A sales tax is a consumption tax levied by a government on the sale of certain goods and services. It is typically added as a percentage or sometimes as a fixed fee to the price of the item at the point of sale. Understanding sales taxes helps businesses stay compliant. And since it’s our duty to inform you and keep you out of trouble, this guide will cover everything you need to know about how sales taxes and how they work in the U.S.
How Sales Tax Works
Sales tax is usually calculated as a percentage of the purchase price. Some goods and services are fully taxable, others are partially taxable, and some are tax-exempt depending on the state. For example, groceries and prescription drugs are exempt in many states but not in others.
While other countries use a Value Added Tax (VAT) administered at a federal level, the USA’s sales tax is administered at the state and sometimes local levels, meaning the rules and rates vary for each state, as each state sets its own base sales tax rate.
Some states, like California, Tennessee, and Louisiana, have high-tax states with combined state and local rates around 9%. Other states like Hawaii and Wyoming maintain lower base rates around 5%, while Alaska, Delaware, Montana, New Hampshire, and Oregon have no state sales tax, although Alaska allows its cities and counties to charge local sales taxes. To get a full grasp of how this is administered for each state and if the local taxes apply, check the Sales Tax Institute state-by-state breakdown.
Sales taxes don’t apply to everything. Certain items are exempt from sales tax in some states, particularly essentials like food and beverages intended for home preparation and consumption. In some cases, exemptions apply only below a specific price threshold. For example, in New York, clothing and footwear under $110 are not subject to sales tax, but any amount above that is taxed at both the state and local levels.
Additionally, several states offer sales tax holidays—designated days each year when consumers can purchase specific items tax-free. These events often coincide with back-to-school seasons and apply to items like school supplies, clothing, and computers, offering families a temporary break on essential purchases.
How to Calculate Sales Tax
Step 1: Convert the Sales Tax Rate to a Decimal
If the sales tax rate is given as a percentage, divide it by 100 to convert it to a decimal.
Example: 7.5% → 7.5 ÷ 100 = 0.075
Step 2: Multiply the Item Price by the Tax Rate
Multiply the original price of the item by the decimal tax rate.
Example: $80 × 0.075 = $6
Step 3: Add the Tax to the Original Price
Add the tax amount to the original price to find the total cost.
Example: $80 + $6 = $86
Result: The total with sales tax is $86, which includes $6 in tax on an $80 item at a 7.5% rate.
This formula works for any price and tax rate: Total = Item Price + (Item Price × Tax Rate)
Sales Tax Nexus: What It Means for Businesses
Nexus is a key concept in determining whether a business is required to collect sales tax in a particular state. Before 2018, a business generally only had to collect sales taxes in states where it had a physical presence, such as a storefront, office, or warehouse. This meant that many online retailers could avoid charging sales tax in states where they had no physical footprint, which gave them a pricing advantage over local brick-and-mortar stores.
However, states were eager to reclaim that lost tax revenue. In 2018, the U.S. Supreme Court ruling in South Dakota v. Wayfair changed things up. The decision allowed states to require out-of-state businesses to collect sales tax based on economic activity alone, even without a physical location in the state.
In effect, the ruling decoupled the traditional definition of nexus from physical presence and introduced what is now called economic nexus. Under this model, a business may be required to collect sales tax if it meets certain sales thresholds, such as $100,000 in annual revenue or 200 transactions in a state. However, this change didn’t take effect nationwide automatically. Each state had to pass its law implementing economic nexus rules.
It’s also important to note that nexus still includes physical connections, not just economic ones. A business may establish nexus by:
- Having employees, warehouses, or inventory in the state;
- Using affiliates (like partner websites that drive traffic and earn commissions);
- Participating in drop shipping arrangements or storing products in fulfillment centers (like those operated by Amazon).
This complexity has created friction between the digital economy and traditional tax systems. For example, New York enacted an “Amazon law” requiring large online retailers like Amazon to collect and remit sales tax—even if they had no physical presence in the state—based on their affiliate relationships.
Sales Tax Remittance
1. Understand Your Sales Tax Obligations
To remain compliant, businesses must identify where they have a sales tax nexus, which could be due to a physical presence (like an office or warehouse) or economic activity (such as crossing a revenue threshold or number of transactions in a state). Once the nexus is established, the next task is to determine which of your products or services are taxable in that jurisdiction, as these rules vary by state.
2. Get a Sales Tax License
After confirming where you’re obligated to collect sales tax, you’ll need to register for a sales tax permit in each of those states. This is a legal requirement and involves applying through each state’s department of revenue. The application process typically asks for your business name, address, structure, and contact information. Once approved, you’ll receive a tax ID or permit number that authorizes you to collect sales tax legally.
3. Collect Sales Tax
With your permits in place, you can begin collecting sales tax on eligible transactions. Most businesses use a point-of-sale (POS) or accounting system—like QuickBooks—that automatically calculates the correct tax rate based on the buyer’s location and the type of item being sold. It’s important to ensure your system accurately tracks taxable and tax-exempt items, especially if your business sells in multiple states or offers a wide range of products and services.
4. Review, File, and Pay
The core of the remittance process is filing and paying the sales tax you’ve collected. On a regular basis—monthly, quarterly, or annually, depending on the state—you’ll need to review your sales records to calculate how much tax is due. Tools like QuickBooks make this easier by generating reports that summarize your total sales, taxable sales, and the amount of tax collected. Once you verify this information, you can file your sales tax return through the relevant state portal and submit your payment by the due date.
5. Record and Keep Good Records
After filing and paying, don’t forget to record the payment in your accounting system. Keeping these records organized is critical not just for bookkeeping but also in case of an audit. Supporting documents like e-filing confirmations, canceled checks, or filing receipts should be stored securely for several years.
Use Taxes
Use Taxes are similar to sales taxes but apply when a consumer buys something from out of state and don’t pay sales tax at the time of purchase. For example, if someone living in Georgia buys a car in Florida—where the tax might be lower—they’re still required to pay Georgia’s sales tax when they bring the car home. In this situation, the burden of collecting the sales tax shifts from the seller to the buyer.
The idea is to prevent people from avoiding taxes by shopping in lower-tax areas. Use taxes are usually the same rate as local sales taxes, but are harder to enforce unless the purchase is large, like a car or boat.
Excise Taxes
Excise Taxes are special taxes placed on specific goods or services, like cigarettes, alcohol, gasoline, or airline tickets. These taxes are often already included in the price of the item being sold. Instead of being a percentage like sales tax, excise taxes can also be a set amount—for instance, New York City sets a local excise tax of $1.50 per pack of cigarettes, in addition to the $5.35 state tax.
These are sometimes called “sin taxes” because they’re often used to discourage products considered harmful, like tobacco or alcohol.
Conclusion
Sales tax in the U.S. is anything but one-size-fits-all. This is why it’s important to understand its complexities and keep up with the requirements so as to stay out of government trouble. I hope this article has at least helped with the understanding part. If in doubt, you can always consult us here at Startup Geek for clarity.
* This article was reviewed by Steve Lee of Diligent Co. You can reach out to him at steve@diligentco.net
