Tax calculation 101

Confused about how to charge sales tax, or if you even have to? Don’t worry, a lot of sellers are. Calculating the right rate depends on a lot of factors, including what you’re selling, where you're selling, and who you’re selling to.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this page is for informational purposes only and does not provide legal or tax advice.

Collecting sales tax

Sales tax should always be a consideration. Even if you don’t currently sell out of state or all of your sales are exempt, you need to be aware of sales tax compliance requirements for the state(s) where you do business. 

There are many ways of establishing sales tax obligations, also called nexus. A good place to start is learning about the nexus laws for each state you sell to or have employees in.

Possibly. Even if all of your sales are tax exempt, some states still require you to register and collect exemption certificates from your buyers to show that you don’t need to charge sales tax on those transactions.

It depends on the labor or services provided, as well as the location in which they’re performed. Each state has its own rules about what gets taxed and by how much. 

Before you enter into a contract, check with your tax professional. It’s also a good idea to research the taxability of your services with the local tax authority and register if necessary.

Sales tax nexus refers to the relationship a business has with a state that creates an obligation to collect and remit sales tax.

There are many ways to create nexus, such as hitting a certain sales or transaction threshold, having employees in a state, storing inventory in a warehouse, selling at a trade show or festival, and more.

We recommend researching the nexus triggers for each state you do business in, or where you have employees, contractors, affiliates, or goods.

Each state has its own rules and process for sales tax registration. 

Before you expand your business to new states, be sure to check with local tax authorities so you know when to register and when to start collecting tax on your sales.

The process for handling sales tax is different for each business, but the broad strokes are fairly similar. For each sale, you’ll need to:

  1. Assess item taxability

  2. Determine the appropriate tax rate(s)

  3. Apply the tax to the sale

  4. Collect tax from the customer

Equally important is what you do with the taxes you collect. Remember that the tax isn’t actually a part of the sales price; you’re merely holding the money for the state until it’s time for you to file a return and remit all taxes for a given tax period.

The details depend on your business’s tax compliance process. But generally speaking, you’ll need to set aside all taxes you collect during a given tax period. When you file your tax return, usually on a monthly, quarterly, or annual basis, you also remit the taxes you’ve collected to the state.

No. Collecting sales tax is the process of obtaining tax from your customers. Remitting is when you pass that tax on to the appropriate tax authorities.

Tax holidays are designated periods, usually a few days, during which certain purchases are temporarily exempt from sales tax. States determine whether they’ll offer tax holidays and decide what’s exempt, when, and for how long. Some examples include back-to-school supplies, hunting equipment, or disaster preparedness items.

This problem can be avoided by using a reliable source for determining sales tax rates. But if you know you’ve overcharged a customer, it’s best to acknowledge the error and make every effort to refund the excess tax.

If you’ve undercharged taxes, you can try to collect the taxes afterward, but this is an approach with limited success. Unfortunately, the seller is ultimately responsible for remitting the taxes, so you’ll still need to send the correct amount to the state, regardless of whether you collected it from your customers.

Not necessarily. Some products, customers, or sales types are tax exempt. In the case of products, each state has its own rules about what shouldn’t be taxed in their jurisdictions. You’ll need to make sure your sales and invoicing system can keep track of these products and in which jurisdictions they are tax exempt. 

When a customer or sale qualifies for a tax exemption, you’ll need to omit the tax and collect an exemption certificate. The certificate is proof you don’t owe tax to the state for that sale if you’re audited.

Each state has its own rules around product taxability. For example, many states have an exemption or reduced tax rate for groceries, since food is a necessity. Then there are products with exemptions based on state commerce priorities, like farm equipment in Iowa and jet fuel in Atlanta. 

Check with your tax professional and the relevant revenue department website to see if your items have an exemption or reduced tax rate.

The rules vary from state to state. For some states, shipping is always exempt, for others, it’s always taxable. Still others tax shipping in some circumstances, but not others. It can also depend on whether shipping is included in the sales price and how the goods are being delivered.

Selling remotely

It depends on where you do business. Economic nexus is a tax obligation created by hitting certain sales or transaction thresholds, which are determined by state tax authorities. Each state also determines whether exempt sales count toward their threshold.

There are also ways of establishing other forms of nexus that aren’t reliant on the number or amount of sales. For instance, in some states, you can create nexus if you have employees working there or if you store goods in a local warehouse. Some states also require you to collect and remit taxes on sales made at trade shows or events, regardless of how much you sell.

It depends on where you’re selling and how much business you do. Each state has its own rules for when you’re required to collect and remit taxes. 

But yes, once you’ve reached sales thresholds in another state, you’ll be obligated to register to collect taxes from customers and remit those taxes to the local authorities.

Maybe. Some states require marketplaces and online platforms to collect sales tax on behalf of their sellers, others don’t. If you’re selling online, you’ll need to know where the platform is collecting for you and where it's not. In the case of the latter, you need to track your sales and register to collect sales tax when you reach state thresholds.

Another thing to consider is multichannel sales. For example, if you sell on a marketplace, through your own site, and in person, the marketplace may collect taxes on sales made through their platform, but you’ll still be responsible for taxes on sales from the other channels.

Some do. Most states, as well as Washington, D.C., and Puerto Rico, charge a state sales tax. Some states also allow counties and cities to impose additional taxes. In these states, the rates vary based on tax jurisdiction. 

Delaware, New Hampshire, Montana, and Oregon don’t have sales tax. Alaska doesn’t have a state sales tax, but municipalities are allowed to impose sales tax at a local level.

Generally speaking, if you make enough sales to customers in another state and trigger a tax obligation, you’ll need to charge the tax rate for the address you’re shipping to. But not all states follow that rule. Different states have different sourcing rules that need to be addressed when you set up your tax strategy. You can learn more about how states apply various sourcing rules here.

This might be the trickiest part of the sales tax process. Each of the more than 13,000 sales and use tax jurisdictions has its own rates and taxability rules. 

You can reference tax rate tables or upload them to your sales systems, but they must be updated regularly to keep up with ongoing regulatory updates. They’re also often organized by ZIP code and don’t account for the nuances of product taxability.

The most accurate way to determine a tax rate is to look it up based on address. Cloud-based tax calculation solutions do this automatically, and they’re updated regularly with the research their in-house teams perform. 

You can also look up rates directly from the state tax authority or use a sales tax calculator.

If you’re only using a sales tax rate calculator for your sales tax calculations, there are still actions and considerations you should take into account:

  1. Determining who’s responsible for collecting and remitting the sales tax amount
  2. Understanding your origin-destination obligations, local tax-collecting rules, and product taxability in each state
  3. Finding out if your product or service is taxable in the responsible party’s jurisdiction
  4. Applying the rate shown above to your product or service’s value

Because your customers are paying the taxes, you need to determine and apply the applicable rate for each individual sale. If your customers find out they’ve been overcharged, you could lose sales and get bad publicity. In some cases, companies have ended up in court.

Guessing or averaging tax rates can also land you in trouble with tax authorities, leading to penalties and fines.

There are over 13,000 sales and use tax jurisdictions in the United States. A lot of them line up with ZIP codes, which is why rate tables are often organized that way. However, ZIP codes are determined by the United States Postal Service, which is not beholden to tax authorities. 

Some tax jurisdictions cover multiple ZIP codes, some ZIP codes contain multiple tax jurisdictions — and the borders for each don’t always align. Which is all to say ZIP codes can be used to estimate sales tax, but aren’t reliable for calculating accurate rates.

Tax rate tables are a static source of information; however, tax authorities frequently make changes to tax rates and rules. There were more than 40,000 rate and taxability updates in the U.S. and Canada in 2020 alone. If you’re going to use tax rate tables, you’ll need to update them at least once a month.

It depends on multiple factors, including the locations of all three parties, the taxability of the goods, and where you and your supplier have nexus (an obligation to collect sales tax).

You’ll need to determine the details of your sales with a tax professional, but in most cases:

  1. The customer pays sales tax to the seller
  2. The seller purchases the goods, tax exempt, from the supplier and provides a resale exemption certificate
  3. The supplier maintains the certificate as proof of sales tax exemption
  4. The seller remits the tax to the appropriate jurisdiction

Managing tax exemptions

When a customer makes a tax-exempt purchase, you’ll need to collect either a paper or digital copy of a valid exemption certificate. The certificate is your proof to the tax authorities that you don’t owe the taxes on that particular sale. 

After the sale, store the certificate securely so you can access it if you're audited. If you don’t collect the certificate or if you lose it, you’re responsible for remitting the tax.

Wholesale orders are typically exempt from tax. At the point of purchase, you’ll need to collect either a paper or digital copy of a valid exemption certificate. The certificate is your proof to the tax authorities that you don’t owe the taxes on the sale. 

After the sale, store the certificate securely so you can access it if you're audited. If you don’t collect the certificate or if you lose it, you’re responsible for remitting the tax.

Each state sets its own rules around economic nexus thresholds. Some states count exempt sales, others don’t. Many states also require you to file returns even if you don’t owe any taxes, a process known as $0 returns.

Yes. When you purchase something for resale, it’s tax exempt based on the assumption that the end customer will pay the tax on their purchase. However, if you end up using the item, you’ll need to remit use tax to the state.

Applying international taxes

Just as each state has its own rules for sales tax, each country has its own rules and regulations for taxing international sales. Most include some combination of value-added tax (VAT), goods and services tax (GST), customs duties, and tariffs. 

Before charging taxes on international sales, you’ll need to determine the requirements for the destination country, including registration, de minimis values, and item classification.

No. If you sell internationally, you’re going to have to manage some combination of value-added tax (VAT), goods and services tax (GST), customs duties, and tariffs, regardless of the amount of your sales.

Other countries charge transaction taxes, not sales tax, per se. Most of the world charges a value-added tax (VAT) or goods and services tax (GST), which are similar in that a customer pays tax to the seller and the seller remits tax to the government.

There are also other import taxes, like customs duties and tariffs that apply to international sales.

Value-added tax (VAT) and goods and services tax (GST) are transaction taxes used in many countries around the world. They’re similar to sales tax in that a buyer pays tax to the seller and the seller remits tax to the government. However, unlike sales tax, which is paid only by the end user of a product, VAT and GST are assessed at each stage of goods production, from sourcing material, through manufacturing and distribution, to the end user.

Customs duties are a tax customers are required to pay on imported goods. They can be charged at the point of purchase and remitted by the seller, a method known as Delivered Duty Paid (DDP). Alternatively, a seller can ship Delivery At Place (DAP), where the customer pays the duties directly to customs before their parcel is released for delivery.

A tariff is a duty required on imported goods. There are different tariffs on different products for each country, based on government treaties and domestic laws and commerce priorities.

Import taxes are the taxes assessed on goods purchased from outside the country. They generally include tariffs and customs duties.

Harmonized System codes, also referred to as Harmonized Tariff codes, are classification codes that must be applied to all international shipments. Each product has the same six-digit identification code for all countries in the HS code program. Countries choose to further classify products by appending additional digits to the base code. The codes are used to determine tariffs and customs duties for each imported product.

Simplifying calculation

You can automate tax calculation with a solution like Avalara AvaTax. Cloud-based programs provide regularly updated rates with built-in product taxability. 

You can also find tax calculation solutions for specialty products, like beverage alcohol, lodging, and energy, or for international tax calculation.

Generally speaking, an automated tax calculation program is going to be more accurate and efficient than calculating rates manually or from sales tax tables.

Manually looking up tax rates is typically not enough to ensure compliance. There’s an increased element of risk when selling in multiple states. For more accurate sales tax rates, you need more robust calculations that consider other factors, such as origin-destination obligations, local tax-collecting rules, and product taxability in each state.

Connect with Avalara for the answers you need to do tax compliance right.

Connect with Avalara for the answers you need to do tax compliance right.