In fact, along with Brazil and India, the United States has one of the most complex tax systems in the entire world.
Today, we’ll demystify U.S. sales tax for you, whether you live in the U.S. or live outside the U.S. and are looking for information about selling to buyers in the U.S.
How sales tax works
There is no national sales tax in the U. S.
Instead, sales tax is governed at the state level. Each state can decide whether or not to have a sales tax, and forty-five states and Washington D.C. all do. Only five states – Alaska, Delaware, Montana, New Hampshire and Oregon – do not have a sales tax.
Sales tax is a small percentage – usually between 4 and 8% of a retail sale. Sales tax is collected by the retailer and passed on to the state at periodic intervals. The state then uses that sales tax to pay for state and local budget items like schools, roads, transportation and public safety.
Most states that have a sales tax also allow local areas (like cities and counties) to have a sales tax, too. When making a purchase at a brick and mortar store in the U.S., you might see that you paid an odd number like 6.75% in sales tax.
This is generally because you are paying a statewide tax rate, city and/or county taxes, and maybe a “special taxing district” tax rate. Here’s an example from the city of Centennial, Colorado:
- Colorado State Rate – 2.9%
- Arapahoe County – 0.25%
- City of Centennial- 3%
- Regional Transportation District Tax – 1%
- Scientific and Cultural Facilities District- 0.1%
- Total- 7.25%
When should merchants collect sales tax?
In the U.S., eCommerce sellers (whether brick and mortar or online sellers) are only required to collect sales tax in states where they have “sales tax nexus.”
Sales tax nexus is just a fancy, legalese way of saying “a significant connection” in a state. If you have nexus in a state, then that state considers you on the hook for charging sales tax to buyers in the state. You’ll always have sales tax nexus in your home state, but you may find that certain business activities create nexus in other states, too. They include:
- A location – an office, warehouse, fulfillment center, store, or other physical place of business
- Personnel – an employee, contractor, salesperson, installer or other person doing work for your business
- Inventory – Most states consider storing inventory in the state to cause nexus even if you have no other place of business or personnel
- Affiliates – Someone who advertises your products in exchange for a cut of the profits creates nexus in many states
- A drop shipping relationship – If you have a 3rd party ship to your buyers, you may create nexus
- Selling products at a tradeshow or other event – Some states consider you to have nexus even if you only sell there temporarily
- Economic nexus – Exceeding the online sales or transactions amount set by the state
Sales tax nexus applies whether you are based in the U.S. or outside the U.S. If you have a location, personnel, inventory, economic nexus, etc. in a U.S. state, then that state requires you to collect sales tax from in-state buyers.
Once you start selling online, you must first determine nexus, and then determine nexus, get registered, and then collect and remit taxes to be compliant. This typically starts in the state where your business is registered. Most states impose sales tax, but several such as Oregon and Alaska, do not. If your home state charges sales tax, then you will likely have “nexus” in the state.
To help you determine whether or not your business activities give you sales tax nexus, you can find out what every U.S. state sales tax laws have to say about nexus here.
A Special Note on Economic Nexus Threshold
Economic nexus is the newest form of sales tax nexus. A pivotal 2018 Supreme Court of the United States ruling, South Dakota v. Wayfair, paved the way for U.S. states to require that sellers who meet a certain sales or transactions threshold in the state collect sales tax from buyers in that state.
Often, the threshold is $100,000 sales in a state in a year, and/or 200 sales transactions into the state in a year. But you can see each state with an economic nexus law, and find out their thresholds in:
Need to determine if you have economic nexus? DIY with TaxJar .or connect with us for a done for you sales tax nexus evaluation. TaxJar offers a Sales and Transactions Checker that will notify you if you have, or are approaching, economic nexus in a state.
Register for a permit with each state where you have nexus
If you have “nexus” in a state, you must register for a sales tax permit. It’s important to understand what the requirements and potential liabilities are for the specific state you have a “nexus” in.
An accounting firm, like Bean Ninjas, state sales tax office, or government website are all great resources to guide you through registering to collect sales tax. Each state is different, so it’s important to seek out information relevant to your state.
Pro Tip: It’s illegal to collect sales tax without a valid sales tax permit within certain states.
Most states consider it illegal to collect sales tax from buyers without holding a state sale tax permit. In their suspicious minds, if you are collecting without a permit you may be keeping that money in your pocket.
As with everything having to do with sales tax, registering to collect sales tax is different in every U.S. state. You can find our state-by-state guides on how to register for a sales tax permit here.
Is there a difference in the tax process for FBA sellers, dropshippers, and ecommerce shops?
This is one of the biggest questions we get asked, and we want to address it before we dive into the details.
The answer to this is still being debated within ecommerce communities.
This is because when you sell on a platform like Amazon, it’s not clear if the person buying your products is your customer or Amazon’s.
However, the tax process shouldn’t differ regardless of the state(s), which you may require to register due to nexus (More on that in the next section, or if you dropship, sell on Amazon or directly from your own warehouse.
Collecting sales tax
Once you have your state sales tax permit, your next step is to ensure that you are collecting sales tax from buyers in your nexus state (or states.) If you sell on multiple sales channels (ex: Shopify, Amazon or through Salesforce Commerce Cloud) make sure you are collecting sales tax from all of your buyers in your nexus states on all of your sales channels.
Most online shopping carts and ERPs have a setting to allow you to automatically collect sales tax from your customers. That said, some shopping carts and ERPs have more robust sales tax collection engines than others.
Origin v. Destination Sales Tax
Once you’ve determined your business’s “nexus” status, you’ll need to know the difference between origin and destination sales tax. Some U.S. states have “origin-based sales tax sourcing” and some have “destination-based sales tax sourcing” for online sellers.
Essentially, if your home state is origin-based, you’ll need to charge everyone in your state the rate for where your business is located. In origin-based states, like Tennessee, an online seller based in the state charges the sales tax rate at the origination points of a shipment (i.e. your home or warehouse.)
If your home state is destination-based, then you’ll need to charge everyone in your state the tax rate where the item is being delivered. Keep in mind that states have different rules for out-of-state sellers. In a destination-based state (and most U.S. states are destination-based) then you as an online seller are required to collect sales tax at your buyer’s ship to address. This means keeping track of sales tax rates all around a state. And states can have hundreds of sales tax rates!
This can be a tough concept to wrap your mind around, so you can read a lot more about origin vs. destination-based sales tax sourcing here.
Do you charge a shipping charge to your customers? If so, you may have to think about sales tax on shipping charges, too. Some states consider shipping charges a part of the taxable sale (and thus you should charge sales tax on the shipping charges), and others consider shipping charges separate from the taxable sale (thus you do not have to charge sales tax on those charges.) You can see which states consider shipping taxable here.
Most tangible personal property is taxable. But some states will legislate that some items – usually necessities like groceries or clothing – are not taxable. As with everything related to sales tax, this varies by state. For example, clothing is not taxable in the state of Pennsylvania. If you had nexus in Pennsylvania and sold clothing to a buyer in Harmony, PA then you would not charge sales tax. You can check here for information about what products are and are not taxable in each U.S. state.
Pro Tip: Contact a qualified accountant for a sales tax analysis to understand what states apply to your business and why. Once you’ve identified that there’s a requirement to collect, you must register in those states and immediately begin collecting sales tax from those customers to avoid any fines or penalties.
Notice and Report Laws
Some U.S. states have “notice and report” laws, which are similar to states with economic nexus laws. The difference is they require sellers to collect sales tax for their state when they meet certain thresholds instead of simply having a physical location in their state.
For example, the state could require sellers that do $100,000 or more in revenue in their state to register for sales tax even if they don’t have a physical presence in their state.
Pro Tip: Check out this guide from TaxJar, which goes into detail on “notice and report” laws and the states that utilize them.
Retailers often have the opportunity to buy items to resell without paying sales tax at the time of purchase. Resale certificates, otherwise known as a reseller’s permit, are presented to the vendor at checkout. As a seller, you may also accept a certificate from another retailer. This TaxJar post gives more details about resale certificates and when you can use them.
Reporting and filing
When your state sales tax filing due date rolls around (remember, this will usually be either every month, every quarter or once per year), then it’s time to report how much sales tax you’ve collected.
In a handful of states with no local tax rates, this is fairly easy. They merely want you to report how much sales tax you’ve collected from buyers in that state. But in most states, reporting sales tax is a complicated and time-consuming hassle.
The majority of U.S. states want you to break down how much sales tax you collected from buyers in each county, city and other special taxing jurisdiction. This can be difficult if you have a high volume of sales, sell on multiple channels, or simply because your customer’s county and special taxing district can be difficult to determine!
That’s where a sales tax automation solution comes in. (We’ll share more on this topic later in this guide!) Technology can connect with all the channels on which you sell, pull in all of your transactions, and provide you with a sales tax return-ready report. All you need to do is fill in the info from your report and you’re ready to file. Or, if you’d rather never touch a sales tax return again, you can AutoFile your sales tax returns in most U.S. states.
There are a few important considerations to remember when you file sales tax:
- File on time – States generally levy a penalty of about $50 per past due filing, and also charge a small percentage of interest on any late payment.
- File “zero returns” – File a sales tax return on your due date even if you don’t have any sales tax due. Most states require this, and will levy a penalty if you fail to file, no matter if you had collected sales tax over the taxable period or not.
- Don’t discount sales tax discounts – About half the states with a sales tax will allow you to keep a small percentage of the sales tax you’ve collected. While this amount is usually around 1% of the sales tax you collected, be sure to take advantage of this free money!
A Note on Sales Tax Filing for Non-U.S. Sellers
Most states require that you pay via automated clearing house (ACH) transfer from a U.S. bank account. We recommend contacting a good CPA or tax attorney if you need help getting set up to collect sales tax in the U.S.
I hope this article has given you a broad view of U.S. sales tax. If you have questions or comments, start the conversation here!
Get familiar with the reporting and filing frequency in each state where you have “nexus”
Reporting and sales tax filing frequency can vary from state to state, but it’s often related to the volume of sales instead of state “nexus.” For example, smaller sellers with lower volumes of sales will generally file quarterly taxes. Larger sellers would be responsible for filing and reporting their sales tax on a monthly basis. It’s still important to check with your individual state for sales tax regulations and requirements for paying sales tax.
Review your sales tax reports regularly
Automated tax software is capable of generating a variety of useful reports. Two important numbers to look at during reporting include what the sales were for the period and the amount of sales tax collected. Reports will often go by state, but there are different tax rates for various counties and cities. For this reason, you should go through an accountant or use tax software, like Avalara or TaxJar, which are capable of generating these reports.
These reports should be reviewed on a monthly basis at a minimum.
Pro Tip: It’s important to be mindful of what your own specific trends look like within one jurisdiction from one period to the next. This helps to ensure you aren’t paying a consistent amount to a specific jurisdiction, and all of a sudden, the amount is two or three times more without a shared influx in sales. Paying close attention to your numbers will help prevent costly mistakes like this.
Understand employment taxes
When hiring someone to join your team, you need to understand the capacity the person is working at.
Should they be classified as a full-time employee, part-time employee, or freelancer?
If you hire an employee, you’re responsible for a portion of their taxes, whereas contractors and freelancers are responsible for withholding their own taxes.
Whether you have full-time employees, part-time employees, or freelancers, you’ll want to follow all employment laws in your state. This means, among many other things following minimum wage laws, paid time-off mandates, and paying applicable taxes for employees. For freelancers, you’ll need to submit a 1099 form for all workers at year-end.
Pro Tip: The distinction between an employee and a freelancer is nuanced. We recommend chatting with an employment attorney or accountant if you have any questions.
Automating the sales tax handling process
Trying to set up and manage this process manually is extremely time-consuming. We recommend using an app such as Avalara or TaxJar or a qualified eCommerce accounting firm like Bean Ninjas if your needs are extensive (20+ jurisdictions using a Sales Tax Specialist like TaxValet.com.
In addition to automating the sales tax compliance process, these apps can also help you find sales tax exemptions.
Sales tax exemptions are beneficial, but only if you aren’t wasting your time identifying them. If the benefits are no longer outweighing the amount of time you spend identifying and involving yourself in the task, then it’s time to outsource through software or a service provider.
Pro Tip: When looking for sales tax exemptions, such as sales tax holidays in specific states during back to school time, you can also find the information you need by going to the state agency’s Transaction Privilege Tax Reference Guides. Many amnesty days or discount days will be listed on the state’s website or email list. A less time-consuming way to review the information is to use the guides provided by both Avalara and TaxJar.
Finally, you’ll want to maintain a balance and not become too hands-off. We recommend running a quality check of the data being pulled from sales channels to see that operations are running the way that you’ve set up or have been instructed by an expert to execute.
Collecting sales tax for eCommerce businesses can get complicated. This is particularly true when you have nexus in multiple states.
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- Bean Ninjas launches new eCommerce tax division in Australia
- Making tax digital for VAT: Guide for Small Businesses
- VAT EU: What non-EU businesses need to know
- 7 powerful ways to minimise tax (legally!)
- Pros and Cons of Popular US Business Structures
- How to choose the right business structure for success
To get started, check out our free eCommerce toolkit, which can help you establish a solid foundation and understand any potential tax liabilities. Download it here.
This article was last updated by the Bean Ninjas team in November 2021. The original version of this article was written by Jennifer Dunn of TaxJar, a service that makes sales tax collection, reporting and filing simple for more than 20,000 eCommerce businesses. Ready to automate sales tax? To learn more about TaxJar and get started, visit TaxJar.com.