Executive Summary
- Sales Tax is imposed by the state, and sometimes counties, cities, and special appraisal districts. Usually sale taxes are submitted to the state for all taxing entities. You must register for a sales tax permit with the state to collect sales tax.
- Virtually all products sold are taxable to the end users. Exceptions are noted in your state’s sales tax code.
- Only certain services are taxable. The service must be explicitly defined as taxable in the sales tax code.
- You must collect sales tax in any state in which you are physically present (sales representatives, installers, delivery vehicles all count as physical presence).
- Even if not physically present, most states now expect you to collect tax if you have a “significant economic presence”. This is generally being defined as greater than 200 transactions and greater than $100,000 in revenue.
You think so and you hope so. Not an unusual answer and given the complications inherent in sales tax, an understandable one.
Sales tax has its origins in the 1930’s when Kentucky and Mississippi were the first states to impose a tax on the sale of tangible items. Back then it was fairly simple. You buy a sack of flour at the Dry Goods store in your hometown, you pay the state and local sales tax where the sale occurred. The store owner collects the same sales tax rate on all their sales and remits them to the state. Easy.
Sales tax audits, on average, cost companies $96,552
But since 1930, commerce has gotten more complicated, both in the distance from which we shop from our home and in the types of goods and services being bought and sold. In 1930, the states didn’t think about telecommunications services, cable, internet subscriptions, or even inter-state magazine subscriptions. You shopped in the stores in your town. You bought tangible goods. Not much room for debate here.
Well, now we are in 2019 and consumers constantly buy goods (including digital goods) from all over the country. There are now many layers in the distribution channel, including the manufacturer, distributor, retail outlet and ultimate consumer. Add to this complication the fact that states have suffered greatly since 2009 with reduced tax revenues as a result of the recession. An increase in sales tax rates causes a public outcry, but if the state can collect from businesses in other states and add new goods and services to the taxable category, they can achieve increased revenues and haven’t attracted much public notice. So what do you think most states are working on right now?
So let’s start with the basic rules of sales tax and then we’ll discuss some changes that have occurred just in the last two years.
What is sales tax and where does it come from?
In it’s simplest form, sales tax is a tax on the sale of tangible goods and certain services. It is imposed by your state’s Taxation Department or Department of Revenue or Comptrollers Office (the name varies by state). Sales taxes can also be imposed by the county, city, and even some special appraisal districts, so these entities’ rates are added to the state rate to determine the total sales tax rate. Sales tax rates generally vary between 4% and 11.25%. Only five states do not impose a sales tax: Alaska, Delaware, Montana, New Hampshire and Oregon.
What do I have to do when I start my business?
If you are selling a product or will be providing a taxable service, you must obtain a sales tax permit from your state. Visit the department’s website and they usually have a section on new businesses or applying for sales tax permits. The state will issue you a Sales Tax Permit, including a Sales Tax ID Number and will assign a filing frequency (monthly, quarterly, or annually) depending on your projected revenues.
How do I collect sales tax?
If you have a retail storefront, this is pretty straight-forward. Your business will add sales tax on all sales (I’m ignoring Exemptions or Resale Certificates for now). You will collect that tax from your customers at the rate imposed by your state, county, city and special appraisal district as applies to the location from where you are selling. (If you move locations or add a location, you must apply for a new Sales Tax Permit with the correct address. Failure to do so could mean you are collecting at an incorrect rate and will have to pay the correct rate later, plus interest and penalties.)
If you sell online or if you sell services, it all depends on your state’s sales tax laws and now, on the sales tax laws that you are selling into. See “What if I don’t have a Retail Storefront?” below.
How to I remit sales tax?
You will report to the state, usually monthly, the amount of taxable sales for the previous month and remit the collected tax. You will report to the state which counties, cities and special appraisal districts you collected for, but you will remit all of the money to the state. Many states now allow you to file these returns and pay electronically. Some require you to do so.
Some states require payments more frequently than monthly . Over certain revenue levels, some states now accelerate payment before the 20th (Arkansas and Oklahoma are two that I know of). Check your state tax department website for more information.
What are these Exemption Certificates or Resale Certificates you speak of?
The states are attempting to collect the sales tax only once in its progression to the end consumer. I think of it as the sales tax food chain. The last one “eating” or “consuming” the goods is the one responsible for sales tax. Therefore, if you are a distributor that sells to retailers, the states expect the retailer to collect the tax from the end consumer, not you. However, this food chain must be documented and that’s where Resale Certificates come in. If I am a retailer buying from you, the distributor, I will give you a Resale Certificate that indicates my business name, my sales tax ID number and specifically what I buy from you that I resell to the end consumer. You, the distributor, must keep this Resale Certificate on file and be ready to present to the state if requested during a sales tax audit. (These certificates are not mailed into the state.) The Exemption Certificate is for government agencies, religious organizations, etc. that the state has ruled are exempt from sales tax.
So, if you are transacting a sale at your location, you should always charge tax unless you have one of these certificates on file. According to the 2013 Wakefield Research Survey on Sales and Use Tax Management, 30% of businesses undergoing sales tax audits did not have these certificates on file.
What’s my risk with incorrect sales tax filings or not filing at all?
Big. States are suffering from reduced revenues and are looking for any way to increase their collections. Not filing at all is not a good idea, because the state’s are pretty good are finding you, either from other state filings or your physical presence. Your business is at a higher risk for a sales tax audit from the state than it is an income tax audit from the IRS.
The risk with incorrect filings is that you will eventually be audited and you won’t be able to go back to the consumer after the fact for the taxes you failed to collect. So you will have to pay the tax, penalties and interest. According to the Research Survey mentioned above, of those companies audited for sales tax, it cost the companies, on average, $96,552.
What if I don’t have just a retail storefront? What if I sell on-line? By catalog? By phone?
If you get orders via phone, mail or internet and ship them to other states via common carrier (UPS, FedEx, Post Office), the old rule was that you did not have to collect any sales tax on those sales. The states would determine if you had “Nexus” in their state, a fancy word for “physical presence”. If you had sales reps in the state, or a distribution center, or you delivered the goods in your own vehicles, you were considered to have a physical presence and were expected to collect sales tax in that state.
Well, guess what? Ecommerce transactions in 2018 accounted for over 14.3% of total retail sales and Amazon alone accounted for 40% of that number. That’s $517.36 billion in sales that many states have not been able to collect sales tax on. States have been screaming that this old notion of “Nexus” had to change. Some estimates put the lost sales tax revenue at $17 billion.
In June of 2018, in South Dakota v. Wayfair, Inc., the Supreme Court ruled that states may require the collection of sales tax by vendors shipping products into their state who are not physically present in their state. The South Dakota sales tax law, passed in 2016, required all sellers with greater than $100,000 in revenue or over 200 transaction in South Dakota to collect sales tax. It was challenged by several large retailers, but the case with Wayfair ultimately made it to the Supreme Court, where the law was upheld.
So, if a state has not yet passed similar legislation, expect them to do so soon. As of December 2018, 31 states had laws requiring taxation of out-of-state purchases. So if you are shipping products to another state, assume when you hit 200 transactions or $100,000 in revenue, you will be required to collect and remit sales tax in that state.
Am I selling a good or a service? What if I lease or rent things to consumers?
The answers to the above questions all depend on what is written in your state’s sales tax code.
As a general rule (very general- there are hundreds of exceptions):
- the sale of goods to an end user is subject to sales tax.
- Leases and rentals are also usually considered taxable. (In some states, rentals incur an additional rental tax.)
- A service is usually only subject to sales tax if it is specifically included in the state’s sales tax code.
Described another way, sales tax laws usually started with the assumption that all sales of goods were taxable and all services were not taxable. Then specific laws were added to exempt certain products (some food items) and to tax certain services (data processing). This makes some sense if you think about the history of commerce described above.
Most state revenue departments will answer your specific questions about the collection of sales tax. I would just avoid giving them a business name, if possible, and tell them you are researching these questions for a new business- you don’t want them to think you have done it wrong for years and end up initiating an audit.
What the heck is the Use Tax in Sales and Use Tax?
Think about the sales tax food chain again. If you, as the end of the food chain, purchase an item on which you do not pay sales tax, you are liable for the tax as the consumer- called Use Tax. The reality is that individuals almost never file and pay use tax and the states don’t enforce it at the individual level because of the cost and the difficulty of tracking these purchases. The exception to this is on large items that cross state lines such as automobiles or airplanes.
Businesses, on the other hand, are ripe for the picking for use tax, and if you are audited for sales tax, expect them to look at the use tax as well. Basically, anything you buy for use in your business and not for resale on which you are not paying sales tax (because the seller didn’t collect it from you) should be reported for use tax. Things to look for in this category are anything you buy from out-of-state, including magazine subscriptions, mail-order office supplies, furniture, any inventory items you use internally.
Also, be careful when you give your vendors a resale certificate, because if you are too broad in your description of what you are reselling, the vendor will not charge you tax on those items and you will owe use tax.
Most states combine their sales and use tax returns, so you can report your use tax liability when you report your sales tax liability.
In short, sales taxes can be complicated and can cause big problems for your business. Make sure you as the owner know if you are in compliance and get a trusted advisor, internally or externally, to ensure you stay in compliance. The rules on sales tax are constantly changing- I would bet some changed in the time it took you to read this article.
