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What is U.S. sales tax?

The U.S. doesn’t have federal regulations for U.S. sales tax or a base sales tax. Instead, states control their own state sales tax and rules. Further, cities and counties within states can also levy local sales taxes.

This creates over 13,000 U.S. sales and use tax jurisdictions across the country that can set their own rates. And rates can frequently change. As a result, unravelling the complexities of U.S. sales tax and managing its obligations is a huge challenge for businesses selling into the U.S., or planning to.

Findings from a 2023 survey of U.K.-based businesses revealed that 60% of U.K. business leaders shelved their expansion plans due to U.S. sales tax complexity and compliance costs. But the U.S. remains a lucrative market. To reap its rewards, the barrier of U.S. sales tax must — and can — be overcome. How? It begins with a sound understanding of what U.S. sales tax is and how it works. 

So, what is sales tax exactly?

U.S. sales tax is a consumption tax on the sale of most (but not all) goods and services. It’s usually collected at the point of sale and expressed as a percentage of the purchase price or service fee, and paid by the consumer. This sales tax can apply to both tangible goods and intangible services. It’s not an income tax.

U.S. sales tax is imposed by state and local governments — there is no uniform U.S. sales tax rate that applies to all states. Each state that collects U.S. sales tax (there are some that do not) sets its own rates and rules. The rates can also differ within a state, as counties and cities within them can also set their own rates. As a result, the rates can vary widely depending on the state and local jurisdiction. This is one of the main reasons why U.S. sales tax compliance can be so challenging for businesses, as manual processes for tracking and calculating a huge number of rates can be difficult and time-consuming (not to mention boring). 

U.S. states set their own thresholds for triggering sales tax obligations for businesses. Some states base their threshold on a dollar amount a business makes in revenue, while others go by a number of sales transactions made.  

Is sales tax the same as value added tax (VAT)?

While both are indirect taxes, U.S. sales tax is different to VAT. U.S. sales tax is charged at the point of sale to the final consumer. VAT is charged throughout each step of the supply chain. VAT is usually set at a national level, without local tax rates across different regions of a country. The rates are also relatively static, and change with much less frequency than U.S. sales tax.

Which states have the highest and lowest U.S. sales tax?

California currently has the highest sales tax, at 7.25%. Indiana, Mississippi, Rhode Island, and Tennessee follow closely behind at 7%. 

States with the lowest sales tax include: Alabama (4%), Colorado (2.9%), Georgia (4%), Hawaii (4%), Louisiana (4.45%), Missouri (4.23%), New York (4%), North Carolina (4.75%), Oklahoma (4.5%), South Dakota (4.5%), and Wyoming (4%).

Some states — Alaska, Delaware, Montana, New Hampshire, and Oregon — do not have a statewide sales tax. However, counties and cities within these states could still impose their own local sales tax regulations.

What is U.S. sales tax for?

The tax revenue collected by authorities generally funds a range of state and local public services, from schools and healthcare, to public transport and infrastructure projects. Funds can also be used for parks, recreation areas, and community development projects.  

How does sales tax work?

Let’s look at a practical example of how U.S. sales tax is based on a percentage of the sale price of an item. Though percentages vary across jurisdictions, let’s say the rate in question is set at 10%. 

Someone buying a $100 shirt from a retail store in this jurisdiction would pay 10% on top of the sale price, taking it to $110 owed at the till. The retailer is responsible for reporting and remitting the $10 to that jurisdiction’s tax authority. 

Though U.S. sales tax is collected by the seller, not all businesses are required to collect U.S. sales tax. There are exemptions, such as nonprofits and charities. And it’s not just certain types of organisation — some products are exempt too, such as certain medical or agricultural items. As with U.S. sales tax rates, rules and requirements around exemptions vary across states. 

How can a non-U.S. business have U.S. sales tax obligations?

A business doesn’t have to be located — or have any other kind of physical presence such as a warehouse or distribution centre — within the U.S. to be liable for U.S. sales tax. 

Nexus — the commercial connection between a business and a U.S. state — can be established remotely, ever since the landmark 2018 South Dakota v. Wayfair U.S. Supreme Court ruling. This means a business in Bruges, Berlin, or Birmingham that’s selling into the U.S. could have to pay the same amount of U.S. sales tax as those based in New York or Texas.  

What is the difference between sales tax and use tax?

If a U.K. or European-based business does not establish nexus with a state — for example, if they do not breach that state’s threshold — and therefore does not collect U.S. sales tax, the consumer becomes liable for the corresponding consumer use tax, which is due when U.S. sales tax isn’t paid on a taxable transaction.

OK, I’ve established nexus within a U.S. state — what’s next?

If you discover that your business has established nexus within a U.S. state — or multiple states — you’ll need to register for U.S. sales tax with the state tax authorities. Just like rates, rules and thresholds, the registration process(es) can vary across states. Our sales tax risk assessment can help you determine where you have nexus.

Once you’ve completed the necessary registration processes, you can start calculating and collecting U.S. sales tax. You’ll need to file returns at a frequency dictated by the local and relevant authorities. There’s also the matter of managing exemptions, which can involve requisition, validating, and storing exemption certificates.  

Avalara can help

Mastering U.S. sales tax compliance can be a huge challenge. Tracking state sales tax as well as local sales tax manually can be near impossible, especially as you expand or diversify your products or services. And having to manage potentially thousands of exemptions won’t make things easier. Avalara expertise and insight can help simplify the process.

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