Calculating sales tax: It takes more than just numbers
- Sep 17, 2018 | Mike Plaster
At a glance, calculating sales tax seems simple: Take the price of a taxable product or service and multiply it by the sales tax rate.
And on that level, it is simple. For example, a $10 product and an 8 percent tax rate means 80 cents in sales tax, for a total cost to the customer of $10.80.
With sales tax, though, it’s almost never really quite that easy. The real trick is figuring out what needs to be taxed and then calculating the rate — which, depending on how your business operates, could mean learning the rules in any number of the more than 12,000 tax jurisdictions across the U.S.
Let’s take a closer look at how all of this works.
A quick sales tax primer
Sales tax is simply a tax that consumers pay when they purchase taxable goods and services. The seller collects it and remits it to the state and/or local authorities, according to where they have nexus (that is, a connection to that state or jurisdiction, such as having a physical location or significant economic activity there). The taxes are then used by states and municipalities to fund various government operations.
You probably already know that not every state charges sales tax. Alaska, Delaware, Montana, New Hampshire, and Oregon don’t — but they often allow “selective sales taxes,” or local taxes on services such as lodging. And in Alaska, the state allows certain jurisdictions to levy their own sales taxes.
What is subject to sales tax?
Aside from nexus, perhaps the most important consideration for calculating sales tax is whether what you’re selling needs to be taxed at all. This isn’t as clear-cut as it sounds, because what’s taxable in one state might not be taxable in another. In a few states, what’s taxable in one jurisdiction might not be taxable in another — we’ll get to these home-rule states in a bit.
Generally, tangible personal property is subject to sales tax — that means most things that can be moved, touched, or felt. Some items, such as groceries, are often exempt from sales tax, as are items purchased for resale. (If it’s a taxable item, the sale to your end customer would be taxed, however.)
Even services can be taxable, depending on the state or jurisdiction.
How do you calculate the tax?
If you have nexus, and your item or service is taxable, it’s time to figure out how much tax to charge. First, you need to consider sourcing, or the location where a sale is taxed. Most states are destination-sourced, which means sales are taxed based on where the buyer takes possession of the item. In origin-sourced states, sales are taxed according to where the seller is located. However, these rules work differently for remote sellers. If you’re based in one state and selling into another state where you have nexus, sales will generally be destination-based.
Each state handles their sales tax a little differently. In most, there’s a base rate charged by the state, and cities or other jurisdictions are allowed to charge additional tax on top of that rate.
For example, in Washington, even though the base rate is 6.5 percent, people in Seattle pay a rate of 10.1 percent on taxable items — King County levies a 3.5 percent tax, and Seattle has its own 0.1 percent tax on top of that. In the meantime, just down I-5 in Olympia, Washington, the total tax is 8.9 percent; while the city charges a 2.4 percent tax on top of the base state rate, there’s no additional charge for Thurston County.
In some states (as well as in Washington, D.C. and Puerto Rico), the base rate is the only rate; no additional sales tax is permitted.
- New Jersey
- Rhode Island
Complicating matters further, a handful of states allow jurisdictions to create their own rules — not just in terms of adding a percentage on top of the state’s rate, but even the ability to tax certain items that aren’t taxed elsewhere in the state.
That also means you might have to register with both the state and the various jurisdictions to collect sales tax — for example, if you have nexus in Denver, Colorado, you’d need to register, collect, and remit taxes separately for the state and the city.
Home-rule states include Alabama, Alaska, Colorado, Idaho, and Louisiana. Arizona is one as well, but the state handles administration for all jurisdictions except Native American reservations.
A note about ZIP codes
A lot of businesses make the mistake of using ZIP codes to find sales tax rates, but it’s important to note that sales tax jurisdictions do not map to ZIP codes. Two customers who live next door to one another can be in the same ZIP code, but have different tax rates. So it’s best to use geolocation — as Avalara AvaTax does — to ensure you charge the right amount of tax. (Avalara does more than help you calculate sales tax; they can help you collect and file, too.)
When it’s time to calculate and collect
For brick-and-mortar sellers, the sales tax calculation process is a lot like we described at the beginning of this post. You simply need to configure your system to charge the appropriate state and local sales tax for your location.
If you sell to customers remotely, however, the other factors above can all come into play. So you’ll need to ask yourself the following questions:
- Is your item taxable in the state or jurisdiction where your customer is located (or where you’re located, if you’re in an origin-sourced state)?
- If it is, do you have nexus in that state or jurisdiction?
- If you have nexus, what’is the total tax rate you need to charge? Factor in the state rate and additional local tax, if any.
It’s a lot for a small business to manage, especially when you throw remittance and filing into the mix. And because sales tax laws change all the time, what you needed to charge last month might be completely different just a few months later. Many businesses get lost in all the requirements and fall out of compliance even when they’re trying to do the right thing.
That’s why Avalara created solutions just for businesses like yours — tools designed to automate the entire process, ensuring you always charge the right percentage, remit the right amounts, and send the right filings. It also ensures that instead of worrying about sales tax, you can focus your energy on the right things for growing your business.
Visit avalara.com or call 877-759-6520 today. We’ll help you get sales tax right.