When it comes to selling in the USA, charging sales tax correctly can be tricky. As a seller, you are legally obliged to collect and remit sales tax on behalf of the state in certain circumstances, which creates a compliance burden.
You only need to charge sales tax on your transactions in a state where you have nexus. For this discussion, we refer to the case where a business has nexus and has registered for sales tax and is therefore obligated to add tax to their quoted selling price.
First Things First, Ask Yourself These Four Questions
Before you start calculating how much sales tax you need to collect, you need to make sure that you are even liable for sales tax in the first place and then for how much sales tax.
Do you have nexus?
Nexus is the connection between your business and a state that obligates you to collect and remit sales tax. But how do you know if you’ve established nexus? It can be as simple as having a physical presence like a storefront or warehouse, or as intricate as having economic nexus, which depends on the amount of sales or transactions in that state. If you do not have nexus then you do not need to collect sales tax or learn how to calculate it (yet).
Which state’s tax applies?
Sales tax is generally a destination-based tax – if the product is delivered to a customer in a state (or downloaded in the case of digital products), then it doesn’t matter where the seller is based or where the physical goods came from. This includes deliveries that originate outside the US – goods delivered to a customer in New York are subject to NY sales tax whether they were shipped from Manhattan, Miami or Mumbai.
What tax rate applies?
Unlike other consumption taxes (like VAT or GST), there are multiple sales tax rates within a state to consider. When you have to charge VAT in the UK, the VAT rate will either be 20% (or in very few cases, a reduced rate of 5% may apply), When you sell to a U.S. state – although there is a fixed “state-wide” sales tax rate, each jurisdiction is allowed to add a local sales tax to the state rate,
For example, the state rate in California is 6%, but a sale to Los Angeles could be taxed at almost 10%. In total, there are over 13,000 local tax jurisdictions across the US and the rates can vary from 3% to 11%
What product are you selling?
If thousands of local rates didn’t complicate matters enough, the type of product being sold also affects what sales tax to charge. For example, food might be exempt in some states (so no tax applies), but taxable in others. Within a state, the same food item may be exempt from state tax, but certain localities will add local tax! It goes on and on – the point is that the only accurate way to calculate tax is to assess the combination of the product type and the delivery address of the buyer, and only then can you determine what rate to apply.
How to Calculate Your Sales Tax
Once you’ve determined the applicable tax rate and confirmed that you have nexus and your product is taxable, it’s time to calculate the total sales tax for the transaction.
Here’s how you can do it:
Step-by-step calculation:
- Determine the tax rate: Add together the state sales tax rate and any applicable local rates (county, city, or special district taxes) to get the total combined tax rate.
- Apply the tax rate: Multiply the combined tax rate by the sale price of the product or service. This will give you the amount of sales tax you need to collect.
- Add the tax to the sale price: Finally, add the calculated sales tax to the original sale price to get the total amount the customer needs to pay.
Example 1: A simple in-state sale
Let’s say you’re selling a $100 item in a state where the sales tax is 6%, and the local county adds an additional 2%. The total combined tax rate is 8%.
- Combined tax rate: 6% (state) + 2% (local) = 8% total sales tax rate.
- Sales tax calculation: $100 (sale price) × 0.08 (tax rate) = $8 in sales tax.
- Total sale amount: $100 (sale price) + $8 (sales tax) = $108 total the customer pays.
Example 2: A sale involving multiple local taxes
Now, suppose you’re selling a $50 item in a state where the state tax is 4%, the city adds 1.5%, and there’s an additional 0.5% special district tax. The total combined tax rate is 6%.
- Combined tax rate: 4% (state) + 1.5% (city) + 0.5% (special district) = 6% total sales tax rate.
- Sales tax calculation: $50 (sale price) × 0.06 (tax rate) = $3 in sales tax.
- Total sale amount: $50 (sale price) + $3 (sales tax) = $53 total the customer pays.
Using a Sales Tax Rate Calculator
Manually calculating sales tax can be straightforward for one or two sales, but it gets complicated quickly when you’re dealing with multiple jurisdictions or products with different taxability. A sales tax rate calculator can simplify this process.
You simply input the location, and the calculator will automatically determine the correct tax rate. This tool can save you time and reduce the risk of errors, ensuring that you stay compliant with state and local tax laws.
In Conclusion
It should be clear that deciding what sales tax rate to apply to your transactions is no simple matter – it is almost an impossible task without software to do the heavy lifting. But it is vitally important that you get this right because failure to charge the correct tax and remit it to the state tax office can result in penalties and other punitive measures that can be deadly to your business.