Published July 3, 2025
Discover How Sales Tax Is Calculated with Real-Life Examples
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Updated - Originally published February 5, 2025
With sales tax, it’s not the math that’s difficult. It’s understanding the what, where, and how.
In my years helping businesses with sales tax, I’ve found it’s helpful to use concrete examples as I walk through the components of sales tax calculation, the most common mistakes, and the negative impact of incorrect sales tax calculations. I’ve done this so many times in conversation that I figured it would be helpful to do it in writing.
Below I’ll start by walking through the foundational principles and then provide some simple examples that help those principles stick so you can ensure your business is in good shape with your sales tax obligations. Let’s dig in.
One of the biggest challenges around sales tax starts with a lack of information about what sales tax is and how it applies to your business. Since every business is unique and so many different elements affect sales tax, there are dozens of places where you may be missing critical components to handle sales tax.
In its simplest form, sales tax is a government-imposed tax on goods and services represented as a percentage of the transaction value. Governments use the money collected from sales to fund government programs and public services. Your sales tax dollars might go towards:
Sales tax is an important form of revenue for local governments. Since sales tax is a local tax, not a federal tax, the rules and regulations around sales tax vary from state to state, county to county, or even city to city! It’s also a form of indirect tax. As the retailer, you collect the tax from the customer at the time of sale and then remit the tax collected to the government.
Real estate agents may claim the phrase “location, location, location,” but it also applies to sales tax. Location is everything for determining sales taxability. For example, five states don’t charge sales tax at all: Alaska, Delaware, Montana, New Hampshire, and Oregon (also known as the NOMAD states). But even in those states you still need to stay on top of changes—Alaska recently passed legislation stating that local jurisdictions can opt to require e-commerce businesses with qualifying nexus to collect sales tax.
The point is that your sales tax obligation is dependent on a lot of variables and many of those variables themselves are moving targets. To begin to get a grasp of your own obligation, start with nexus.
Think of nexus as an official connection between your business and a state or local jurisdiction. It defines when you must pay sales tax in a state or municipality. Different factors—physical presence, sales volume, or other considerations—can establish nexus in a jurisdiction. So knowing your nexus will keep your business compliant with all the sales tax obligations you need to meet. (Use our free nexus calculator to get started.)
Another aspect that makes calculating sales tax so difficult is that (on top of nexus and location) sales tax is subject to change due to sales tax holidays, exemptions, or qualifying items. For example, in some states, groceries and food items may be taxed at a lower rate than other items. And with the surge in digital products, the sales tax laws around those also vary.
As you assess your sales tax responsibilities, review the following areas:
Whether or not you need to pay sales tax on shipping costs depends on the state. Connecticut, for example, requires businesses to charge sales tax on shipping costs for taxable sales, but not on exempt sales. In Kansas, you no longer have to pay sales tax on shipping if it is separate from the product price on the invoice.
To ensure you comply, check local sales tax laws to correctly calculate sales tax for shipping.
With an understanding of what components make up sales tax calculations, we can put it into practice with a simple algebraic equation.
Sales Tax = Transaction total x (Sales tax rate / 100)
That’s easy enough so the bulk of your time will be spent researching sales tax rates by state to determine the amount to charge on taxable sales. States may also pass updated legislation affecting sales tax rates, so staying vigilant about rate changes is important. (This is just one reason why having sales tax professionals, and tax calculation technology, on your side can alleviate some pressure around sales tax compliance.)
As you assess your taxability, you’ll become more familiar with what to look for to stay compliant. Let’s look at two examples of how businesses successfully calculate their sales tax.
Let’s say a Nevada-based sauna manufacturer does three commercial-grade sauna installations at a resort in Kissimmee, Florida. By sending an installation crew to Florida, they have a physical presence in the state (triggering nexus) and must collect and remit sales tax on the product (building materials) but not the service (the installation). Let’s look at the math.
The sales tax rate in Kissimmee is 7.5%. If the sale price for three saunas is $125,000, then the sales tax calculation would be:
Sales tax = $125,000 x (7.5 / 100)
Sales tax = $125,000 x 0.075
Sales tax = $9,375
Add sales tax to sale price of the saunas:
$125,000 + $9,375 = $134,375
Installation should be billed separately or as a separate line item.
Total transaction cost for the customer (installation + product & tax): $164,375
As you can see, the company still needs to charge for installation ($30,000), but if they calculated the sales tax on the transaction total of products and services, they would be overcharging on sales tax. That’s a fast track to unhappy customers. The best way to avoid this is to have everything on a separate line item on your invoices or invoice separately for taxable and non-taxable items.
Yet another example of how frustrating sales tax can be: if your crew was later sent to Orlando, Florida, you’d need to change your math because the sales tax rate drops to 6.5%. So don’t assume you know the sales tax rate even if you’ve worked in the state or area.
Let’s look at a Georgia-based software company (SaaS) with a high sales volume in California and Texas.
The sales tax rules for both states are vastly different.
Sales Tax in California: California does not charge sales tax on SaaS or digital products unless the SaaS produces a physical product. In this case, the SaaS company would be exempt from sales tax.
Sales Tax in Texas: Texas sales tax laws state that if your business meets economic nexus (>$500,000 in sales in the preceding 12 months), you’re responsible for collecting and remitting sales tax. Statewide, there is a 6.25% sales and use tax on SaaS, with local jurisdictions adding up to 2%, making the total tax rate as high as 8.25% in some areas. However, Texas allows a 20% exemption on SaaS sales, meaning sales tax applies to only 80% of a taxable SaaS sale.
So, for example, in Houston (where the tax rate is 8.25%), if our SaaS company had $750,000 in sales over the past 12 months, they have met economic nexus and must collect and remit sales tax. If they made $60,000 in sales last month, sales tax applies to 80% of that total:
Taxable sales = $60,000 x 0.80
Taxable sales = $48,000
To determine their sales tax responsibility for the month:
Sales tax = $48,000 x (8.25 / 100)
Sales tax = $48,000 x 0.0825
Sales tax = $3,960
The same equation applies for individual transactions. If the SaaS product retails for $100, only $80 would be taxable:
Sales tax = $80 x (8.25 / 100)
Sales tax = $80 x 0.0825
Sales tax = $6.60
As these examples likely make obvious, sales tax is not a “set it and forget” type of tax. I know it’s challenging to keep up with all of the changes and regulations surrounding sales tax, but getting complacent can cost you big, especially if you get audited. Here are some of the biggest risk areas when it comes to accurately collecting and remitting sales tax:
Simple as it may be, miscalculations from basic math are among the most common sales tax mistakes. This is one reason I suggest a good mix of software and human expertise.
Business owners often use the wrong sales tax rate if they aren’t current with new legislation. Failing to catch these changes can result in over/undercharging customers. The same goes for rate changes from one jurisdiction to another. Knowing how to properly apply sales tax rates, even if it’s just one city over, is critical to getting your sales tax process right.
Miscalculating sales tax can also come from improperly applying discounts, coupons, or shipping charges. Sometimes, it’s just a series of rounding errors that can throw off your sales tax calculations.
Misclassifying products and services is another common sales tax miscalculation. This can be difficult because different products and services can be taxed at different rates. Business owners must understand the taxability of their products and services and how they should be taxed. It may even vary from product to product.
Missing when you reach nexus in a jurisdiction can lead to a failure to collect sales tax. Whether it’s a physical footprint or meeting the economic nexus qualifications, you have to recognize when you will be responsible for collecting and remitting sales tax.
Another element of staying sales tax compliant is regularly updating and checking exemption certificates. Exemption certificates document your non-exempt status for certain transactions. Neglecting to obtain and maintain valid certificates can result in uncollected sales tax liabilities during audits.
Just like poor bookkeeping can hold up accurate financial reporting, poor recordkeeping can leave you vulnerable to big mistakes with your sales tax. Keeping accurate records can help track changes and tax responsibilities. In the event of an audit, an accurate record of your sales tax process is practically priceless.
The final contender for how you might miscalculate your sales tax is missing special circumstances. This can look like special taxation districts (like tourist areas) or sales tax holidays. Missing these could result in financial liabilities and non-compliance.
By understanding every element of sales tax calculation, you can confidently expand your business without worrying about miscalculations. Reliable sales tax software, regular self-audits, and consulting with experts are pillars to ensuring compliance. If you’re not sure what your next step should be, or just want expert help taking it, schedule a free call with us to ask questions and get a game plan that will let you stay compliant while staying focused on growing your business.
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