How U.S. Sales Tax Works: A Guide for Online Sellers
The United States has one of the most complicated sales tax systems in the world, and it can be tough for online sellers to wrap their heads around how sales tax works. This guide will explain the basics of U.S. sales tax so online sellers aren’t completely and totally lost.
U.S. Sales Tax is Governed at the State Level
Many online sellers are initially surprised to learn that there is no “national” or “federal” sales tax in the U.S. Sales tax is governed at the individual state level, and forty-five states and Washington D.C. all have a sales tax.
Since sales tax is governed at the state level, each state gets to make their own sales tax rules and laws.
U.S. Sellers are Only Required to Collect Sales Tax from Buyers in Some States
Even though sales tax rules and laws vary from state to state, new only sellers are only required to deal with sales tax in one state – the state where your business is based. However, as your business grows, you may find yourself collecting sales tax from buyers in multiple states due to the concept of “sales tax nexus.”
Sales tax nexus is just a fancy way of saying a “significant presence” in a state. Though nexus laws vary from state to state, the following factors often create sales tax nexus:
- A location
- A drop shipping relationship
- An affiliate
- Making sales at a tradeshow or craft fair
You can read what creates sales tax nexus in every state here. If you have nexus in a state, your next step is to register for a sales tax permit in that state and collect sales tax from your buyers in that state.
Sales Tax Rates Vary Widely
Some countries have one country-wide sales tax rate. Not so in the United States. Each U.S. state sets their own statewide sales tax rate (usually 2-6%), and then most states allow local areas such as cities, counties and “special taxing districts,” to add sales tax rates on top of that. States, cities and other local areas then use this sales tax to pay for budget items like schools and hospitals.
For example, the sales tax rate in Centennial, Colorado is made up of:
- 2.9% Colorado state sales tax rate
- .250% Arapahoe County sales tax rate
- 2.5% Centennial city sales tax rate
- 1.10% district tax rate
Someone buying a toothbrush in Centennial, CO would pay a total of 6.75% in sales tax. This money is then distributed to the state of Colorado, Arapahoe County’s government, Centennial’s government, and the entity governing the district tax for them to use to fund their budgets.
As an online seller, this means you are required to know how much sales tax to collect from your buyers, and then to remit it to the right places. Fortunately, most online shopping carts and marketplaces have built in sales tax collection so you don’t have to figure these rates out yourself!
Most Products are Taxable, Some Are Not
In the U.S., most “tangible personal property” is considered taxable. So, if you sell furniture, or toys or cell phone cases, you’ll generally be required to charge sales tax on those items.
But some states have made exceptions for items they consider to be “necessities.” For example, clothing is not taxable in Pennsylvania, textbooks are not taxable in Kentucky, and groceries are not taxable in most states.
It’s not always as simple as just not charging sales tax, though. Some states make this a bit more complicated. New York, for example, only considers clothing priced at $110 or less to be non-taxable. And Illinois does tax grocery items, but at a reduced rate of 1%. Also, some local areas may tax certain products even though the statewide sales tax rate doesn’t apply.
Again, most shopping carts and marketplaces will allow you to classify your products so that you charge your customers the right rate. Be sure to set your shopping cart’s sales tax collection up correctly, or you may get a complaint from an unhappy customer who wasn’t expecting to pay sales tax on their purchase.
Charge for Shipping? It Might be Taxable
Most states consider shipping to be a taxable part of an eCommerce sale. In their eyes, since you sell online, you must ship the item for the customer to receive it.
Let’s look at an example:
Say you sell the hottest Q4 children’s toy to a buyer for $100, plus $5 for shipping. In states where shipping is taxable, you’d charge sales tax on the $105 transaction total.
In states where shipping is not considered taxable, you’d only charge sales tax on the $100 item price, but not on the $5 shipping charge.
You can see a list of states where shipping is taxable here. Most online shopping carts and marketplaces allow you to specify whether you want to charge sales tax on shipping charges. Of course, you can always get around the need to do this by offering free shipping!
Sales Tax Administration Varies from State to State
As an online seller, your interactions with a state when getting registered to collect, reporting and filing sales tax will vary from state to state.
Some states ask for more detailed information than others when it comes to registering for a sales tax permit.
And some states want you to file sales tax returns at different intervals. As a rule, the more revenue you make from buyers in a state, the more often a state will want you to file a sales tax return and remit the sales tax you’ve collected. You’ll generally find that a state asks you to file sales tax monthly, quarterly or annually. Though some states have other frequencies, like semi-annually or fiscal-annually.
Some states make it harder than others to file sales tax, too. When you file your sales tax returns, most states want you to tell them how much sales tax you collected from buyers in each city, county and other taxing district. This can be a pain to extract from your sales data, especially if you are high volume or sell on more than one shopping cart or marketplace. Fortunately, sales tax automation software makes that part easy for online sellers.
U.S. sales tax is complicated, but I hope this guide has demystified it. For a whole lot more information, check out our Sales Tax 101 Guide for Online Sellers, or ask a question in the comments!
TaxJar is a service that makes sales tax reporting and filing simple for more than 10,000 online sellers. Try a 30-day-free trial of TaxJar today and eliminate sales tax compliance headaches from your life!