Most small businesses that sell taxable goods or services must register with state tax authorities, collect sales tax from customers, and remit it on schedule. Requirements vary by state and may apply even if you sell online or operate in more than one state.
What is sales tax?
Sales tax is a tax imposed by state and local governments on the sale of goods and services. There is no federal sales tax in the United States. States and localities use the revenue to fund public services like schools, roads, and emergency services.
In most states, sales tax applies when a triggering event occurs, most often the completion of a retail sale. (A retail sale is a sale to the end user of a product or service, as opposed to a sale for resale.) While sales tax used to mainly apply to physical goods, states have since broadened their tax base to include leasing transactions, certain services, and digital goods.
City and municipal governments can also levy their own sales tax on top of the state rate, so the total rate a customer pays can be a combination of both. Your obligation as a business owner to collect and remit sales tax begins as soon as your business establishes nexus in a state, whether through a physical presence or through your sales volume there.
What is considered taxable varies by state, but common examples include retail merchandise, prepared food, certain digital products, and some services. Sales tax rules vary widely, so an item that is taxed in one jurisdiction might be exempt just across the state border. On top of that, tax rates can shift depending on local county or city boundaries and the specific product type.
State sales tax rates generally run between 4% and 7.5%. Combined state and local tax rates can total above 10% in some areas.
Five states do not impose a general state sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Even so, local jurisdictions in some of these states may still levy their own sales tax.
Examples of taxable goods and services
Sales tax typically applies to retail sales, leases, and rentals of tangible personal property, unless specifically exempt, as well as certain taxable services. Many states also tax digital goods, though states can differ in how they define what counts as a digital good.
Common examples of taxable goods and services include:
- Tangible personal property (physical items you can touch and move, such as furniture, electronics, and clothing)
- Digital products, such as music, e-books, streaming services, and downloaded software
- Prepared food and beverages sold by restaurants, taverns, and caterers
- Utilities, such as electricity, gas, and telecommunications services
- Hotel and short-term rental occupancy
- Vehicle and equipment rentals
- Admission charges and membership dues, such as tickets to events or gym memberships
- Property repair, maintenance, and installation services
- Certain professional and business services
Keep in mind that taxability rules can vary by state, and even by local jurisdiction within the same state. For example, in New York, haircuts, manicures, tattoos, and massages are exempt from sales tax everywhere in the state except New York City, where they're subject to the city's local sales tax.
Note on excise tax. An excise tax is a separate tax imposed on specific goods, such as fuel, alcohol, tobacco, and firearms. It can apply in addition to regular sales tax.
Different sales tax systems
There are several different sales tax systems that states use. The main difference is whether the law places responsibility on the seller, the buyer, or both. That distinction can affect who must pay, collect, remit, or challenge the tax. Depending on the system, it determines who is on the hook for the tax, who has standing to challenge it, and who can file a claim for a tax refund.
In some states, the tax is imposed on sellers, who can choose whether to absorb the cost or pass it along to customers. In other states, the tax is imposed on purchasers, with sellers responsible for collecting the tax on the state’s behalf. And in still other states, the liability is shared between sellers and purchasers.
There are three general types of sales tax systems:
- Seller (vendor) privilege taxes. These taxes are imposed on retailers for the privilege of making retail sales in the state. Retailers usually have the option of absorbing the tax themselves or passing it along to purchasers.
- Consumer (sales) taxes. This tax is imposed on the person making the retail purchase. Sellers act purely as agents who collect the tax on the state's behalf, so they don't have the option to absorb it. They're usually required to state the tax separately on receipts or invoices.
- Retail transaction taxes. These taxes apply to the sale itself, with both sellers and purchasers sharing legal responsibility for it. Purchasers are responsible for paying the tax, and sellers are responsible for collecting and remitting it, similar to a consumer sales tax. What makes this a hybrid is that the liability technically rests on both parties, even though, in practice, sellers handle it the same way they would under a consumer sales tax, with no option to absorb the cost themselves.
In general, sales tax is calculated based on gross receipts, meaning the full amount a seller receives from a purchaser, not the seller's net profit on the sale.
Sales tax vs. use tax
Sales tax applies to retail sales of certain tangible personal property and services within a state. Use tax applies when you buy taxable goods or services from an out-of-state seller, often online, who isn't required to collect sales tax because they don't have nexus in your state. In that case, the responsibility doesn't disappear, it just shifts to you as the buyer.
The two taxes differ in who's responsible for handling them. With sales tax, the seller collects payment directly from the buyer at the point of sale and remits it to the state. With use tax, that responsibility shifts to the buyer, who must calculate and remit the tax directly to the state after the purchase.
A few other things worth knowing about use tax:
- Use tax generally mirrors your state's sales tax. The same exemptions typically apply to both, and are calculated using the same tax base and rate. If a purchase would have been exempt from sales tax, it's generally exempt from use tax too.
- If you've already paid sales tax to another state on the same purchase, most states will credit that amount against your use tax liability, so you won't be taxed twice on the same item.
- Use tax can also apply to inventory you pull out of stock for your own use. For example, if you run a store and buy products tax-free under a resale exemption, but then start using one of those items yourself instead of reselling it, you may owe use tax on it.
What is nexus?
Nexus is the connection your business has to a state that triggers a sales tax obligation there.
There are two main ways a business can establish nexus.
- Physical nexus is the traditional standard, based on having some physical presence in a state. This can include having an office, warehouse, or retail location there, storing inventory in the state (including through a fulfillment service), or having employees or sales representatives working there.
- Economic nexus is a newer standard, and it doesn't require having a physical presence in a state. Instead, it's based on the volume of business you do in a state. Though the economic nexus threshold can vary by state, many states use a threshold of $100,000 in sales or 200 transactions within the state in a year. Once you cross a state's threshold, you're generally required to register and start collecting sales tax there, even if you've never set foot in the state.
The Supreme Court's 2018 decision in South Dakota v. Wayfair allowed states to tax remote sellers based on sales activity alone, without requiring any physical presence in the state. Before that ruling, physical presence was generally the deciding factor. Since Wayfair, states have moved quickly to enforce economic nexus, particularly against internet retailers.
What is a state tax ID?
A state tax ID is a number issued by a state's tax department or department of revenue to identify your business for state-level tax purposes. It's used for things like payroll withholding, sales tax collection, and other state compliance requirements.
A state tax ID is not the same as your federal employer identification number (EIN). An EIN is a federal number issued by the IRS for federal tax filings and other business purposes, and it's separate from any state-level registration. Most businesses that sell taxable goods or services need both: an EIN for federal tax filings and a state tax ID for state tax filings.
You'll generally need a state tax ID if your business collects sales tax, has employees, or owes other state-level taxes. This applies even to sole proprietors or single-member LLCs with no employees, if they're collecting sales tax.
Exact requirements vary by state. Businesses operating in multiple states typically need a separate state tax ID for each state where they have a business presence, since a state tax ID is only valid in the state that issued it.
What small business owners should know about sales tax
Sales tax compliance starts with knowing where you have obligations, what you sell that is taxable, and where you need to register. Staying on top of your federal obligations is a priority, but don't overlook your state tax obligations. Complying with them is just as crucial.
These are the key areas to plan for:
- Nexus. Determine whether your business has a significant enough connection, physical or economic, to a state to trigger sales tax obligations there.
- Taxability. Know which of your goods or services are actually subject to sales tax, since this varies from state to state.
- Registration. Register with the state tax department for a state tax ID and a sales tax permit. This applies to every state where you plan to make taxable sales, including the state where your offices are located, as well as any state where your online sales cross that state's economic nexus threshold. Some states also require a separate permit for each business location within the state.
- Collections. Since you'll typically be the one collecting sales tax from customers, plan to start accounting for it with your very first taxable sale. Just as important, know when you're not required to collect tax because a customer has a valid exemption claim.
- Payments and returns. Once you've collected sales tax, remit it to the appropriate state agency along with the required return. States set their own filing frequency (monthly, quarterly, or annually) based on your sales volume. Even if you owe nothing for a given period, missing a required "zero dollar" return can still trigger a penalty.
- Professional knowledge and guidance. A good accountant or tax professional can be a valuable resource, but building your own working knowledge of your state's tax rules will help you get the most out of that relationship.