Sales Tax 101

by Jun 7, 2020Taxes

What is Sales Tax?

Sales tax is a tax placed on consumers by their state and local government. Sales tax is charged to the consumer and is calculated as a percentage added to the price of a product.

How does Sales Tax work?

The seller is responsible for calculating sales tax, collecting it from consumers, filing with the state, and remitting the funds to state and local government. States and local governments use that money to fund things like schools, parks, roads, and special projects. There’s no federal sales tax. In the United States, sales tax only exists on state and local government levels.

How do you know if you are required to collect sales tax?

For any state you have sales in, you need to figure out two things and in this order:

1. Is what you’re selling a taxable item in that state?

If it’s not a taxable item, then you can proceed as usual and invoice the client without sales tax.
If it is a taxable item, you then need to figure out the next step.

2. Do you have sales tax nexus in that state?

If you don’t have sales tax nexus in that state, you have nothing to worry about, and you could proceed as usual and invoice a client without sales tax. If you do have sales tax nexus in that state, you need to register with the state to collect and file sales tax. You’ll also need to add sales tax to your invoices for your clients.

 

What are taxable items?

Tangible Goods

In general, most states tax tangible goods, meaning physical items you can touch. For example: a wedding album, a thumb drive, or a custom-designed t-shirt.

Services

Some states tax services. New Mexico, Hawaii, West Virginia, and South Dakota broadly tax most services. 20 other states tax certain services. You could see why it’s so important to make sure you understand each state’s rules.

How do you know which rate to charge?

Sales tax rates vary across states, cities, counties, and local areas. You may have to calculate a mixed sales tax rate.
For example, I’m in Buffalo, New York. Sales tax for the State of New York is 4%, and in Erie County where I live, the county sales tax is 4.75%. So that’s a total of 8.75%, where when I report, 4% goes to the state and 4.75% goes to my local county.

How do you register to collect sales tax?

You could start by looking up sales tax laws for your state. Every state has a website that includes taxation information for individuals and for businesses. You can click HERE and go to the IRS listing of all state websites for your convenience.

You’ll need to find the state that you want to navigate to, then you’ll find the sales tax portion of their site. Each state has a publication that goes into detail explaining when you have to register to collect sales tax, how you figure out what rate you’re using, and how often you’ll need to file and pay.

What if it’s is not clear on the state’s website?

If you cannot determine if you need to be collecting sales tax, or you’re just not sure how to file, call the state. When I’m working with a new client in a particular state and it’s not clear to either of us if they need to be collecting sales tax, I will pick up the phone and call. I’ll explain the business, what they sell, how they sell it, and get direct guidance from that state’s sales tax office as to what we need to be doing. This is a valuable resource. You should use it, and it’s free. Talking directly to the state will remove any doubt of what you should be doing to stay compliant.

What the heck is Nexus?

Nexus is just a fancy way of saying you have a significant presence in a state. If you have sales tax nexus in a state, then you have to register, calculate, and collect sales tax. Nexus is an easy concept to understand, but determining what activities or thresholds trigger nexus in each state can be a little bit challenging, as rules vary widely from state to state. Let’s look at some examples of sales tax nexus.

Physical presence

One of the most basic nexus rules is that if your business has a physical presence in a state, you’ll be required to collect and remit sales tax there. It’s relatively simple if your business is located in a particular state and you only have sales within that state, then you only collect and remit your home state sales tax. However, if you have locations of your business in multiple states, you may create nexus in each of those states. This can apply to branches, stores, warehouses, drop-shipping facilities, or any real estate or property that belongs to your business in another state.

Delivery and distribution

As long as you ship goods to customers by a common carrier, such as USPS, UPS, or FedEx, you’re unlikely to trigger a sales tax obligation through delivery, but you’ll need to check each state carefully. In some cases, however, the use of a drop shipper or a contract with a distribution company that functions as a drop shipper is considered a taxable nexus creating activity in some states.

Employee location

Nexus can also be created if you have employees in a different state, or if employees or contractors conduct any work at a customer’s out-of-state location or deliver products in another state on your behalf. Nexus may apply.

Event attendance

Regularly attending trade shows in other jurisdictions beyond the physical location of a business can also be considered nexus in certain states.

Advertising and affiliates

If you advertise online or use affiliates to get business, you may trigger nexus. When a business in another state sends customers to your business through links on a website, this can create nexus in the originating state, according to the affiliate or click-through nexus laws.

You can see how this starts to get a little overwhelming

Economic Presence

In the summer of 2018, a new nexus trigger called Economic Presence was born, to make everything just a little more interesting. You may have heard some things about it on the internet or on social media – especially, the supreme court case of South Dakota versus Wayfair.

South Dakota versus Wayfair

On June 21st, 2018, the supreme court enacted the economic presence requirement. This removes the requirement to have a physical presence in a state to create sales tax nexus. There are new criteria that will trigger sales tax nexus based on sales and transactions in a particular state.
Let’s look at some examples of economic presence.

California

For example, California has added economic nexus. This puts California’s threshold at $100,000 or more of sales in the State of California or more than 200 transactions in the previous or current calendar year.

This means if you are selling taxable goods in the State of California even if you live in say New York, if you are meeting the threshold of $100,000 or more in sales or 200 transactions in the previous or current calendar year, you may have to charge sales tax on California transactions.

Let’s look at another example

Connecticut

Connecticut has a threshold of $250,000 or more in sales AND 200 or more transactions in the previous calendar year. You can see how this is a little bit different than California. So Connecticut wants you to have sales of $250,000 or more AND 200 transactions. So you have to meet both criteria to trigger economic nexus in Connecticut.

High-Level Overview

45 states have sales tax. There are only five states without sales tax, and those are represented in gold, which are Alaska, Delaware, Montana, New Hampshire, and Oregon. Of the 45 states with sales tax, 36 of them have already adopted economic nexus and more states are adopting it as time goes on. This is a great example of how sales tax laws vary from state to state. That’s why it’s so important to understand sales tax laws and nexus for any state you have sales in.
You can click HERE to see the details of the economic nexus for each state that has adopted it and some details on those that are in the works of adopting it.

Why is Sales Tax compliance important?

Because non-compliance can cost you! States do not mess around when it comes to non-compliance. You could end up owing large amounts of penalties and fines, not to mention back sales tax if unpaid. They can shut your business down. They can put a lien on your business or personal accounts based on your business entity. You could go to jail. We’re talking directly to jail, do not pass go, do not collect $200 kind of jail time. This is serious. It’s crucial you understand the sales tax laws of any states that you do business in.

Want more bookkeeping and tax-related tips to help you effectively run your creative business? Click here to join my free Facebook community #CreateMore with Tiffany Bastian and join me live every Friday as I answer all of your questions!

– Tiffany Bastian

5 Bookkeeping Basics for Creative Entrepreneurs

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