Published January 10, 2025
What is Sales Tax? A Complete Guide for Beginners
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Understanding sales tax is a huge part of any business strategy. As businesses grow and cross into new markets, managing sales tax becomes more complex and requires diligent maintenance to stay compliant. But why is it such a big deal? Sales tax is a unique form of taxation with a whole host of rules and regulations that can vary from city to city. This can make it difficult to manage without the proper understanding of how it works and how it affects your business.
When you understand the nuts and bolts that drive sales tax rates and compliance, you better position yourself to price your products and services wisely and successfully manage your sales tax obligations. From there, your business can thrive in new markets and avoid hefty fines.
Sales tax is a consumption tax (a tax on what people spend instead of what people earn) that is imposed by the government on certain goods and services. It is paid by the consumer at the point of sale, collected by the retailer, and remitted to the government. It’s also a form of indirect tax because although the customer is paying the sales tax, the money collected passes through the retailer to the government.
Sales tax is determined as a percentage of the purchase price of a good or service. The federal government defers to the states to determine sales tax rates. Four states have no sales tax: Delaware, Montana, New Hampshire, and Oregon. Alaska has no statewide sales tax but allows local governments to set their own sales tax rates.
The money collected from sales tax is used to fund government programs, infrastructure, education, transportation, and healthcare. It’s an important source of revenue for local and state governments.
If you’re reading up on sales tax, you’ll likely come across use tax as well. Use tax is a conditional sales tax charged on any goods purchased without sales tax when sales tax would normally apply. You would pay use tax on an item at the use tax rate of the state it is being used.
Use tax is in part meant to keep shoppers from crossing state lines or jurisdictions just to avoid paying sales tax. For example, if shoppers in Washington cross into Oregon to shop for clothing sans sales tax, they would be responsible for paying use tax on their purchases.
Another example would be if a farmer purchased farm equipment in another state but only paid state sales tax, not local sales tax. Once the farm equipment is brought to his home state and used in his local jurisdiction, he will be responsible for paying use tax at his local sales tax rate.
Use tax is hard to enforce, however, because it is up to the consumer to calculate and pay use tax. Both sales tax and use tax are used for the same purposes. The main difference between them is how they are applied to the product or service. Sales tax is levied at the time of purchase whereas use tax is imposed by the jurisdiction where the product or service is used.
Calculating sales tax can get complex quickly. It is based on a percentage of the purchase price, but there are additional factors that play into what determines that percentage. Forty-five states have a statewide sales tax and thirty-eight states have local sales tax rates, as well.
State and local sales tax rates can combine to determine the total amount of sales tax that should be collected at the time of sale. For example, the minimum sales tax rate in New Orleans in 2024 is 9.45%. It is made up of both state and local rates. The state sales tax rate is 5% and the local parish sales tax rate is 4.45%. (Louisiana has one of the highest sales tax rates in the United States.) Alaska has no state sales tax rate, but jurisdictions are permitted to determine their own sales tax rate. Juneau, for example, charges a 5% sales tax rate.
Sales tax rates can also vary based on the type of good or service. Many states do not impose on groceries, or they tax groceries at a lower rate to help support low-income families, while things like alcohol or tourism might be taxed at a much higher rate. When calculating your sales tax responsibilities, it’s critical that you understand what categories your products and services fall under to make sure that you are collecting the correct amount of sales tax.
In the end, your sales tax calculations are based on the local sales tax laws of any jurisdiction where you have met the economic nexus requirements.
Nexus is a large component of determining sales tax responsibility. Nexus refers to the connection between a business and a local jurisdiction. Before the Supreme Court case South Dakota vs. Wayfair in 2018, online retailers who did not have a physical presence in a state were not required to collect and remit sales tax. This meant that local governments were missing out on sales tax revenue from online superstores like Amazon and Wayfair which were direct competitors to local businesses. Now, any business that meets the local requirements for economic nexus is obligated to collect and remit sales tax. Economic nexus may be reached by several factors:
to pay sales tax even if their individual sales do not meet nexus requirements. This is generally based on whether or not the marketplace as a whole meets the nexus thresholds for a jurisdiction.
With the variety of nexus requirements over thousands of sales tax jurisdictions, business owners must monitor their nexus regularly to avoid hefty fines for neglecting sales tax obligations.
In the often long process of production and manufacturing, products pass through numerous hands before they reach the end user where sales tax is collected. There are situations where you may be exempt from paying sales tax or you need a resale certificate to avoid paying sales tax when none is due. Carefully monitoring when sales tax is applicable ensures that consumers and businesses are not over or undercharged for sales tax.
Let’s take a look at this example: A farmer who grows coffee beans sells the raw beans to a roasting company. To avoid paying sales tax on the coffee beans, the roasting company must obtain a resale certificate that indicates that they are not the end user of the coffee beans. The roasting company then sells the roasted coffee beans to a packaging company which also has a resale certificate that exempts them from paying sales tax.
The roasted and packaged coffee beans then pass through yet another step of the process when they are sold to a distribution company (which also has a resale certificate). The distributor places the product in coffee shops where now the roasted coffee beans will be sold with the addition of sales tax to the end user. The coffee shops will be responsible for calculating, collecting, and remitting the sales tax to their local jurisdictions.
Each step of the manufacturing and distribution process requires that businesses obtain resale certificates to avoid paying sales tax when none is due. Sales tax is only collected at the final sale to the end user.
Due to the dynamic and diverse nature of sales tax, it can be a major factor when determining pricing for products and services. Your pricing model will depend on how your business decides to approach sales tax.
If you choose to include sales tax in the final price of a product, you are faced with two options:
When sales tax laws change, especially when they increase, your business will have to decide if raising prices will affect customer relationships. Drastic price increases can disrupt customer loyalty and you may want to consider long-term pricing strategies to cover increases in sales tax rates.
While more tedious, some businesses prefer to alter the pricing of their products based on the sales tax rates in that jurisdiction. This means the same product in Oklahoma City would be listed at a different price in Nashville. This can be more difficult to manage and possibly cause customer confusion, but can help you control costs more effectively.
As you look at pricing your products and services, consider the easiest way for you to manage profitability and successfully collect and remit sales tax. Once you have your processes in place, sales tax can become a naturally occurring piece of your business strategy.
The most important thing when it comes to sales tax is that you maintain compliance. That means staying up to date with nexus requirements and new legislation. Get help from The Sales Tax People to improve your sales tax process and protect your business’s continued success.
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