A Complete Guide to Sales Tax For Small Business Owners
Running a business, regardless of its size, includes the unavoidable task of paying taxes on products and services sold. Sales tax, in particular, is a significant obligation that can be daunting for many small business owners to manage correctly.
Sales tax typically applies to tangible goods sold within a state but can also cover certain services, such as professional, repair, and installation services. Additionally, some states impose taxes on digital items such as streaming or downloadable content.
Sales tax regulations vary greatly depending on your location, making it crucial for small business owners to understand their local tax laws to improve regional sales. To help with this, we've compiled a comprehensive guide covering all the essential aspects of sales tax and tips for managing it effectively.
Let's start with the basics.
What is Sales Tax?
Sales tax is the fee charged to consumers when they purchase goods and services. Businesses are responsible for collecting sales taxes from their customers and remitting them to the relevant government body where a sales transaction has occurred.
While it may sound like an added expense and a complex task, failing to comply may result in hefty fines imposed on businesses. Also, sales taxes are critical for sustaining local and state governments. Generally, most items are subject to sales tax. However, there are some exemptions to sales tax depending on the type of product being sold or its value in certain states or municipalities.
What is a Business Tax?
A business tax is imposed on a company's revenue, profits, or property. It differs from sales tax, a consumption tax collected from customers on selling goods and services and remitted to the government by the seller. Business tax focuses on the financial activities of the business itself, while sales tax is paid by consumers.
When is Your Business Exempt from Sales Tax?
Sales tax does not apply to businesses that do not have a nexus.
Nexus is the vital connection between taxpayers and their states, granting authority to tax within bounds. With sales tax nexus, states would be able to collect taxes from those who are subject to them.
Before the monumental 2018 Supreme Court decision in South Dakota v. Wayfair, businesses were required to have a physical presence in a state to establish a nexus. However, after the Wayfair decision, companies must pay sales tax despite their physical presence in a state after reaching a certain sales threshold.
This sales threshold or nexus for most states is $100,000 or 200 transactions.
A few states have a higher sales tax nexus, such as Alabama ($250,000), California ($500,000), Mississippi ($250,000), New York ($500,000 and 100 transactions), and Texas ($500,000).
You also have states such as Alaska, Delaware, Montana, New Hampshire, and Oregon where no sales tax applies.
So, if your business does not have sales worth $100,000 or above, or if you’re selling your products and services in states where there is no sales tax, you’re exempt from sales tax.
You can also avoid sales tax when you have a resale certificate.
A resale certificate ensures you don't have to pay sales tax when purchasing materials necessary for creating your company's products.
For instance, clothing store owners don't need to worry about paying sales taxes on the fabric they purchase to make apparel—their customers foot the bill instead via retail sale tax once they buy the final product.
How Important is Sales Tax to Your Business?
Streamlined Sales Tax (SST) simplifies complex tax collection and administration for retailers and businesses selling across multiple states. With SST, companies can maximize efficiency in their sales process without having a physical presence in each state where transactions occur.
SST was introduced in 2000 by the National Governor’s Association (NGA) and the National Conference of State Legislatures (NCSL). It has 25 member states.
Sadly, few businesses know this state-run program and the benefits sellers can gain. Here are some of the benefits you can experience as a business:
State level administration of sales and use tax collections.
Uniformity in the state and local tax bases.
Uniformity of major tax base definitions.
A central electronic registration system for all member states.
Simplification of state and local tax rates.
Uniform sourcing rules for all taxable transactions.
Simplified administration of exemptions.
Simplified tax returns.
Simplification of tax remittances.
Protection of consumer privacy.
There is also an additional benefit to being a volunteer seller. The state provides compensation for CSPs (Certified Service Providers) to help get your Certified Automated System (CAS) up and running—seamlessly integrate it into your existing system, quickly calculate the taxes due, and effortlessly file returns, as well as take care of any remittance needs.
Here are the 23 member states of the SST.
Arkansas
Georgia
Indiana
Iowa
Kansas
Kentucky
Michigan
Minnesota
Nebraska
Nevada
New Jersey
North Carolina
North Dakota
Ohio
Oklahoma
Rhode Island
South Dakota
Utah
Vermont
Washington
West Virginia
Wisconsin
Wyoming
Difference between VAT & Sales Tax
You may choose to offer your products and services outside the US. In such scenarios, you need to understand Value-added Tax (VAT) and how it differs from Sales Tax in the US.
Here are a few quick pointers explaining the difference:
To summarize, value-added tax and sales taxes have some similarities but also important differences, such as taxable rate levels, when taxation occurs within the production/distribution chain, and how resellers are taxed for goods purchased for resale purposes.
Understanding these nitty-gritty sales tax regulations can be tricky, so getting help from experts or leveraging a skilled bookkeeper is highly recommended for any small business owner!
How To Calculate Sales Tax in the US?
Let's take an example of an item priced at $100 with a 7% sales tax rate. This means that you would need to multiply $100 by 0.07 (the decimal form of 7%) to get the amount of sales tax collected, which is $7 in this case. Adding to the original cost of $100 brings us to a final price charged to the buyer: $107.00.
However, though it may sound simple on paper, in real-time, there are many complex scenarios in which businesses need to use appropriate formulas and methods to calculate sales tax.
Let’s look at the standard sales tax formula applicable to most businesses.
Sales Tax Formula
The standard formula to calculate sales tax is:
Sales Tax = Net Price X (Sales Tax Rate/100)
The formula to calculate the final price of the product with sales tax is:
Final Price = Net Price + Sales Tax Amount
Let’s put these formulas to action with two different examples.
Suppose a business operates in Alabama, and the state charges an average sales tax of 9%. What would be the selling price of a $150 product?
As you can see, the final product price is $163.50.
Likewise, using the above formulae, you can calculate the final product price with sales tax for any of your products.
It’s best to use sales automation software such as QuickBooks, which will automatically calculate the sales tax for all of your sales. We will look at this in just a bit.
In the meantime, you can use the sales tax calculator below for a quick calculation.
Sales Tax Rate by State
The sales tax landscape in the United States can vary significantly from state to state -- with five states forgoing a statewide rate altogether. However, many municipalities still collect their taxes on top of existing rates, making overall percentages higher than expected.
The table below outlines every US jurisdiction's average total sales tax rate based on current local conditions; Alaska has its unique entry as it only allows municipal-level taxation but no overarching policy.
Sales Tax Automation
Thanks to financial technology advancements, many small business owners can save time and resources through sales tax automation.
Sales tax automation uses specialized software to ease the burden of managing sales tax compliance. It helps streamline calculating, collecting, and remitting taxes owed on taxable transactions.
This can save small business owners time and resources by ensuring that all due taxes are accounted for and remitted correctly.
Three Benefits of Sales Tax Automation
Speed and Accuracy: Tax laws vary by state or jurisdiction, so a business must have access to up-to-date rules, regulations, and exemptions when calculating sales tax obligations. With automated solutions, this information is already embedded into the software, allowing businesses to configure their system based on their specific needs quickly. The accuracy and speed at which sales tax automation can be accomplished is possible by integrating specific tax information into the software.
Power and Control: These systems' power lies in their ability to automatically detect different types of products or services being purchased and then adjust rates accordingly. Businesses can also have full control over what products are exempt from taxation or not subject to certain state taxes. Automation allows for detailed tracking capabilities so companies can accurately collect applicable taxes from customers. This reduces mistakes and ensures accuracy in reporting for audits or potential disputes with taxing authorities.
Forms and Templates: In addition to accurate calculations, automated systems offer features such as pre-filled forms for filing returns with the necessary agencies. These forms are populated automatically using data collected during transactions, eliminating manual entry errors while ensuring correct filing deadlines are met on time every time. Automation also simplifies multi-state filings by allowing users to manage multiple locations as one entity rather than having separate accounts for each state they operate in - a great benefit for businesses that sell across various states or countries with varying tax requirements.
Sales Tax Software with Automation Features for Small Businesses
Creating sales automation software or using advanced spreadsheets for sales tax compliance can be challenging. Instead, sales tax software offers a comprehensive solution to keep businesses updated on local and federal tax requirements and ensure accurate tax collection from customers across various markets.
These tools streamline transaction management, providing customer support teams, accounting personnel, and e-commerce administrators with everything needed for successful tax filing processes across multiple industries. This simplifies and automates sales tax compliance, reducing the risk of errors and ensuring timely remittance.
With that said, here are the top 6 sales tax software you should use.
QuickBooks
Avalara
ProSeries Tax
123Sheets
TaxJar
Vertex
Sales Tax in QuickBooks
QuickBooks is highly regarded as the best financial software for small business owners. It automates sales tax calculations, applying the correct rate based on date, location, product type, and customer. Accurate product categorization ensures proper tax application, as tax rates and rules vary by state. The initial setup involves categorizing products correctly to ensure compliance with varying state tax regulations. This automation eliminates guesswork and simplifies tax management for businesses.
How to Set Up Sales Tax in QuickBooks Online?
Here's how to set up sales tax in QuickBooks Online.
1. Navigate to the Sales Tax Section:
Go to the Taxes tab.
Select Sales Tax (It might also be called Sales Tax Center in some versions).
2. Add Your Tax Rate and Agency:
Click on Add/edit tax rates and agencies.
Choose New.
Select whether you're setting up a Single or Combined tax rate.
Single Rate: Used if you only collect one sales tax rate for a single agency.
Combined Rate: This is used if multiple sales tax rates need to be combined for a single agency (common in some US locations).
Enter the Tax Details:
Name: Give the tax a descriptive name for easy identification.
Agency: Select the tax agency you pay to (e.g., State Department of Revenue).
Rate: Enter the sales tax percentage you collect.
Save: Click Save to create the tax rate.
3. (Optional) Set Up Automatic Sales Tax (if applicable):
QuickBooks can automate some sales tax calculations based on your location.
If prompted, you can answer location-based questions to allow QuickBooks to set up automatic sales tax.
Important Note: Even with automatic setup, it is crucial to review the tax rates and agencies for accuracy in your specific location.
4. Tell QuickBooks Where You Collect Sales Tax:
This step determines if you must collect sales tax for all your sales or only in specific locations.
Select Yes if you collect sales tax in your state (or other applicable jurisdiction).
Choose No if you don't collect sales tax (less common).
5. (Optional) Add Sales Tax to Your Products and Services:
Go to the Products and Services section.
Edit each product or service and assign the appropriate sales tax rate you created earlier.
This ensures the sales tax is automatically calculated when creating invoices or receipts.
6. Review and Maintain Your Sales Tax Settings:
Regularly review your sales tax rates and agencies to ensure they're accurate and up-to-date.
Tax rates and regulations can change, so staying updated is crucial.
Simplified Sales Tax Management with QuickBooks
QuickBooks ensures accurate tax calculation by classifying products correctly according to their category and location. Business owners can monitor sales tax information and view reports on amounts collected, taxes due, and payments within a single dashboard.
QuickBooks simplifies tax management by clarifying payments or refunds to customers and government agencies. It also tracks filing deadlines to avoid penalties, ensuring timely returns for businesses operating in multiple states.
By automating calculations, categorizing products, and offering detailed reports, QuickBooks helps small businesses manage sales taxes accurately and efficiently, minimizing errors and missed deadlines.
How to record sales tax payable in QuickBooks?
To record sales tax payable in QuickBooks, there are two methods.
Method 1: After Filing Your Sales Tax Return
Go to Taxes and select Sales Tax (QuickBooks Online) or Sales Tax Center (QuickBooks Desktop).
Review what you owe: Ensure everything is accurate before filing. Look for the return due this month and select View Tax Return. If needed, you can also use the Tax Period Date dropdown menu to select an older return.
File Your Return (Optional): If you still need to, complete the filing process within QuickBooks (applies if your version supports it).
Record Payment: Once you can record the sales tax payment owed, select Record Payment.
Payment Details: Enter the following details:
Tax Payment: Enter the total sales tax amount you owe.
Payment Date: Select the date you made the payment.
Bank Account: Choose the bank account you used for the payment.
(Optional) Print a Check: If you're printing a physical check, check the box next to "Print a Check" before selecting Record Payment.
Method 2: Manual Recording (During Transactions)
This method is helpful if you want to track sales tax liability as you record sales:
Enable Sales Tax Tracking: Make sure your products and services have the appropriate sales tax rates applied. You can set this up in the Sales Tax or Sales Tax Center section.
Record Sales Transactions: When creating invoices or receipts, ensure the sales tax is calculated automatically based on the pre-configured tax rates.
Sales Tax Liability Report: Monitor your sales tax liability by running reports like the Sales Tax Liability Report. This report summarizes the total sales tax you've collected but still need to pay.
Record Payment: Once it's time to make the payment, follow steps 4-5 from Method 1 above.
QuickBooks Sales Tax Adjustment
QuickBooks simplifies the process of adjusting sales tax. If an adjustment is needed, follow these steps:
Select "Make Adjustment": When recording a sales tax payment, choose "Make Adjustment" to increase or decrease the sales tax amount for reasons such as credits, discounts, fines, interest, penalties, or rounding error corrections.
Enter Adjustment Details: Input the adjustment amount and specify the reason. You can enter either a positive or negative amount.
Select an Appropriate Account: Choose an account to track the adjustment. Do not select the Sales Tax Payable account. Use the following guidelines:
Credit or Discount: Select an income account, such as Other Income.
Fine, Penalty, or Interest Due: Select an expense account.
Rounding Error: Use an income account for harmful errors or an expense account for positive ones.
This ensures accurate tracking and proper financial records in QuickBooks.
Ease Your Sales Tax Compliance Hurdles
PayTraQer is a powerful application that syncs online payments and e-commerce sales with QuickBooks Online, ensuring accurate sales tax compliance more straightforwardly than ever.
With PayTraQer, businesses can quickly and easily record all payments received and, as a result, all associated taxes paid. The automated, real-time updates save time and money for businesses that would otherwise spend hours manually entering data into multiple systems. This automation also eliminates the possibility of double-entry mistakes or inaccuracies due to manual data entry. Additionally, PayTraQer can be customized for business needs by integrating with other applications, such as Shopify or Stripe, which provide more detailed information on customer orders.
FAQs
What are the main 3 types of taxes?
The three main types of taxes are:
Taxes on Income
Taxes on Property
Taxes on Goods and Services
Which states do not charge sales tax?
Five states don't require sales tax from their citizens, but that doesn't mean local areas in these same states won't. Delaware, Alaska, Montana and New Hampshire have avoided state-wide taxation on purchases – though cities within may still impose a fee for your goods or services. In Oregon specifically, it's more of an exception as both the state government AND most counties do not collect taxes despite some municipalities instituting fees here and there.
Which states have the highest sales tax?
With the highest total sales taxes around 9.5%, five states are leading the pack: Tennessee, Louisiana, and Arkansas at a near tie of 9.55%, Washington with just slightly less than them at 9.23% - while Alabama rounds out this top 5 list with its impressive score of 9.22%.
Are there any items or services that are exempt from sales tax?
Many states provide exemptions or exclusions for specific items or services from their sales tax laws. Some common examples include:
Food and groceries
Prescription medications
Educational materials
Clothing and shoes (up to a certain price threshold in some states)
Medical and dental services
It's important to note that these exemptions vary significantly from state to state, so it's always a good idea to check your area's specific sales tax laws.
Is VAT the same as sales tax?
A Value-Added Tax (VAT) is a flat levy applied to purchases, much like a sales tax. However, instead of paying the entire amount at once when consumers purchase, part of it can be redistributed among different entities involved in the transaction.
How much is sales tax in the UK?
On 4 January 2011, the UK's VAT legislation significantly changed: The standard rate rose from 17.5% to 20%. However, some transactions, such as postage stamps and financial dealings, were exempt from this new tax increase. Businesses must abide by different VAT rates depending on their customers' goods or services.
What is the difference between a sales tax and a use tax?
Sales and use taxes are both consumption taxes, but they apply in different situations and serve various purposes.
Sales Tax
Collected by the Seller: Sales tax is charged at the point of sale and collected by the retailer.
Applicable on Tangible Goods and Some Services: It is typically applied to tangible personal property and sometimes specific services, depending on state laws.
Location-Based: The rate and applicability of sales tax depending on where the sale occurs. Each state and sometimes local jurisdictions can set their own sales tax rates.
Use Tax
Paid by the Buyer: Use tax is owed by the buyer when sales tax has not been collected by the seller. This typically happens when goods are purchased out of state or from an online retailer that does not collect sales tax.
Self-Reported: The buyer reports and pays the use tax to their state tax authority.
Ensures Tax Fairness: Using tax helps ensure that out-of-state purchases are not used to evade sales tax, thus maintaining fair competition between in-state and out-of-state sellers.
What is sales tax for small businesses?
Sales tax is a consumption tax imposed by the government on the sale of goods and services. Small businesses must collect this tax from customers and remit it to the appropriate tax authority.
Why is it essential for a business owner to understand sales tax?
Understanding sales tax is crucial for a business owner because it ensures compliance with state and local tax laws, helps avoid penalties, and maintains accurate financial records.
How does a small business collect sales tax?
A small business collects sales tax by adding the applicable tax rate to the sales price of taxable goods and services at the point of sale. The collected tax is then remitted to the state’s Department of Revenue.
What is a sales tax return, and how often must it be filed?
A sales tax return is a report filed with the state’s Department of Revenue detailing the sales tax collected during a specific period. The filing frequency (monthly, quarterly, or annually) depends on state regulations and the sales volume.
What is a sales tax permit, and how do I obtain one?
A sales tax permit is a state-issued license that allows a business to collect sales tax. To obtain one, a company must register with the state’s Department of Revenue, often through an online application process.
When should a small business pay sales tax?
A small business should pay sales tax according to the schedule specified by the state’s Department of Revenue, typically after filing the sales tax return for the period.
What is the sales tax nexus, and how does it affect my business?
A sales tax nexus is a connection between a business and a state that obligates the business to collect sales tax. This nexus can be established through physical presence, economic activity, or other business operations within the state.
How can the Small Business Administration help with sales tax compliance?
The Small Business Administration (SBA) provides resources and guidance, including workshops, webinars, and informational materials, to help small businesses understand and comply with sales tax regulations.
How does state sales tax vary across different states?
State sales tax rates and regulations vary widely. Some states have no sales tax, while others have high rates and different rules on what is taxable. Businesses must know the specific requirements in each state where they operate.
What are the sales tax obligations for online sales?
For online sales, businesses must collect sales tax in states with nexus. This may include states where the company has a physical presence, reaches certain sales thresholds, or engages in specific business activities.
How does the Department of Revenue assist with sales tax collection?
The Department of Revenue provides guidance, forms, and online tools for businesses to register, collect, and remit sales tax. They also offer support through customer service for any sales tax-related queries.
What should I know about sales tax for goods and services?
Sales tax applies to most tangible goods and, in some states, to specific services. Businesses must understand which of their products or services are taxable under their state’s tax laws.
How do state and local sales taxes differ?
State sales tax is mandated by the state government, while local sales tax is imposed by counties, cities, or other local jurisdictions. Businesses must collect and remit both state and local sales taxes if applicable.
Why is it essential to file a sales tax return on time?
Filing a sales tax return on time is crucial to avoid penalties, interest charges, and potential legal issues. Timely filing ensures that the business remains in compliance with state tax laws.
How can a small business ensure compliance with all sales tax requirements?
A small business can ensure compliance by staying informed about state and local tax laws, keeping accurate records, using reliable accounting software, and seeking advice from tax professionals or the Small Business Administration.