Sales Tax Primer: Origin-based vs. Destination-based
- Nov 2, 2015 | Stephanie Faris
In many states, sales tax can vary from one city to another. This isn’t a big deal as long as a business sells from a fixed location like a store or restaurant. However, the Internet has made sales tax calculations more complicated, since businesses are often selling to customers who live in another city or state, where sales tax rates are completely different.
When shipping to customers, there are two separate ways sales tax is calculated, depending whether the state is a destination-based or origin-based business. "Origin-based" means sales tax is based on the city from which the shipment departs rather than the city where the customer receives it. "Destination-based" is the opposite. This distinction is important because it impacts how a business pays taxes on the items it ships.
How does this work in practice? Let's use Tennessee -- one of 12 origin-based states -- as an example.
Origin vs. Destination
As an origin-based state, Tennessee bases sales tax on the city from which the shipment departs rather than the city where the customer receives it. If it were a destination-based state, businesses would need to charge sales tax based on the tax for the specific area to which an item is shipped. In Tennessee, this would be tricky, since sales tax rates can vary from 9.25 percent to 9.75 percent from one city to the next. Complicating this is the fact that state sales tax on items like food is reduced to 5 percent, with local taxes added onto that amount.
What About Out-of-State Business?
Most states, including Tennessee, require out-of-state businesses with nexus in Tennessee to charge sales tax based on the local rate where the item will be received. Out-of-state sellers with nexus in Tennessee therefore treat shipments as though the state were destination-based.
The good news for Tennessee businesses -- as for businesses in most other states -- is that when they ship out-of-state, they are not required to collect sales tax on those purchases unless they have nexus in the destination state. If they don't have nexus elsewhere, this means they’ll only be tasked with keeping up with sales tax on items they sell within the state of Tennessee. Businesses are required to report all of their sales to the Department of Revenue on their sales tax returns, but deduct the portion made up of out-of-state sales.
Don't Forget Shipping and Handling
In addition to collecting sales tax for the item purchased, businesses may also be required to collect sales tax on shipping and handling for all taxable items shipped within the state. In Tennessee, this includes the cost of bundling items, but it only applies to delivery when the seller handles it. If delivery is handled by a third-party delivery service, common carrier, or the postal service, no sales tax is required in Tennessee as long as those charges are stated separately on the invoice. This applies both to shipments within the state and across state lines.
The Bottom Line
Doing business in an origin-based state like Tennessee is easier -- retailers can set one sales tax rate and charge that rate uniformly. Businesses in destination-based states, and out-of-state businesses with nexus in Tennessee aren't so lucky. Things aren't so easy when the sales tax rate charged is based on the destination of the package, which is not always the same as the standard state rate.