How is sales tax calculated?

What is sales tax?

Sales tax is a tax imposed on customers, when they purchase any products and services. It is a pass-through tax, which means you collect it from customers and remit it to your local or state government.

For many businesses in the U.S., collecting sales tax is a compulsory part of selling any goods and services. But before you start collecting, you need to figure out how much sales tax needs to actually be collected.

Figuring out sales tax can be tricky, because of things like hard to understand sales tax laws, and what state, county, and city your business or the customer has a physical presence in. In simple terms, if the products or services that you sell are subject to sales taxes, you are required to do the following:

  • Calculate how much sales tax to charge
  • Collect sales tax from buyers
  • Pass the tax onto the state’s taxing authority, by filing a sales tax return

Here we’ve described how sales tax is calculated, and all the thinking that goes into the process, to help businesses figure out if they need to charge taxes, and if so, how?

Consider whether you need to charge sales tax

Whether you need to collect sales tax depends on a few things:

  • What you’re selling is actually taxable: most tangible property in the U.S. is taxable. However, there are some exceptions to this in some states, such as essential items including groceries, clothing, or textbooks. You will need to check your state requirements to see if your goods are taxable. Likewise, the same must be done for services.
  • Your state collects sales taxes: Alaska, Delaware, Montana, New Hampshire and Oregon all do not impose sales taxes. Keep in mind there might be local taxes though.
  • You have a nexus where you are selling: the definition of a nexus varies in different states, but the overall definition is that you are connected to the state in some way – for instance by means of an employee
  • Origin-based or destination-based sales taxes: 

Calculating sales tax (in a singular, physical location)

If you sell from one location, simply find out your local, county and state tax rates, add them up and charge accordingly. You can use sales tax calculators to help you learn how to find the tax rate in a place. An example of a website that helps you to do so is TRUiC; all you have to do is enter your business’ city and zip code.

Calculating sales tax (selling online)

If you sell online, calculating sales tax can be a bit more difficult. The first thing you’ll need to do is figure out if you run your business in an origin-based or a destination-based state.

Origin-based vs. destination-based states

In origin-based states, sales taxes are based on where you, the seller, lives, and is not impacted at all by the location of the buyer. You would then take into consideration your local, state and county taxes.

In destination-bases states, you should be charging your customers sales tax on the rate where you are delivering the item to, considering their local, state and county taxes.

Once you’ve figured out what kind of sales tax to use, you can again use the calculator or work out the pricing yourself. Most states tend to be destination based, with currently only 12 states being origin-based, including Arizona, Illinois, Ohio and Pennsylvania. It’s important you get the right sales tax – you really have to get into specifics of where the buyer lives: there are over 10,000 sales tax jurisdictions in the U.S., so it’s a good idea to be sure of the sales tax rate, lest you end up charging more or less to a customer.

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