Do I Have to Collect Sales Tax for My Business?

Sales tax is a consumption tax imposed on the sale or lease of goods and services. State and local governments levy this tax. Unlike a value-added tax (VAT), which is collected at multiple stages of production, sales tax applies only to the final retail transaction with the end consumer. This revenue source is a significant component of funding for state and local governments. While there is no national sales tax, individual states and their local jurisdictions establish their own rates and rules, creating a complex landscape for businesses to navigate.

Determining Sales Tax Nexus

Businesses must understand “nexus” to determine if they are obligated to collect sales tax in a particular state. Nexus refers to a sufficient connection or presence within a state that creates a sales tax collection requirement. This connection can arise from various activities, and the specific criteria can differ significantly across jurisdictions.

Physical Nexus

Physical nexus is established when a business has a tangible presence in a state. This includes maintaining an office, a warehouse, or a retail store. Having employees, agents, or other representatives working in a state, even temporarily, can also create physical nexus. Storing inventory in a third-party warehouse or through a fulfillment service creates physical nexus in that state. Even temporary activities, such as attending trade shows or making deliveries with company vehicles, can sometimes establish physical nexus.

Economic Nexus

Economic nexus represents a more recent and widespread basis for sales tax obligations, particularly for businesses engaged in remote sales. This type of nexus is triggered when a business meets certain sales volume or transaction thresholds within a state, regardless of whether it has a physical presence there. For example, many states have adopted thresholds such as $100,000 in gross sales or 200 separate transactions into the state within a calendar year. These economic thresholds vary by state, so a business might meet the economic nexus criteria in one state but not in another, even with similar sales activity.

Other Types of Nexus

Beyond physical and economic presence, other types of nexus can also create sales tax obligations. Affiliate nexus can arise if a business has an agreement with an in-state person or entity who refers customers for a commission. Similarly, click-through nexus may be established if a business generates sales through links on websites of in-state residents who receive commissions from those sales.

What is Subject to Sales Tax

Once nexus is established in a state, a business must then identify which of its goods and services are subject to sales tax. Generally, most tangible personal property sold at retail is taxable. This includes physical items like clothing, electronics, furniture, and vehicles. However, the taxability of specific items can vary widely from one state to another.

Many states provide exemptions for certain categories of goods. Common exemptions often include essential items like most groceries, prescription medications, and certain medical supplies. Some states may also exempt manufacturing equipment or agricultural supplies to support specific industries. When a business purchases goods for resale, these purchases are exempt from sales tax if the buyer provides a valid resale certificate to the seller.

The taxation of services and digital products varies by state. While many services are exempt from sales tax, an increasing number of states are expanding their tax bases to include specific services, such as landscaping, cleaning, or certain professional services. Digital goods, including downloaded software, e-books, music, and streaming services, are treated inconsistently across states.

Calculating Sales Tax

After determining where sales tax must be collected and which items are taxable, the next step involves calculating the correct sales tax amount for each transaction. Sales tax rates comprise multiple layers, including state, county, city, and sometimes special district rates. The combined rate applied to a transaction can therefore vary significantly even within the same state, depending on the specific location of the sale or the customer.

To determine which jurisdiction’s rate applies, businesses must understand sales tax sourcing rules, which are either origin-based or destination-based. In origin-based sourcing, the sales tax rate is determined by the seller’s location. For example, if a seller is located in a city with a 7% combined sales tax rate and ships an item to a customer in a different city within the same state, the 7% rate from the seller’s location would apply. This method is simpler for sellers but less common.

Conversely, destination-based sourcing, which is more prevalent, determines the sales tax rate based on the buyer’s location. If a seller is in one part of a state and ships a product to a customer in another part of the state, the sales tax rate applicable to the customer’s specific address would apply. This approach requires businesses to accurately identify the precise location of the customer to apply the correct combined tax rate. Sales tax is calculated by multiplying the taxable sales price by the applicable rate and charged to the customer at the point of sale.

Sales Tax Registration and Remittance

After establishing nexus and identifying taxable items, businesses must register and remit sales tax. Businesses must formally register for a sales tax permit with the tax authority in each state where they have a collection obligation. This registration process is completed online through the state’s Department of Revenue website.

During registration, businesses provide information including their legal name, business type, federal Employer Identification Number (EIN), business activities, and estimated sales volume. Upon successful registration, the state tax authority will issue a sales tax permit and assign a filing frequency. Common filing frequencies include monthly, quarterly, or annually, with higher sales volumes often resulting in more frequent filing requirements.

The ongoing obligation involves collecting sales tax from customers at the time of sale and then remitting these funds to the appropriate tax authorities. Businesses must maintain accurate records of all sales, distinguishing between taxable and non-taxable transactions, and the amount of sales tax collected. Sales tax returns are filed online through the state’s tax portal, requiring businesses to report total sales, taxable sales, and collected sales tax for the filing period. Due dates for filing and payment are specific to each state and filing frequency. Failure to file returns or remit collected sales tax by the due dates can result in penalties, including interest charges and monetary fines.