The majority of U.S.-based businesses that sell products or services must collect, report, and pay sales taxes on a regular basis. As a business owner, it’s important to understand this process and to get intimately familiar with the local, state, and federal requirements.
Determine if you need to collect sales tax
The first step to collecting sales tax is to determine if you need to do it at all. A few states don’t collect sales tax; these are Alaska, Delaware, Montana, New Hampshire, and Oregon. But it’s not always just down to the state. “There are many taxing localities involved, each with its own tax rate and list of taxable products and services,” explains Jean Murray, a business tax expert who holds a doctorate in small business management and entrepreneurship, in an article for The Balance. Additionally, if you sell online, you’ll need to determine whether you need to collect sales tax from customers across a variety of states. According to Murray, there are approximately 11,000 tax collection entities in the U.S., making the process a potentially very complicated one.
Consider the type of product you sell
Some essential items like groceries and prescription drugs are exempt from sales tax, though this isn’t consistent across all states. Furthermore, physical goods are often treated separately to services, which states may once again treat differently. For example, in Hawaii, New Mexico, South Dakota, and West Virginia, sales tax is automatically applied to services. Other states may waive sales tax on services depending on their nature.
Digital products may also be treated separately. “Several states haven’t yet clearly stated how sales tax is charged to digital products,” says Kat Boogaard, a freelance writer specializing in entrepreneurship, in an article for Intuit. “Some states treat them exactly like tangible personal property, while others treat them as tax exempt.” Some states even differentiate digital goods from software or distinguish digital products that can be accessed offline versus those that can only be used online.
Register for state sales tax
After establishing that you need to collect sales tax for specific goods in a specific state, you must register for your sales tax permit in that state. “The permit will allow you to collect, report, and pay sales taxes on taxable items,” says Murray. Most states allow you to register online and will require your Federal Employer ID number as well as in-depth information about your business and its ownership structure. With some luck, your state’s sales tax website will have links to all of the local sales tax websites, where you will be able to find more information and register for local tax collection entities. The locality and state where you must pay sales tax is based on what is known as your “tax nexus,” which takes into account where your business is physically located — even if it is your home — as well as where it engages in commerce.
Find out how much sales tax you must collect
Sales tax rates are always changing and keeping up can be tricky. They can range from 0 percent to above 7 percent, and the sales tax in your business’s jurisdiction may not be the same as the sales tax where your customer resides. Some states charge sales tax based on the seller’s location (known as origin-based) while the majority charge based on the buyer’s location (known as destination-based). “If you are selling in multiple locations, you must include the correct sales tax for each location,” Murray adds. Depending on the scope of your business, calculating the appropriate amount of sales tax for each product you sell can be a major task.
If you’ve gotten this far and feel like you’re more confused than when you started, you’re not alone. “It’s normal if the idea of managing your sales taxes is making you chew your nails. Figuring out all of the sales tax laws and details is intimidating,” says Boogaard. Sales tax laws are complex, complicated, and dense, and making sense of them while running your business can be a nigh-insurmountable task if tackled alone. Make sure to hire professional help and use specialized accounting software to help you handle sales tax and avoid getting fines and penalties.