The next time you buy something, you might want to take a second and look at the receipt. If you are like most people, you will probably grumble that the item listed at $10 actually cost $10.87. But if you are of a certain mindset, you might also wonder how the shop determined to charge an extra 87 cents for tax, and not a different amount.
For businesses that collect tax, getting that amount correct is rather important — collect too little, and they have to make up the difference out-of-pocket; collect too much and they have technically stolen from their customers. Knowing the correct amount of tax to charge and remit requires understanding a range of regulations imposed by a number of potential government jurisdictions.
As part of our Sales Tax 101 Series, this article will aim to demystify some of the complexity behind assessing the correct tax amount.
How do I Know What Tax Rate to Charge?
The first thing to internalize about assessing transactional taxes is that they are location-based. That is, the transaction needs to be tied to a location from which a tax rate can be determined. For the most part, that location is where the customer takes possession of the goods or, for services taxes, where the services are provided.
For brick-and-mortar retailers, it’s pretty straightforward: The customer will go to the store, pick out what they want, go to the counter to pay, and take possession at the counter. Therefore, the location that matters for assessing tax is the store’s location.
This gets a little more complicated, though, when the transaction involves a delivery. In this scenario, there are two potential locations: Where the seller shipped the goods from, or where the customer received the goods. The question then is which to apply; the shipper’s location or the customer’s?
Thankfully, states have largely dealt with this complexity by establishing that either the former will apply (and so the tax is “origin-based”) or the latter will (so the tax is “destination-based”) for all deliveries made within the state. An important aspect to note is if you are selling products for delivery within the same state that you are based in, you should make sure whether your state is origin-based or destination-based and assess the correct address’ tax.
When it comes to interstate deliveries, the picture is a bit easier: Possession is always deemed to take place in the delivered-to state. The shipping-from state, for a number of reasons, should not be assessing tax on goods being delivered elsewhere; whereas the destination state has a more clear obligation to collect tax. This does create complexity for businesses shipping to a lot of different states, though, as there are a lot of possible tax rates to determine.
For decades, businesses have largely only had to worry about taxes in the state where they are located or where they conduct certain activities (i.e. “physical presence”). However, in the wake of the recent Supreme Court decision in South Dakota v. Wayfair, relying only on this kind of local focus is imperiled. States are now permitted to expand their nexus requirements and require remote sellers to collect and remit tax on their sales into the state. This will almost certainly add a great deal of burden on businesses that make lots of interstate deliveries, as they will now need to look up the tax rates at many more addresses.
There is a lot to unpack with Wayfair, and a lot of uncertainty in how states will take advantage of it. (You can find much more information from Sovos on Wayfair here.) For now, just know that in the future remote sellers’ tax liabilities and need to get accurate, address-specific tax rates will likely get much more onerous.
Ok, I Know Where I Need to Assess Tax. Now What?
Once you know where tax is being assessed, the next step is determining all the taxes and different rates that may apply — and, of course, there’s no simple or universal rule for that. Instead, you need to closely examine the rules of the state and see what all the state allows when it comes to tax jurisdictions.
When it comes to tax jurisdictions, it’s best to work from top down. Start with the biggest applicable area, and then see if there are more specific rates to apply. Since there is no national sales tax, that means the place to start is at the state level.
45 states, plus the District of Columbia, currently impose a statewide sales tax. If you do happen to make a sale in or to Delaware, New Hampshire, Montana, or Oregon, you can ignore all of this — none of those states imposes sales taxes. Alaska also does not have a statewide sales tax, but it does permit local regions to collect their own sales tax.
Speaking of local taxes, 38 states permit localities to impose an additional tax on top of the state’s rate. These taxes are generally based on established geographical boundaries, such as county or city limits. In some cases, the local rates are even higher than the state rate. Colorado, for instance, has a state tax of only 2.9%, but local taxes impose up to an additional 8.3%.
On top of these state and locality-based taxes, many states also permit what are called “special district” taxes. These are generally to fund specific community improvement projects, such as regional transportation services or cultural development. It’s important to note with these special district taxes that the areas they cover may have little connection to geographic borders. Transportation districts can cover many counties at a time — even the entire state — where cultural districts may be only a few blocks carved out in a city.
So, after you have determined the address where the tax will be determined, you will need to figure out all the jurisdictions that impose a tax at that address. State revenue departments will often provide online lookup tools to help out their taxpayers. But for businesses that need to look up many different addresses, this can be an overwhelming task.
Is Location the Only Thing That Matters When Assessing Taxes?
Of course it would be too easy if all that mattered when it comes to tax rate determination was knowing the address where the tax should be applied. To complicate things, states also have rules that can change the tax rate depending on the product being sold.
Now, we should all be able to agree these are, for the most part, a good idea — after all, isn’t lowering the cost for infant care or medical products a social positive? But they do complicate things for businesses determining their tax liabilities.
What might such businesses need to look out for? Well, it depends on the products they are selling. By and large, the generally applicable sales tax will be correct. But for certain markets, such as food retailers, or for certain products, such as beverage alcohol or oil and gas, special rules may apply.
Also, be aware of temporary changes to a state’s tax requirements. Many states will grant sales tax holidays, where some goods or purchases under a threshold are tax exempt. These often happen at specific times of the year — for instance tax holidays on school supplies in August, or on emergency hurricane supplies in summer are fairly common. Again, the intent of the government is to provide a social good, but it can complicate things for the retailers.
Sales Tax is All I Have to Worry About…Right?
By and large the tax that we’ve been talking about so far is Sales Tax: A levy added to the purchase price of a good or service, collected and remitted to the state by the seller. And for the most part, that will be the tax that most affects a business’ day-to-day operations.
But, as a word of warning, sales tax is not the only tax that may apply.
Often in the same breath with sales tax, people mention something called “use tax.” Where sales tax can be seen as a tax on the privilege of selling a good or service, use tax can be seen as a tax on the privilege of using a good. It comes in two flavors: sellers’ use and consumer use. The former is when the seller still collects and remits the tax, but due to state regulations, it is administered as a “use” tax; the later is when the consumer has the duty to pay the tax, likely with their next income tax statement. If you are in a position to collect sellers’ use tax, you should pay close attention to those requirements. Generally, use tax will have the same rate as sales tax, and they are often filed on the same form — but these are not universal rules, so make sure to check with the local revenue department.
Some states impose other, additional taxes that business must pay. An example of this is Washington state’s Business and Occupational (B&O) Tax. While they may operate much like sales tax, as a levy on a business’s revenue as determined by individual sales, they will have different rates and filing requirements than sales taxes. While not very common, businesses would do well to check with the local revenue department to know what all taxes they may be liable for on top of sales tax.
Dealing with taxes and assessing the correct rates for each address and product you may be selling is complicated. Ask us how we can help you!
See for yourself how Taxify by Sovos can help your business collect and remit tax in every jurisdiction where you have an obligation.