Sales Taxes: The Ultimate Guide for Small Business Owners

Sales tax is one of many types of small business taxes that entrepreneurs are responsible for paying. Forty-five states and Washington D.C. all have sales tax. States use this money to pay for budget items like schools, roads, and public safety.

Businesses that sell a product or a taxable service must collect sales tax from their customers. The processes of calculating the correct sales tax rates, collecting payment, submitting sales tax returns, and paying the tax can be very time consuming, particularly for first-time business owners. This is particularly so if you sell multiples types of products or operate in multiple states.

To help you sort things out, we’ll cover the steps involved in collecting, reporting, and paying sales tax. We’ll start out by helping you figure out if your product or service is subject to sales tax. After reading this, you should feel much more confident in reporting and paying your sales taxes.

Collecting, Reporting, and Paying Sales Tax

Step 1: Determine if your product or service is subject to sales tax.

State laws vary pretty significantly in terms of which products and services are subject to sales taxes. If you sell only in Alaska, Delaware, Montana, New Hampshire, or Oregon, then you do not have to pay statewide taxes, though Alaska and Montana allow localities to charge sales tax.

Generally, retail items like handbags and clothes are subject to sales taxes. Prescription drugs and food items usually are exempt from sales taxes, though the rules vary from state to state. Things get more complicated if you sell items online or digital items.

If you sell a taxable product or service, you must pay sales tax in any state where your business has a “tax nexus.” For example, you can establish a nexus by operating a physical store in the state, employing one or more individuals in a state, or exceeding a particular sales volume in a state.

Sales Taxes for Online Sellers

Many online sellers have to pay sales tax in the wake of a 2018 Supreme Court decision, South Dakota vs. Wayfair. In this case, the Supreme Court decided that states can require online sellers to charge and collect sales tax—even if the seller doesn’t have a store or other physical presence in the state.

After Wayfair, 24 states require ecommerce sellers to collect and pay sales tax.^[1] Fortunately, most of these states exempt online sellers that process fewer than 200 internet transactions or $100,000 in sales each year.

Sales Taxes for Digital Products

Sales tax laws have had to evolve as internet streaming becomes more popular, and more and more people consume media and television online. The majority of states now tax digital downloads. ^[2] These include items like downloadable books, ecourses, and digital music files.

Sales Taxes for Services

Traditionally, only tangible products were subject to sales tax. However, many states now tax services to fill up their tax coffers. Generally, professional services like medical services and legal services are exempt. Personal services like hair salons, pet grooming, and lawn care are typically subject to sales tax.

If you are confused about whether your product or service is taxable, it’s a good idea to contact your state’s tax agency or department of revenue.

Step 2: Register for a sales tax permit.

Before you can collect sales tax, you must register for a sales tax permit in each state where you have a taxable nexus. If you do business in multiple states, you’ll need to register in each of those states. In most cases, this can be accomplished for free on each state’s department of revenue website. You’ll need basic business information, such as your employer identification number and business address, to register. At the end, you’ll receive a sales tax ID that you should use when reporting your sales tax.

Step 3: Calculate the sales tax rate.

At the outset, the sales tax rate that your company must charge depends on where you sell. If you sell in multiple states, you’ll need to calculate and collect the tax in each of those states. 

The majority of states have destination-based sales tax. This means that the sale is considered to take place wherever the buyer uses the product. For instance, let’s say you have a store that’s based in New York, but you ship an item to a customer who lives in New Jersey. You must calculate and charge the customer the New Jersey sales tax (in addition to any local sales tax). You’d also have to file a New Jersey sales tax return.

A handful of states are origin-based sales tax states, which means that the sale is considered to take place in the state of origin, even if you ship the item somewhere else.^[3] California has a hybrid origin and destination-based sales tax law.

Step 4: Collect the sales tax at your point of sale or checkout cart.

To make sales tax calculation easier, try point of sale software like Square. Thanks to Square’s integration with TaxJar, all you need to do is input the locations where you sell, and the app will calculate the correct state and local sales tax rates.

Whether you choose to use a POS or make your own calculations, you’ll need to display the amount of sales tax separately from the purchase price of the item. Square is set up to show sales tax on a separate line in the receipt.

Sign Up for Square for Free

Step 5: Send sales tax return and payment to the state.

The last step is to submit your sales tax return to the state, along with the actual payments you’ve collected from customers. If you use accounting software like QuickBooks, you can set it up to have sales tax payments automatically post to a separate account.

Due dates for filing sales tax vary a lot based on which state you transact in. The deadline usually falls on the 20th or 25th day after the reporting period ends. Some states require you to report and pay sales tax each month, whereas others are on a quarterly or yearly cadence. Often, the reporting and payment schedule is more frequent for higher volume sellers. Fortunately, most states make it possible to report and pay your taxes online.

Even if you have no transactions during the reporting period, you should still submit a sales tax return in any state where you have a tax permit. Failure to do so can result in a fine or even having your sales tax permit revoked.

Remember to find out your state’s deadlines, and stick to them. About half of the states with a sales tax will let you keep a small portion of the sales tax collected when you pay on time. This amount is generally only 1%-2% of the sales tax you collected, but it’s free money!^[4]

If you don’t want to remember deadlines, consider enrolling in an automated tax filing service, such as AutoFile from TaxJar. They will file your sales tax returns for you on time for a monthly subscription fee.

Sales Tax Myths and Misconceptions Explained

Now that you know the basics of sales tax collection, calculation, and reporting, don’t let these myths trip you up.

Myth #1: The IRS will audit me if I don’t collect sales tax correctly.

Many small business owners think their business will face an IRS audit if they don’t collect sales tax correctly. In fact, the IRS has nothing to do with sales tax! The IRS is our national taxing administration, but sales tax is governed at the state level. There is no national sales tax in the U.S.

Instead of contending with the IRS, if you have sales tax questions or problems, you need to deal with the state’s taxing authority. This authority is generally called the State Department of Revenue, but it can go by other names. California’s taxing authority, for example, is called the California Department of Tax and Fee Administration.

Myth #2: I only sell online, so I don’t have to collect sales tax.

Internet sales are similar to other types of products after the Supreme Court Wayfair case. If you sell taxable items and have “sales tax nexus” in a state (more on that concept below), then you are required to collect sales tax from your buyers—no matter if you made the sale face to face or online. That said, most states require online sellers to pay sales tax only if they do over a certain number of transactions or revenue.

Before you start collecting sales tax, you’re required to register for a sales tax permit with your state’s department of revenue.

Myth #3: I only have to collect sales tax from buyers in my home state.

This is one of those myths that can be true, but there’s often more to it. Long story short, in the U.S., online sellers are only required to collect sales tax in states where they have a sales tax nexus. “Nexus” means a significant connection to a state.

You always have nexus in your home state—even if you merely work from your kitchen table—but other common business activities might give you nexus in other states. These activities include having an employee, physical location, salesperson, installer, or contractor in a particular state, or even just storing inventory in a state. You can read more about the definition of nexus here.

Myth #4: If I didn’t collect sales tax, I don’t need to file a sales tax return.

This is another myth that can end up costing you money. If you hold a sales tax permit in a state, then you should always file a sales tax return on your due date. That’s even if you didn’t collect a penny in sales tax.

States use your sales tax return to figure out if you’re still in business. If you don’t file a sales tax return, most states have some form of penalty. Some states might fine you up to $50, while other stays might cancel your sales tax license if you continue to miss filing deadlines.

Myth #5: I should charge sales tax on everything I sell.

In a perfect world, sales tax would be simple. But in many states, some items considered to be “necessities”—like groceries, clothing, and even textbooks—are either not taxable or taxed at a different rate. For example, groceries are tax free in Kentucky but taxed at a reduced rate of 1% in Illinois. Clothing is tax free in Pennsylvania but taxed at the normal rate in Arkansas. Be sure that you’re charging the right sales tax rate for your product or service. Your point of sale software or an automated sales tax filing service can help with this (If you have questions about what is taxable and what isn’t, you can always contact your state’s department of revenue.)

Sales Taxes Demystified

Calculating, collecting, and reporting sales taxes can be a pain, but ultimately, sales taxes go towards a good cause. These taxes are what fund state and local budgets and pay for schools, roads, fire prevention, and other important issues.

Point of sale software, like Square, and sales tax filing services can take some of the headaches out of sales tax collection and reporting. And once you’ve been in business for a couple years, sales tax reporting will become second nature.

Article Sources:  

1. Digitalcommerce360.com. “24 states will have online sales tax laws in effect as of Dec. 1“
2. Quaderno.io. “Sales Tax for Digital Goods in the U.S.“
3. Taxjar.com. “Origin-based and Destination-based Sales Tax Collection 101“
4. Taxjar.com. “Sales Tax by State: How to Discount Your Sales Tax Bill“