Calculating and understanding sales tax can be a bit complicated especially for those selling to customers throughout multiple states or countries. So, we have invited Mark Faggiano, Founder and CEO of TaxJar, to shed light on how you can ensure you are charging the correct sales tax.
We talk to tons of online sellers, and one of the most common question we see when it comes to collecting sales tax is: “Wait, am I doing this right?”
We get it. Figuring out which sales tax rate to charge your customers can be complex. Not to mention, there are probably 19 other things on your to do list ahead of “Make sure I’m not totally screwing sales tax up.”
This quick guide will explain why sales tax is charged the way it is in the U.S., and how to make absolutely certain you’re charging your customers the correct rate.
Sales Tax 101
Forty-five U.S. states and Washington D.C. have a sales tax. Merchants with sales tax nexus in a state are required to collect sales tax from their buyers in that state and remit the fund back to the state. From there, those funds are used to pay for budget items like roads, schools and public safety.
What Makes Up a Sales Tax Rate?
You’ve probably noticed in your day-to-day life that sales tax rates vary from place to place, even within a state or county. A few factors make up your standard sales tax rate:
State sales tax rate – Each state with a sales tax has a statewide sales tax rate, generally ranging from 4-8%. About 10 states stop there and only have a statewide sales tax rate for the whole state. But most states also have…
County and city sales tax rates – Cities and counties want money to fund budget items, too, so in most states they can also require merchants to charge a sales tax. City, county and other local rates are added on to state rates.
Example: The sales tax rate in Norfolk, Nebraska is 7.5%. That’s the 5.5% Nebraska state sales tax rate plus the 2% Norfolk city sales tax rate. (Madison
County, where Norfolk is located, does not have a sales tax.)
Special taxing districts – Sometimes several local areas will be part of a “special taxing district.” This generally occurs when a big project – like a public transit system – will affect multiple localities. One example is the “Metro Commuter Transit District (MCTD)” which encompasses New York City and 7 New York counties.
Example: The sales tax rate in Suffern, NY is a combined 8.375%. That’s the 4% New York state rate, the 4% Rockland county rate, and the .375% MCTD (special taxing district) rate.
Check out TaxJar’s Sales Tax Calculator to look up a sales tax rate for yourself.
Sales Tax Sourcing Rules
“Sourcing” is where sales tax gets tricky for eCommerce sellers. There are two main types of sourcing rules, and states fall into either category:
Origin-based sales tax sourcing – In origin-based states, if you are based in the state and not considered a remote seller, then the rules say you collect sales tax based on the total sales tax rate at your business location.
Destination-based sales tax sourcing – Most states are destination-based states. In destination-based sales tax states, the rules say that you should charge sales tax based on the combined rate at your buyer’s location. By now you know how tricky this can get, with all those different city, county and special taxing district rates playing their part. Two towns that are 10 miles apart can have vastly different sales tax rates.
All states fall into either the origin-based or destination-based category, with the important exception of California, which is a “modified-origin” state. (You can read more about California sales tax here.)
For eCommerce sellers with sales tax nexus in multiple states, it’s important to note that if you are considered a “remote seller” (not based in a state) then you are required to use destination-based sourcing even when selling into origin-based states. Again, there are exceptions in California, Arizona and New Mexico.
Sales tax sourcing rules can be tough to wrap your mind around, so we wrote a whole post about Origin vs. Destination-Based Sales Tax States.
As if this weren’t confusing enough, there’s also the fact that some products aren’t taxable in some states. Or some products are taxed at a different rate in some states.
For example, in Illinois grocery items are taxed at a reduced rate of 1%. In many other states, grocery items are not taxable at all. In New York, clothing under $110 is exempt from sales tax. But clothing is taxable in most states.
Each state will have differing rules about which products are taxable and tax exempt.
Then there’s the matter of shipping. Some states consider shipping charges part of the total sale, and thus taxable if the sale is taxable.
Other states do not consider shipping a part of the total sale as long as the shipping charge is separately stated on the invoice.
Still other states, like Virginia, consider shipping non-taxable except if shipping and handling are combined – then the whole charge is taxable.
How Can I Collect the Right Amount of Sales Tax?
In the past, it has been up to you or your shopping cart to ensure you’re collecting the right amount of sales tax from your customers all the while following sourcing and product and shipping taxability rules. What a hassle.
TaxJar’s SmartCalcs sales tax API takes care of all that hassle – and it’s absolutely free for Magento merchants!
No matter if you have nexus in multiple destination-based states, or sell a product that is taxable in some states and exempt in others, TaxJar has your back.
Check it out for yourself with a 30-day-free trial.
There’s a whole lot more to sales tax than just charging the right rate. For more info, check out our Sales Tax 101 for Online Sellers guide. Or start the conversation in the comments!
TaxJar, a Magento Premier partner, is a service built to make sales tax calculation, reporting and filing simple for eCommerce sellers. Try a 30-day-free trial of TaxJar today and eliminate sales tax compliance headaches from your life!
About the Author
Mark Faggiano is the Founder and CEO of TaxJar – a service that automates sales tax compliance for over 5,000 eCommerce businesses. Mark has built a career around his passion for using technology to solve complex problems that hamper growth for small businesses. He previously co-founded and grew FileLater to become the web’s leading tax extension service for both businesses and individual taxpayers before it was acquired in 2010.