When it comes to sales taxes, most of the compliance responsibilities fall upon the seller. If your business happens to make taxable sales of property or services, you need to be prepared to handle the obligation to register with your state's department of revenue; compute the tax; collect the tax; and pay the tax to your state.
You Must Register with State If You Make Taxable Sales
If you plan to make sales that are subject to sales tax in a state, you must register to collect the tax by applying for a sales permit for each separate place of business you maintain in the state.
In some states, it's a criminal offense to operate without the requisite permit, so you should secure a permit before you make your first sale. Once you receive the permit, you must display it at your place of business.
In most states, the fee imposed to obtain a sales permit is nominal. However, you may be required to furnish a deposit or a surety bond as part of the registration process. Many states require new sellers to post such deposits or bonds to secure the timely payment of their taxes.
We're using the term "sales permit" here in a generic sense to refer to the document a seller must secure before making taxable sales in a state. Depending on the state, such document may be referred to as a "permit," "license," or "certificate of registration."
Use tax registration. In recent years, most states have stepped up their attempts to require out-of-state retailers such as mail-order sellers and telemarketers to register for the purpose of collecting their use taxes. A state can't compel you to register or to collect its use tax unless you have established a physical presence within the state. This physical presence is called nexus and it is critical not only for sales tax, but for state income tax as well.
The nexus requirement is related to the fact that a state's taxing power extends only as far as it borders. So, before a state can subject you to any of its tax obligations, you must have done something within the state to justify the state's exercising its powers over you. At this point in time, merely making sales to residents of the state is not alone sufficient to establish the requisite connection (nexus.) In fact, the U.S. Supreme Court has ruled that nexus will not exist unless you engage in some minimal level of physical activity within the state.
What's sufficient to create nexus—and thereby subject your business to a state's taxing jurisdiction? Here are some possibilities:
- You maintain an office, store, or other business facility in the state.
- You or your employees enter the state to take orders, perform services, or otherwise do business on your behalf.
- You own or lease real property that is located in the state.
- You own or lease personal property that is stored or used in the state on a more than occasional basis.
If you limit your contacts with a state solely to communicating with customers in the state by mail or common carriers, you won't be obligated to collect the state's use tax. At present, a similar standard applies with respect to telemarketers and to retailers who sell over computer networks and the Internet (so-called "cybersellers"). However, lively debate and considerable litigation is underway over recently enacted state laws that provide that having "affiliates" in a state who have ads on your web page is enough to create an obligation to collect sales tax on the sales.
Sales Tax Is Usually Based on Sales Price
The amount of tax that is owed on taxable sale is determined by applying the applicable tax rate to the total sales price. The tax generally applies to the total amount received for the property or service, without any deductions for the its cost to you, or any materials, labor or service costs. In other words, the tax base doesn't necessarily bear any relation to the actual profit you may have realized on the sale.
However, sometimes an adjustment to the sale price needs to be made before the tax rate is applied. Some of the more common circumstances that affect the amount (tax base) upon which the tax is determined are
- Cash or trade discounts. As a general rule, discounts that are known and taken at the time of sale are excluded from the tax base. However, the states are split as to whether a discount that is taken after the sale, such as a prompt payment trade discount, may reduce the tax base.
- Coupons and rebates. Whether an adjustment is made depends upon whether the manufacturer or the retail seller issues the coupon or rebate. Manufacturers' coupons that are used to reduce the amount of cash a purchaser tenders generally will not reduce the tax base, because the retail seller can return the redeemed coupons to the manufacturer for credits. A similar rule applies with respect to manufacturers' rebates. In contrast, a purchaser's redemption of coupons that the retail seller issued generally are treated the same as cash discounts.
- Trade-ins. Most states allow the tax base to be reduced by the value of any property that is taken in trade for the item that is sold. Other states allow the exclusion only with respect to trade-ins of specified vehicles and similar items, while some states don't allow any exclusion for trade-ins.
- Transportation charges. Separately stated charges for transportation that occurs after the sale generally are excluded from the tax base. However, some states look to the f.o.b. (free of board or freight on board) point to determine whether the charges are taxable. In these states, transportation charges are taxable if property is sold f.o.b. destination, but not if the property is sold f.o.b. origin (and the charges are separately stated).
- Post-sale labor and service costs. Most states specify that "labor and service" costs are included in the tax base. However, if the costs are incurred after the sale is completed and are separately stated they generally may be excluded. Of course, the key issue here is determining when a sale is "completed." For example, if you sell a satellite dish that can't be used until you install and configure it, your charges for such services will likely be included as part of the sale even if they are separately stated.
- Returns. Most states allow a deduction from the tax base when merchandise is returned. However, the deduction may be limited if the full purchase price is not refunded or credited to the customer (due to a restocking charge, for example).
- Bad debts.Most states allow bad debts to reduce the tax base for the reporting period that the debt is deducted for income tax purposes. Other states allow a credit equal to the tax that was initially paid in connection with the sale to which the debt related.
Sellers Are Generally Responsible for Collecting Sales Tax
Unless you're doing business solely in one of the handful of states where there is no sales tax or where sellers can elect to pay the sales tax themselves instead of collecting it from their purchasers, you're going to have to collect sales tax on all your taxable sales.
Tax Rates Vary Depending Upon the Type of Items
The tax computation may be complicated by the fact that different tax rates may apply to different items that you sell.Most states have both a general rate and one or more special rates that apply to specific types of sales. Adding to the problem is that most states have local jurisdictions that impose their own sales taxes.
Jake operates a convenience store. One customer purchases aspirin, a pre-made sandwich, a can of soup and a six-pack of beer. Depending on the state, Jake may have to apply a different sales tax rate to each item that the customer purchases.
Several Methods Can Be Used to Calculate Tax Due
If you make regular sales, it may be well worth the expense to set up a computer or a cash register that is programmed to determine the tax amount when you input or ring up a sale and that generates a detailed receipt that separately states the tax on the sale.
The alternative is to do the computation manually or on a calculator. However, this is likely to be very inefficient if you make a large number of sales or if you have to use a variety of tax rates on the items that you sell. Most states do provide useful tables of bracket schedules that show how much tax should be collected on a given sale at a given tax rate, but it can be time consuming to use a paper table.
Sales Tax Must Be Separately Stated
Virtually every state requires sellers to separately state the collected tax on the invoices or receipts they provide their purchasers. Requiring that the tax be separately stated basically forecloses later arguments by sellers or purchasers that an unbilled tax was included in the purchase price.
You May Be Able to Deduct Sales Tax Collection Costs About half the states allow sellers to claim a fee as compensation for their time and expenses in collecting the sales tax on the state's behalf. The fee is set at a fixed percentage (0.5 percent to 5 percent) of the collected tax, but is generally subject to a ceiling amount.
Should You Consider Absorbing the Tax?
Only a few states permit sellers to absorb the sales tax. So, unless you are in one of those states, the question is moot. In most states, you have to charge your customers the sales tax or face penalties. However, given that consumers will generally go to great lengths to avoid or reduce the sales taxes they pay, if you're in one of those states where sellers can elect to pay the sales tax themselves, you may be tempted to exercise this option in hopes of drumming up business. For example, you may decide to use your ability to absorb the tax as a negotiating point with selected purchasers. Or, you may go whole hog and hold an "I'll pay your sales tax" sale.
However, is this really a good idea? You mustn't lose sight of the obvious fact that absorbing sales taxes will involve significant costs. Depending on the sales tax rate in your area, you could be adding to your operating costs an amount equal to more than 10 percent of the sales price of each item you sell. Therefore, if you're already operating at a minimal profit margin, you'll want to analyze whether the increased costs will be offset by the additional revenues.
There may be a better solution to stimulating your sales than absorbing sales taxes. States will sometimes institute "sales tax holidays" (intended to offset the cost of back-to-school purchases or other heavy purchasing periods) that provide a limited exemption for sales of items like clothing and school supplies during a specified period (e.g., in August). Sales tax holidays typically last for one week and are restricted to items priced under a certain amount.
Find out if your state offers such a holiday by contacting the state's department of revenue. Then coordinate your marketing and promotional efforts accordingly.
Know When You Have to Remit Sales Taxes to the State
Once you've collected sales tax from your purchasers, the obvious next step is reporting and paying the tax to the appropriate authorities. Most states generally require you to file a tax return and remit the sales and use taxes you have collected on a monthly basis. (More and more states are providing for, or even requiring, electronic reporting and payment.) However, each state has special rules that may require you to file and pay on a more or less frequently, depending on the amount of your tax liability.
Be Wary of Local taxes. Perhaps the most difficult aspect of dealing with your sales tax obligations arises if you happen to do business in a state where local jurisdictions administer their own sales taxes. Usually, you'll have separate reporting requirements for each such "home rule" locality where you make sales. Unfortunately, the administrative agencies for such localities are frequently understaffed and poorly financed, and offer little in the way of taxpayer assistance and procedures. Believe us, if you have to pay local taxes, you're fortunate if you happen to do business in a state where local taxes are merely added on to, and are collected and reported with, the state tax.
Claim a Refund for Overpaid Sales Tax
If you remit more tax than you actually owe, either because of a clerical error or because of a misinterpretation of the law, a state will generally refund the excess payment. However, if the overpaid tax was collected from a purchaser, most states will require proof that you reimbursed the purchaser for the overpaid tax as a prerequisite to providing the refund.
Accurate Recordkeeping Is Essential
As is the case when you file any tax return, you must maintain an accurate set of books and records that substantiates the sales tax liability you reported on the return. The requisite records generally will include such items as receipts, invoices, cash register tapes, working papers, and exemptions certificates provided by purchasers. Each states specifies a length of time for which the records must be maintained.
Conducting Business Internationally
Looking to do business internationally? See our article on differences between VAT and sales tax.