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How US Sales Tax Works

How US Sales Tax Works

If you’re making sales in the United States, listen up! There’s a new era of sales tax upon us. No matter where in the world you’re located, your business could be liable for sales tax in the US.

What is US Sales Tax?

In the United States, sales tax is a consumption tax that is theoretically only charged once, at the final purchase of the final product by the end consumer.

US sales tax is not a nationwide policy, such as VAT throughout the European Union or GST in Australia. Rather than administered on a federal level, US sales tax exists at the state and local levels. States and local jurisdictions have the power to set their own tax laws and tax rates.

Therefore, when it comes to tax liability, your business’ operations are classified as being either in-state or out-of-state. Out-of-state businesses that sell online are also called “remote sellers.”

Here’s how sales tax breaks down across the 50 states:

  • 45 states and the District of Columbia collect statewide sales taxes. (Alaska, Delaware, Montana, New Hampshire, Oregon do not have any sales tax at all!)
  • 38 states have some form of local sales tax, collected in part or all of the state.

The result is that there are thousands of taxing jurisdictions in the United States! This makes tax compliance pretty complicated for online businesses.

VAT number USA

Actually, there are no VAT numbers in the United States, due to the fact that – well – the US doesn’t have value-added tax. Instead of a VAT number, USA businesses receive a sales tax permit, or seller’s permit, along with a business tax ID. And since sales tax operates on a state level (not the national level), businesses have a different tax ID for each state where they’re registered.

So forget the idea of a VAT number in the USA. Instead, you need to focus on whether you actually need to register for sales tax.

How the US sales tax system works

The US sales tax system works by classifying products as taxable or tax exempt, and then determining whether a business has a nexus in that state. Let’s look at the product taxability first, and then we’ll explain nexus after that!

1. Sales of Tangible Personal Property

Tangible goods like merchandise and manufactured products are generally taxed, but the rules vary across the 50 states. Certain items deemed necessities, like unprocessed food and medicine, could be tax-exempt. (More on that later!) Plus, some states might offer sales tax holidays, when tangible goods that are usually taxed can be sold tax-free for a limited time. A common example of this is children’s clothing before a new school year begins.

2. Professional Services

Across most US states, professional services are generally not taxed. Examples include accounting, consulting, and legal services. But exceptions always exist! In some places, a city or local jurisdiction might opt in to tax a professional service that the state-level authority does not.

Some states do tax services related to tangible personal property, such as maintenance, repair, or installation. Yet even within those states that do apply sales tax to these services, there will likely be cases where the service is tax-exempt, depending on the tangible property and the customer.

4. Software and Data Processing

The taxation landscape for software in the US is quite complex because states interpret the digital-vs.-tangible, good-vs.-service classifications differently. And these different interpretations are applied across software, IT structures, and data processing. Format features, such as streaming or downloading, can also affect the tax definition of products. Tax rules for Software-as-a-Service (SaaS) products, which are delivered through the cloud, might differ from the Platform-as-a-Service (PaaS) model, which allows for application development, web hosting, and deployment. Data processing services, often subject to taxation, have diverse interpretations across states. Exemptions for professional or IT-related services may exist but vary based on the specific nature of the data processing services provided.

5. Rental Equipment

While equipment lease differs from purchases, they typically attract sales tax, similar to other goods and services. Sales tax rates for rental equipment across states vary between 2.9% to 7.25%, with possible additional local government taxes ranging from 1% to 5%.

US sales tax exemptions

Yes, there are such things as sales tax exemptions! Here’s a quick overview to pique your interest further. If you realize your sales may be eligible for tax exemption, you will need to apply for a tax exemption certificate in each state where you’re registered.

Tax exemption based on the type of product

Necessities such as food, medicine, and clothing are often exempt from sales tax. In addition, some healthcare or educational goods and services can be exempt.

Tax exemption based on use of the product

If the product is meant to be resold in the same form in which it’s purchased, it may qualify for a resale exemption. (Because, like we said up top,

US sales tax should only be charged once to the final consumer.) Dropshippers should definitely look into this! On the same note, if the item is used in the production of a final product, prior to resale, it too can be exempt from sales tax. This exemption mostly applies to certain industries, such as agriculture and manufacturing.

Tax exemption based on the type of buyer

If you’re selling to certain organizations, your products might be tax-exempt. Anything sold to the US federal government cannot be taxed. Similar exemptions often exist for state and local governments and agencies, non-profit organizations, or other licensed charitable, religious, or educational groups.

That covers the taxability of products. But selling a taxable product doesn’t automatically mean you need to apply tax to your sales! Whether you’re obligated to charge sales tax in a given place – i.e. whether you need to register for sales tax there – comes down to another factor:

Whether your business has nexus in the state.

What is nexus?

You’ll see this word throughout any US sales tax law or tax explanation. Let us break it down for you.

A “nexus” is a commercial connection in a state. When your business has nexus in a state, that means you’re liable for taxes there; you must register, start collecting, the whole rigmarole.

Though nexus has traditionally referred to “physical presence,” as in a storefront or a warehouse, there are now multiple modern definitions that capture digital and remote commerce, too. These definitions generally hinge on the same set of factors.

Determining factors for sales tax nexus

Although there’s no standard sales tax policy, and no standard definition of “nexus,” the tax policies usually differ in the same ways. Certain characteristics come into play across the board. Understand these factors, and you’ll have an easier time understanding the nuances of any singular state’s law.

Where you’re located

Classic physical presence factor. If you have a retail space, a storage space/warehouse, an office, an employee, or any other tangible representation of your business in a state, then you’re probably required to register for sales tax there.

What you sell

Sales tax policies can differ depending on what type of product you sell. Is it a physical good? Is it a physical service, or a digital service? Is it a digital item, or a digital subscription? Read more for specific guidance on SaaS and digital products.

How you sell it

Certain marketing and selling practices constitute a nexus in some states. Do you sell from a brick-and-mortar, your website, or an online marketplace? Do you use telemarketers that call customers in a state, or do you have any affiliate businesses marketing your product in that state?

How much you sell of it

This nexus is called the economic nexus. To protect small businesses from being overtaxed (or from crippling under sheer tax compliance), most US tax laws include a tax registration threshold. A common tax registration threshold is 200 transactions or $100,000 in sales in the previous or current calendar year (in that particular state). If your business’ annual sales remain under the threshold amount, you do not have economic nexus, and you don’t need to worry about sales tax. If you do surpass the threshold amount, then you better get moving on tax compliance in that state!

To read in-depth about nexus definitions, check out our Quick Guide to US Sales Tax Nexus.

How to calculate US sales tax

Sales tax is calculated as a percentage of the total taxable purchase. It’s a one-time tax charged at the point of sale to the end customer. The money goes from the consumer, to the vendor, to the government, the end.

In the US, sales tax rates are determined at the state and local levels. There is no overarching national sales tax in the US.

If you want to see how to calculate US sales tax with a real example, try out our free US sales tax calculator.

The Streamlined Sales Tax Agreement

Everything above is very complicated with seemingly countless variables. We aren’t the only ones who feel that way! In fact, there’s an organization out there aiming to simplify and standardize the sales tax system across the United States. This godsend of a group is the Streamlined Sales Tax Governing Board.

They’ve introduced the Streamlined Sales and Use Tax Agreement (SSUTA), a comprehensive, simplified tax policy that any state government can adopt. Many already have.

  • 23 full Streamlined member states: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Utah, Vermont, Washington, West Virginia, Wisconsin, Wyoming
  • 1 associate member state: Tennessee

This means the above states share similar tax definitions and policies. Each state still sets their own tax return intervals and filing deadlines. It’s possible to register for all of these states at once and to file simplified electronic returns via SSUTA. Check out their website to see if that makes sense for your business! Either way, they are a great resource.

5 Steps to comply with US sales tax system

Once you know you have a nexus in a state, here are the general next steps and best practices to ensure your business is on the ball.

  1. Get a Federal Tax ID, a.k.a. Employer Identification Number (EIN), if necessary. You probably already have one of these, but just in case… If you’re running a business in the US, you likely need an EIN. This is how the Internal Revenue Service tracks your business’ tax activities, such as paying business income tax.

    • If you’re a US taxpayer, you can apply online and receive your EIN immediately.

    • If you’re an international applicant, the IRS website gives these instructions: “International applicants may call 267-941-1099 (not a toll-free number) 6:00 a.m. to 11:00 p.m. (Eastern Time) Monday through Friday to obtain their EIN.”

      For full information about the EIN, check out the IRS site for Employer ID Numbers.

  2. Register for sales tax in that state. Once you’ve registered, you’re required to comply with all parts of the tax law. To register, check the state’s tax agency website. Many states offer an online application service, some easier to use than others. (The state of New York even offers it in seven languages!)

    • You need a substantial amount of information for the application, including your EIN plus the personal information of any partner or other individual who’s responsible for the business. Here’s a sample checklist from the New York application.
    • Some states will issue you a state tax ID, while others will simply use your EIN.
    • Usually you’ll either receive your sales tax permit instantly, or within 10 business days. If you register via snail mail, it may take 2-4 weeks.

    Note: You can register in all 24 SSUTA Streamlined states at once, with one registration process. Sounds great, but this may come with some extra tax liabilities. You’d likely end up liable for tax in some states even though you don’t have nexus there, simply because you’ve registered. Learn more on the Streamlined Sales Tax Registration System page.

  3. Determine the exact locations of your customers. The exact location will determine which local taxes you need to apply, if any. Best practices for this include:

    • Collect two non-conflicting pieces of evidence that prove where the customer lives. Keep record of this evidence, in case of any tax audit in the future. (Customer location evidence isn’t required by US tax law, but it’s good insurance for your business!)
  4. Apply sales tax to each transaction in that state. Collect it at the time of payment. This one might be a no-brainer, but we needed to include it! We’re thorough. :)

  5. Send proper tax invoices immediately after each sale. A tax invoice is a legal document that shows your business’ information, the customer’s information, tax IDs, tax rate, etc. Delivering airtight invoices is actually very important, since buyers can refuse to pay you until they receive a legally-compliant invoice! To be on the safe side, follow these guidelines for a proper tax invoice.

  6. File sales tax returns on time. Another obvious point, but it’s the clincher! Just as all the other elements of US sales tax are complicated and different across each state, so can be the tax return intervals and deadlines, and the methods of payment. Again, check the state’s tax agency website, make note of important dates, and choose the best payment method for you.

    • State agencies will want your tax return broken down by state, city, and any other local tax jurisdictions. Keep your numbers in line throughout the year to save yourself a huge headache come filing time!
    • File “zero reports” if you didn’t collect anything in a certain jurisdiction where you’re registered with a tax permit. Yep, you still have to file. This is an obligatory check-in! If you want, you can contact a state agency and request to change to a “non-file” status, so you don’t need to file any returns until you sell there again.

Can a non-US business ignore US Sales Tax?

You shouldn't. Especially with the 2018 Supreme Court decision in South Dakota vs. Wayfair, ruling in favor of state governments, these state agencies are tightening up their tax policies and cracking down on remote sellers who aren’t complying with local law. To ignore US sales tax laws would truly be risky business.

What can help you handle US Sales Tax?

The best way to stay on top of the US sales tax system is to use a cloud-based accounting tool that automates the entire process — from charging the correct tax rate to collecting payment to issuing the proper invoice. All of your records are kept safely online for you, even if your computer crashes.

Quaderno handles all of this tax compliance for you, so that you can spend your time focusing on dominating the market — on bettering your product, getting to know your customers, taking care of your employees, or whatever else matters more than fretting over tax technicalities.

In fact, Quaderno can do all of the following:

  • Notify you when you’re about to exceed a sales threshold in any state.
  • Calculate the right amount of tax to charge each customer, right on your checkout page.
  • Collect and store the customer location evidence that you need to get from every sale.
  • Create and send invoices in multiple languages and currencies.
  • Send tax invoices automatically.
  • Provide detailed, easy-to-read records and tax reports.
  • Alert you when tax policies or tax rates change so that you’re always in the loop.

And that’s only how Quaderno can help with US Sales Tax. When it comes to VAT, GST, and other sales taxes around the world, or your own income tax, or simply everyday billing and accounting — Quaderno jumps through all the hoops for you and presents your business data in a way that’s easy to understand. Sign up for a free trial and see how Quaderno can give hours back to your week.

Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the tax authorities.