How to Collect and Report Sales Tax for Your Small Business

If you sell goods or some services you probably need to collect sales tax, and the rules for each state differ.

What Is Sales Tax?

Sales tax is a tax on purchases of products and some services imposed by states and many local governments to pay for services like public transportation and schools. Sales tax is calculated using a percentage of the price of the item and paid for by the buyer at the time of sale. Though the buyer bears the cost, you, as the seller, must collect the tax and send the money to the taxing agency. Business owners are responsible for collecting sales tax regardless of the type of business entity.

All but five states impose sales tax, but the rules about what is taxable, the amount of tax, and the way it is collected differ from one state to the next so it's important to check with the state agency responsible for collecting taxes to understand your responsibilities.

What Types of Products Are Taxable?

Check with your state agency to learn which products and services are taxable. In most states, the agency is called the Department of Revenue, but it might also be called the Department of Finance, State Board of Equalization, Department of Taxation or Tax, the Department of Treasury, or Office of the Comptroller.

In general, taxable products fall into these categories:

• personal property such as clothing, furniture, appliances, and computers
• household items such as cleaning supplies, tools and equipment, and paper products
• food and beverages sold at restaurants and bars
• utilities like gas, electricity, and phone service, and
• hotel room stays.

Many states don't tax food purchased at grocery stores, but they might tax items like candy, soda, and alcoholic beverages even if purchased at the grocery. Prepared foods such as sandwiches purchased at convenience stores might also be taxable. Prescription drugs are usually not taxable, but over-the-counter medicines like aspirin might be.

What Types of Services are Taxable?

In general most retail goods are taxable, but taxable services are more narrowly defined by most states. Taxable services typically fall into these categories:

• services related to personal property such as equipment repair or installation services
• services related to real property—buildings and land—such as landscaping and painting
• digital and information services such as subscriptions, databases, and stock reports
• business services like credit reporting
• personal services such as tanning salons, hair salons, and pet grooming, and
• recreation and entertainment such as concerts, sporting events, and amusement parks.

Professional services such as consulting fees, graphic design, and architecture are typically not subject to sales taxes. But if you were to sell a package of computer equipment with, say, two days of consultation on the setup and training, the full cost of that package might well be taxable.

How Much Sales Tax Should You Charge?

Alaska, Delaware, Montana, New Hampshire, and Oregon don't have a sales tax, and all but Alaska don't have local sales taxes either. The remaining 45 states, and the District of Columbia, all charge sales tax, and of those states, 38 also have local sales taxes.

Each state sets its own sales tax rate, and when there are also local sales taxes the amount is added in. If you operate your business in California, for instance, you are required to charge 7.25% in state taxes. But California's Los Angeles County charges an additional 2.25% in sales tax, so if your business is located there, the total tax you would have to collect from your customer is 9.5%.

What States Have the Highest and Lowest Tax Rates?

California's state tax is the highest, but some states with much lower state rates can end up with some of the highest tax rates when local taxes are added in. Louisiana's state rate is 4.45%, for example, but the average in that state jumps to 9.52% when local sales taxes are added. Tennessee charges a 7% sales tax, but combined with local taxes, it is just behind California with the second highest combined tax rate.

In Alaska, where there are only local sales taxes, the rate is lowest, averaging 1.76%. Other states with the lowest sales tax rates are Hawaii, with a combined rate of 4.44%, and Wyoming, Wisconsin, and Maine, which all have combined rates in the mid-5% range.

Tax laws can change frequently. Make sure you get the most up-to-date information.

Origin or Destination: Which State's Tax Rate Applies?

Most states use what's called a destination-based tax meaning that the tax rate for the state and locality where the customer receives the goods is the one that applies. Let's say you have a shop in Florida and you sell to a customer who asks you to ship the merchandise to Georgia. You would be required to charge sales tax based upon the rate in Georgia. But anyone who made the purchase at your store and walked out with it would pay the Florida tax rate.

Some states, including Arizona, Illinois, Pennsylvania, and others, use what's called an origin-based sales tax rate. The rate is based upon where the seller is located, which means you'll be charging the same rate to all of your customers, no matter where they live or how they receive their purchases.

You should also watch out for laws that apply if you have a physical presence or employees in a state other than the one where you are based. Let's say you have a store in Connecticut, but you hold an annual sale in your warehouse in New Jersey. You might be required to charge New Jersey sales tax rates to shoppers at your warehouse sale even though your company is based in Connecticut. This is known as a sales tax nexus, and it may apply if any of the following are true:

• you have an office, store or other location in a state
• you have employees in a state
• you have a warehouse or you use a 3^rd party fulfillment center in a state, or
• you sell at trade shows or fairs in a state.

Rules for Internet Sales

If you sell online, it's likely you will be subject to a different set of rules for how you collect sales tax. Remote Internet sellers, as states refer to those who sell online, are generally responsible for collecting sales tax based on the rate that applies where the customer receives the goods, even if you are located in an origin-based state. Check with the Department of Revenue or similar agency in the states you plan to sell in for information on the tax rates there.

Steps for Collecting Sales Tax

Once you have determined whether the products or services you sell are taxable, the states where you will need to collect sales tax, and the amount of tax, follow these steps:

1. Register with the taxing agency in each state where you must collect sales tax. You must register with each state where you are selling before you can begin collecting taxes. Depending on the state and what you sell you might need a seller's permit and/or a sales tax permit. Typically you will need to provide your Federal Tax Identification Number, also called an Employer ID Number (EIN) and the NAICS code or codes for the products and service you sell in order to register. The website for the NAICS, North American Industry Classification System, allows you to search for the standardized codes used for your business using keywords.
2. Track and record the taxes you collect. Your invoices or receipts should list the amount of tax separately from the purchase price. Some states require you to file reports on the taxes you collect in addition to remitting the funds. If you only do business in an origin-based state and you have no online sales, you might be able to track the sales tax you collect manually, but most businesses will need software such as Quickbooks to track the sales tax they collect.
3. Send sales taxes collected to the taxing agency according to the required schedule. Each state will have different requirements for how frequently you must remit sales taxes and the due dates. Some states may also require you to break down the taxes collected by locality.

Sales Tax Exemptions and How to Handle Them

Besides products like food and prescription drugs that might be exempt from sales tax, certain types of buyers might not be required to pay sales tax. Resellers, those that buy products to sell to someone else, and some non-profits in some states are two examples.

If your state allows exemptions for these types of buyers, you will need to get a copy of their valid reseller's permit or exemption certificate. You should keep these permits or certificates on file in case you are asked to present them by sales tax agents.