Do I Charge Sales Tax for Out-of-State Customers?
Understand your sales tax obligations for out-of-state customers. Learn when and how to charge, collect, and remit sales tax accurately across different states.
Sales tax is a consumption tax imposed by state and local governments on the sale of goods and some services. Businesses face complexity in applying sales tax, especially with out-of-state customers, because rules are not uniform across the United States. Each state designs its own regulations, creating a patchwork of requirements. This article clarifies when sales tax applies to out-of-state sales and outlines compliance steps.
Establishing Sales Tax Nexus
The primary factor determining whether a business must collect sales tax in a state is “nexus.” Nexus signifies a sufficient connection between a business and a state, compelling compliance with its sales tax laws. If a business establishes nexus, it must register with the state’s tax authority, collect sales tax from customers, and remit those taxes. Without nexus, a business typically has no obligation to collect sales tax for sales into that state.
Historically, sales tax nexus was established through a physical presence. This “physical nexus” meant a business had a tangible connection to a state. Examples include owning or leasing property, having employees or agents working in the state, or storing inventory, even through third-party services.
The landscape of sales tax nexus changed with the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. This ruling overturned the physical presence requirement, establishing that a state could require out-of-state sellers to collect sales tax based on economic activity. This concept is “economic nexus,” triggered when a business meets specific thresholds for sales volume or transaction count within a state.
Most states have adopted economic nexus laws, with common thresholds being $100,000 in gross sales or 200 separate transactions within a state annually. These thresholds vary by state, and some may include both. Businesses must monitor sales activity to determine if they cross these thresholds. Once an economic nexus threshold is met, the business must register and collect sales tax in that state.
Other types of nexus exist beyond physical and economic. Affiliate nexus occurs when a business has an agreement with an in-state person or entity that refers customers for a commission. Click-through nexus involves links on a local website generating sales for an out-of-state retailer. Marketplace nexus places collection responsibility on the marketplace facilitator (e.g., Amazon, Etsy) for sales by third-party sellers.
Calculating and Collecting Sales Tax
Once a business has established nexus in a state, it must determine the correct sales tax rate and implement collection procedures. Sales tax rates vary significantly based on the sale’s location and the product or service type. Sales tax sourcing rules dictate whether the rate is based on the seller’s or buyer’s location.
States are generally “origin-based” or “destination-based” for sales tax sourcing. In origin-based states, the sales tax rate is determined by the seller’s business location. Most states operate under a “destination-based” system, where the rate is determined by the buyer’s location. For remote sellers, sales are almost always destination-based, requiring the seller to apply the sales tax rate applicable to the customer’s address. This often includes state, county, city, and special district taxes, leading to many potential tax rate combinations.
The taxability of products and services also varies widely by state. While tangible personal property is generally taxable, many states exempt items like groceries or prescription drugs. Services, digital products, and software have differing tax treatments depending on state laws. Businesses must understand these rules for each state where they have nexus.
For practical collection, businesses can use e-commerce platforms, accounting software, or specialized sales tax compliance software. These tools automate calculating the correct sales tax rate based on the customer’s address and item taxability. Using such systems ensures accuracy and compliance with varying rates and rules.
Sales Tax Registration and Compliance
After determining nexus and understanding sales tax calculation, a business must register with that state’s tax authority. Obtaining a sales tax permit or license is mandatory before collecting sales tax. The registration process typically involves submitting an online application to the state’s department of revenue.
During registration, businesses provide essential information, including their Federal Employer Identification Number (EIN), business structure, and estimated sales volume. Some states may charge a small registration fee, but many do not.
Once registered, states assign a filing frequency for remitting collected sales tax. This frequency is based on the volume of sales tax collected, with higher volumes requiring more frequent filings. Businesses must adhere to their assigned filing schedule, even if no sales tax was collected, as failure to file can result in penalties.
The remittance process involves submitting collected sales tax to the state, commonly through online portals. Businesses must maintain accurate records of all sales, collected taxes, and remittances. These records should distinguish between taxable and non-taxable sales and provide sufficient detail for tracing transactions. Most states require retaining sales tax records for a minimum of three to four years.
Common Sales Tax Exemptions
Even when a business has nexus in a state and sells a taxable item, certain transactions may be exempt from sales tax. These exemptions require specific documentation from the buyer to justify not collecting the tax.
One widespread exemption is for sales made for “resale.” When a business purchases goods for resale, they are exempt from paying sales tax on that purchase. The sales tax is collected from the final consumer by the reseller. To qualify, the buyer must provide the seller with a valid resale certificate, which the seller must retain.
Certain products and services are commonly exempt from sales tax in many states, though this varies. Examples include most food items for home consumption, prescription medications, and sometimes specific professional services. Businesses must consult the specific regulations for each state where they have nexus.
Sales to tax-exempt organizations, such as charities, schools, or government entities, may also be exempt. These organizations provide the seller with a valid exemption certificate or IRS determination letter. Sellers must obtain and maintain these certificates as proof that sales tax was not collected in good faith. Without proper documentation, the seller could be liable for uncollected sales tax, penalties, and interest.