When Do Businesses Need to Charge Sales Tax?

Sales tax in the United States is a consumption tax imposed by state and local governments on the sale of goods and services. Businesses collect this tax from consumers at the point of sale and then remit it to the appropriate tax authorities. These funds contribute to various public services, including education, transportation infrastructure, and emergency response systems. Sales tax is not a federal tax; instead, each state determines its own sales tax laws, rates, and what goods or services are taxable. Understanding when and how to collect sales tax is an important obligation for businesses operating across various jurisdictions.

Establishing Sales Tax Nexus

Businesses must understand “nexus,” which is the sufficient connection a business has with a state that creates a sales tax collection obligation. Nexus can arise from various activities, and its rules are specific to each state.

Physical nexus is the traditional basis for sales tax collection, established when a business has a tangible presence in a state. This can include maintaining an office, a retail store, or a warehouse in the state. Even activities like having employees, sales representatives, or independent contractors working within a state can create physical nexus. Storing inventory in a third-party fulfillment center, such as those used by e-commerce platforms, can also establish physical nexus. Additionally, engaging in temporary activities like attending trade shows or events where sales are made, or even using company vehicles for deliveries, may trigger a physical presence obligation.

Economic nexus became a key concept in sales tax law after a 2018 Supreme Court decision. This ruling eliminated the requirement for a physical presence, allowing states to mandate sales tax collection from out-of-state sellers based on their economic activity within the state. Most states have adopted economic nexus laws, typically setting thresholds for sales volume or transaction count, such as $100,000 in gross sales or 200 separate transactions into the state annually. These specific thresholds can vary considerably by state, with some states setting higher sales thresholds, for instance, at $500,000.

Beyond physical and economic presence, other types of nexus can also create sales tax obligations. Affiliate nexus arises when a business has a relationship with an in-state affiliate or subsidiary that promotes sales, often through common ownership or branding. Click-through nexus is a specific type of affiliate nexus, triggered when an out-of-state business pays commissions to an in-state person for customer referrals that lead to sales, especially through website links. These forms of nexus show that a business’s connection to a state can extend beyond physical presence.

Determining Taxable Goods and Services

Once a business has established nexus in a state, the next step involves identifying which goods and services are subject to sales tax. The taxability of items varies significantly across states, requiring businesses to research specific rules in each jurisdiction where they have a collection obligation.

Most states generally impose sales tax on the sale of tangible personal property. This category includes physical products that can be seen, weighed, measured, felt, or touched. Common examples include clothing, electronics, furniture, and other physical merchandise. The sale of such goods to the end consumer is typically where sales tax is applied.

The taxability of services is more varied and complex. Historically, many services were exempt from sales tax, but a growing number of states now tax specific services. Examples of commonly taxed services can include certain digital services, repair services, installation services, or professional services. Taxability often depends on whether it’s part of a taxable product or listed as a taxable service in state law.

Digital products represent a continuously evolving area of sales tax. This category encompasses items like software, streaming services, e-books, and downloadable content. States are increasingly defining and taxing these products, though their treatment can differ widely. For example, Software as a Service (SaaS) may be taxed as a service, a tangible product, or be exempt, depending on state regulations.

Navigating Sales Tax Exemptions

Even when a business has established nexus and is selling generally taxable goods or services, specific scenarios can lead to sales tax exemptions. Businesses must accurately identify and properly document exempt sales to ensure compliance and avoid potential liabilities. Exemptions are state-specific and are not universally applied.

Resale exemptions are common and allow businesses to purchase items without paying sales tax if those items are intended for resale. A business typically provides a resale certificate to its supplier, which confirms that the purchaser will collect and remit sales tax when the item is ultimately sold to the end consumer. This certificate serves as documentation for the seller, explaining why sales tax was not collected on that transaction. Businesses must ensure they obtain and verify these certificates to validate the tax-exempt nature of the sale.

Certain types of purchasers may also qualify for sales tax exemptions. Government entities, non-profit organizations, and educational institutions are frequently exempt from paying sales tax on their purchases. To qualify, these organizations usually need to provide a valid exemption certificate to the seller. The seller must retain this documentation as proof that the sale was legitimately exempt.

Some goods or services are exempt from sales tax based on their nature or intended use. Common examples of exempt goods in many states include groceries, prescription drugs, and certain medical devices. Additionally, items used in specific industries, such as manufacturing equipment or agricultural supplies, may be exempt if their purchase is tied to a particular use in the production process. This often applies when an item becomes a component of a product for resale or is consumed in manufacturing. Proper documentation, such as an exemption certificate, is always required to substantiate these tax-free sales.

Applying Sales Tax Rules to Specific Transactions

Understanding how sales tax rules apply to specific transaction types is important for practical compliance, especially for businesses with remote sales. These applications integrate the concepts of nexus, taxability, and exemptions into real-world scenarios. The method for determining the correct sales tax rate can significantly impact compliance requirements.

Sales tax sourcing, either origin-based or destination-based, dictates which tax rate applies to a transaction. In origin-based states, the sales tax rate is determined by the seller’s physical location. Conversely, in destination-based states, the sales tax rate is based on the buyer’s location or the delivery address. Most states utilize a destination-based approach, particularly for remote sales, meaning sellers must apply the tax rate of the customer’s location. A few states employ a hybrid system, where some taxes are origin-based and others are destination-based within the same state.

Online sales have introduced complexities, particularly with the rise of marketplace facilitators. Marketplace facilitator laws require platforms like large e-commerce sites to collect and remit sales tax on behalf of third-party sellers using their platform. This shifts the sales tax collection responsibility from the individual seller to the marketplace, simplifying compliance for many small businesses. However, sellers remain responsible for sales tax on sales made outside these platforms, such as through their own websites, and must still monitor their nexus obligations for these direct sales.

The application of sales tax to shipping and handling charges also varies by state. Some states tax shipping and handling if the underlying product being shipped is taxable, while others do not. The specific rules often depend on whether the shipping charge is separately stated or bundled with the product’s price. Similarly, when goods and services are bundled, states have rules for taxing the combined offering, often based on the primary component or if services are integral to the goods.