What do you think of when I say the word “tax”? Chances are you think of oh-so-fun things like the IRS and the dreaded April 15th income tax due date.
But product sellers actually deal with another type of tax every day – sales tax. You’re either charging sales or figuring out how much you collected or filing a sales tax return.
These are the basics of sales tax, income tax’s less understood, but ubiquitous cousin:
1. Sales Tax is Governed at the State Level
States create their own sales tax laws and regulate how sales tax is governed and regulated. The IRS has nothing to do with sales tax. Instead, if you have a sales tax question, you’d contact your state’s department of revenue (or other taxing authority.)
Because each state creates its own sales tax laws, they’re all a little different. For example, Alabama considers sales of all clothing taxable, while Massachusetts exempts individual items of clothing under $175 from sales tax.
2. Collect Sales Tax from Buyers in States where You Have “Nexus”
“Sales tax nexus” is just a fancy way of saying that you have a “significant connection” to a state. If you have nexus in a state, then that state’s laws require you to charge sales tax to buyers in that state.
Like I said above, every state is slightly different, but here are the factors that commonly cause sales tax nexus:
- You live and/or operate your business in that state – you’ll always have “home state nexus”
- You have inventory for sale stored in that state
- You have an employee, contractor, sales person or other personnel in that state
- You have a store, warehouse or other business location in the state
- You have a drop shipping relationship in that state
- You use 3rd party affiliates based in that state
You can find a list of the factors that create sales tax nexus in each state here.
Remember, if you have nexus in a state, you are required to collect sales tax from buyers in that state. If you’re a fairly simple business, you may only have nexus in your home state. But as your business grows more complex and you use 3rd party fulfillment like Amazon FBA, create drop shipping relationships or hire employees and contractors, you may find you have nexus in more states.
3. Register for a Sales Tax Permit Before You Collect
So you’ve figured out that you have nexus and need to be collecting sales tax. Your next step is to register for a sales tax permit with that state. Don’t skip this step! Most states consider it unlawful to collect sales tax without a permit. Yes, states really do get suspicious that you’re telling customers you’re collecting sales tax but really just pocketing it for yourself.
Here are instructions on how to register for a sales tax permit in every state.
4. How Much to Charge? “It Depends”
State laws about sales tax rates and what rates to charge your customers also vary. A handful of states are origin-based, meaning that if you’re based in that state you’d charge all of your buyers the sales tax rate at your location. But most states are “destination-based” meaning you charge sales tax at the buyer’s ship to address.
You can read a whole lot more about how much sales tax to charger your buyers here.
5. Reporting and Filing Can be Automated
When you register for your sales tax permit, the state assigns you a filing frequency – usually monthly, quarterly or annually.
One of the most difficult parts of actually filing can be figuring out how much sales tax you actually collected (especially if you sell on multiple channels) and arranging your sales tax collected the way the state wants to see it. Most states want you to break down your sales tax collected by county, city, and other special taxing district.
Fortunately you can automate sales tax reporting and filing to take this process off your plate. As your business grows in complexity, that’s at least one time consuming chore you can outsource.
Questions or comments about sales tax? You can find out much more about sales tax in our Sales Tax 101 for Online Sellers guide. Or start the conversation in the comments!