clothing can avoid paying sales tax on fabric purchased to make apparel. The consumer pays the retail sales tax when the final product is purchased.
What is an excise tax?
An excise tax is an additional tax on certain products imposed by the federal government or levied by state or local municipalities. Depending on the type of excise tax, the consumer, retailer, or manufacturer may be responsible for it. For excise taxes paid by the consumer, it is still the responsibility of the retailer to calculate and collect the correct amount.
Some excise taxes are known as “sin taxes,” in which certain jurisdictions levy a higher tax rate on items such as alcoholic beverages or cigarettes. For example, a federal excise tax adds $1.01 to the cost of a pack of 20 cigarettes. In New York, there is an additional state excise tax of $4.35 per pack, meaning the consumer in that state pays two excise taxes that the retailer must collect and remit.
Excise tax can also be relevant when a business imports certain goods such as alcohol or tobacco. If these products are imported for resale or used as a material in a final product, an excise tax is due. Although this additional tax is the importer’s responsibility, the retailer can incorporate this additional cost into merchandise prices.
What is VAT?
Value-added tax, also known as VAT, is a type of tax used in many other countries and is similar to the sales tax used by many US states and localities. It is imposed like a sales tax to raise revenue for the country’s government. All of Europe and many other countries utilize VAT. VAT rates differ by country but range from 5% to 25%. VAT is due at each production stage and at the sale of the final product. So although the result is similar to a sales tax, which is collected just once, VAT differs because each stage of production incurs a tax. Resellers then can claim a tax credit for the VAT paid previous to final consumption. This practice of taxes at each stage is different in the US because resellers use a resale certificate for an exemption from sales tax.
Average state sales tax in every state
Most US states collect sales tax. However, state sales tax does not tell the whole story. Many municipalities tack on their own sales tax, making total sales tax rates higher. Five states do not have a state sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. However, Alaska allows local sales tax. Therefore an average sales tax is shown for Alaska based on the local sales taxes alone. The table below provides the average total sales tax for each state and the District of Columbia.
|State||Average Sales Tax|
|District of Columbia||6.00%|
Sales tax FAQ
Who pays sales tax?
The consumer pays the sales tax to the retailer in addition to the cost of the item or service. The retailer is responsible for collecting and paying the tax to the local or state governments.
Which states don’t have sales tax?
Five states do not have a state sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Although Alaska does not have a state sales tax, local municipalities are permitted to collect sales tax.
What are the advantages of sales tax?
Sales tax provides a way for the state and local governments to raise revenue for the municipal budget. Sales tax revenue benefits the people of the jurisdiction through public schools, public safety, roads, and public libraries.