How US Sales Tax Works

Author: Mark Faggiano  |  November 8, 2017

When selling online you should understand the laws around sales tax throughout the United States. From products to shipping costs, there are rules and regulations around taxes that differ from state to state and item to item. Our partner, Tax Jar, has written a piece to share their sales tax expertise.

coins-currency-investment-insuranceFor a variety of reasons, the United States has managed to build one of the most complex and downright confusing sales tax systems in the world. And as an online business owner, it’s important that you wrap your head around this system so you can at least keep your head down and collect the right amount of sales tax from the right customers.

This quick sales tax 101 guide will explain the ins and outs of U.S. sales tax for online sellers so you can get back to doing what you do best – running your eCommerce business.

Sales Tax is Governed at the State Level

It’s a common misconception that all tax in the U.S. is administered by the IRS. In fact, the U.S. has no federal level sales tax, and no overarching governing body. Instead, sales tax is governed at the state level.

This means that each state gets to make their own rules and laws about things like sales tax rates, which merchants have to collect sales tax, and what items are taxable. It also means that as an online seller, if you have to deal with sales tax in more than one state, you’ll probably find that each state is quite different.

Online Retailers Don’t Always Have to Collect Sales Tax in Every State

One thing online retailers are often surprised to learn is that they aren’t generally required to collect sales from every buyer. Instead, in the U.S., online sellers are only required to collect sales tax in states where you have “sales tax nexus.” Sales tax nexus is just a legalese way of saying “obligation to collect sales tax in a state.”

Each state gets to decide what creates nexus. Common factors that create nexus are having a location, employee or inventory for sale in a warehouse in a state. You can read what each state says creates sales tax nexus here.

Sales Tax Rates Vary from Place to Place

Sales tax is a percentage of a sale that is collected by a retailer and then remitted to a state (and sometimes local areas). Those state and local governments use sales tax to pay for budget items like schools, roads, and fire departments.

Sales tax rates vary from state to state and between local areas.

States set a statewide sales tax rate. Then most states allow local areas – cities, counties and other special taxing districts – to also set a sales tax rate. This means that most areas have a combination of several sales tax rates.

To see how this breaks down, let’s look at the sales tax rate in Marion, Illinois:

6.25% Illinois state sales tax rate

1% Williamson County sales tax rate

1.5% Marion city sales tax rate

8.75% combined total sales tax rate

In other words, if you were buying a toothbrush in Marion, Illinois, you’d pay 8.75% in sales tax on your purchase.

Though there are a few exceptions, as an online seller, you generally charge your buyer sales tax at the sales tax rate of their ship to address. (I.e. if you sold that toothbrush to the buyer in Marion, Illinois, you’d collect 8.75% in sales tax from them.)

Product Taxability Varies from State to State

In the U.S., most “tangible personal property” is taxable. But there are some exceptions, which can vary from state to state. Items like groceries, clothing, medical supplies and textbooks, among other things, are sometimes nontaxable in some states.

For example, clothing is not taxable in Pennsylvania, textbooks are not taxable in Kentucky, and groceries are not taxable in most U.S. states.

Things can get even more complicated. For example, clothing in New York is non-taxable, as long as it’s priced at $110 or less. And while the New York statewide sales tax rate is not applicable clothing priced under $110, some local areas still consider clothing taxable. As another example, groceries in Illinois are taxable, but only at a reduced rate of 1%. Fortunately for online sellers, automated sales tax collection engines can take all these state rules and laws into account so you don’t have to worry about accidentally charging sales tax to the wrong customer in the wrong state on the wrong item!

Shipping Charges are Taxable (Usually)

As an online seller you, of course, get your items to your customers by shipping them. And many online sellers charge a small fee for shipping. It’s important to note that more than half of U.S. states consider shipping to be a taxable charge.

Let’s say you sell a Nintendo Switch for $300 plus $10 in shipping to a buyer in a state like Michigan, where shipping charges are taxable. You’d be required to charge your buyer sales tax on the entire transaction cost – $310.

But say you sell that same Nintendo Switch for the same price to a buyer in a state like Missouri, where shipping charges are not taxable. In that case, you’d only be required to charge sales tax on the $300 item price and not the $10 shipping charge.

You can see which states require sales tax on shipping here.

Sales Tax Administration Varies from State to State

If you deal with sales tax in more than one state, you’ll probably notice many differences from state to state. However, there are a few general rules of thumb.

First, most states want you to file sales tax returns either monthly, quarterly or annually. (Though some will want to hear from you semi-annually or on a fiscal annual basis.)  Usually, the more sales tax you collect from buyers in a state, the more often the state will want you to file and pay sales tax.

States also set their sales tax deadlines on different days of the month. While more than half of the states set the sales tax filing deadline on the 20th of the month following the taxable period, others have due dates on the last day of the month, the 15th, the 23rd, or some other date.

And about half the states with a sales tax even provide sales tax discounts to filers who file and pay on time. This means states will let you keep a small percentage (usually 1-2%) of the sales tax you collected from customers. It’s free money!

I hope this post has helped you wrap your head around the sales tax system in the U.S. For a whole lot more about U.S. sales tax, check out our Sales Tax 101 for Online Sellers guide, or start the conversation 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!

About the Author

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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.