Before you started your small business, you probably only thought of sales tax as a pesky total on the bottom of your receipts—the thing that changed your nice round price into something bizarre. (The Dollar Store doesn’t really work when it’s the $1.07 Store.) But now that you’re a small business owner, understanding sales tax is necessarily a lot more complicated.
In this article, we’ll explain the basics of small business sales tax and what you need to do to get your company legally set up to collect sales tax. By using this article as a starting point, you’ll understand the confusing concept of small business sales tax in no time.
Table of Contents
Understanding The Basics
Before we discuss how to set your company up to collect sales tax legally, we wanted to cover a couple of important basics and some common FAQs about sales tax. If you’ve ever had questions about sales tax, you’ve come to the right place.
What Is Sales Tax?
Sales tax is a government tax on the sale of goods and services.
In Which State(s) Do I Have to Collect Sales Tax?
You must collect a sales tax in any state where you have a nexus.
What Is A Nexus?
We’re glad you asked. In the original sense of the word, a nexus is a connection. When talking about sales tax, a nexus is a legal term that means you’ve created a sufficient physical presence in a state. Once a nexus is established, you are required to pay sales tax on any items sold in or shipped to that state (with the exception of Oregon, Alaska, Delaware, Montana, and New Hampshire, which do not impose a sales tax).
How Is A Nexus Created?
You may have a sales tax nexus in states where:
- You have an office or other property
- You have a storefront
- You have employees (including salespeople and remote workers)
- You have a warehouse
- You attend a tradeshow (or other events)
- You use drop shipping
For example, let’s say my company is headquartered in California, but I also have an inventory warehouse in Washington. That means I would have a nexus in both California and Washington and must collect and pay sales tax in both states.
Each state has slightly different rules about what constitutes a sales tax nexus, so be sure to contact a state’s sales tax authority directly if you think you may have a nexus there.
If you’re still confused about what constitutes a nexus, you can read about it in more detail in the Tackling Taxes section of our Beginner’s Guide to Starting an Online Store ebook.
How Do I Determine Which Sales Tax Rate To Charge My Customers?
Sales tax rates vary by state, county, and even city. And some states—Oregon, Alaska, New Hampshire, Delaware, and Montana—don’t even have sales tax. So how do you know which rate to use?
First, you have to determine the address on which to base the sales tax rate.
If you are selling items from a storefront, your sales tax rate will be based on your store’s address. If you are shipping items, the sales tax rate will be based on the address you’re shipping the items to (not the address you ship goods from).
As we mentioned above, you only have to charge sales to customers when you are selling items in or shipping items to a state where you have a sales tax nexus. So if you are shipping items to a state where you don’t have a sales tax nexus, then you don’t have to worry about sales tax.
Once you’ve determined the proper address to use, all you need to do is consult the state’s sales tax agency to find the sales tax rate for that state, county, and city. (Most states offer a tool that allows you to look up sales tax rate by address online.)
Here is a list of all 50 states’ tax agencies. For most states, the appropriate tax agency will be the Department of Revenue. If you operate out of California, you’ll want to go to the Board of Equalization.
How Much Sales Tax Should I Charge My Customers?
Once you’ve determined the proper sales tax rate (as explained in the section above), you can use this formula to calculate your actual sales tax:
Total Cost x Sales Tax Rate = Sales Tax Total
Let’s do an example. My customer spent $49.95 at my store in California. The sales tax rate is 7.5%. How much sales tax do I charge?
I’ll put the total cost and sales tax rate into our formula.
$49.95 x 7.5% = ?
Since we’re working with a percentage, we have to move the decimal to the left two spaces. So we’re calculating:
$49.95 x .075 = ?
$49.95 x .075 = $3.746
Round to the nearest ten. Now you should have $3.75 as your sales tax amount. Simply add this amount to your total cost (in this case $49.95) and voila! You have the correct price to charge your customer.
$49.95 + $3.75 = $53.70
Luckily for you, you don’t need to manually calculate sales tax. While knowing the principles of sales tax calculation is important, almost all POS and accounting programs do the math for you, and there are plenty of tax software options that can help too. We’ll cover these in more detail later.
What If I Sell Products Online?
Things get trickier when it comes to online sales tax. The sales tax laws for each state were originally created with the brick and mortar store in mind, so figuring out the correct procedures for online sales tax can be a bit difficult.
Luckily, there are plenty of resources available to make this easier. In our eBook The Beginner’s Guide to Starting an Online Store, we devoted a whole section to the basics of eCommerce sales tax. We also recommend TaxJar’s complete Sales Tax Guide for eCommerce Sellers to online sellers who want to learn the nitty-gritty details of online sales tax.
Preparing Your Company To Collect Sales Tax
A lot more goes into charging sales tax than just figuring out the appropriate sales tax rate. You’ll need to take the proper legal measures to ensure your small business is set up to collect and pay sales tax.
Here are four simple steps you’ll need to follow before you can legally charge sales tax:
Step 1: Learn Your State’s Sales Tax Rules
Above all else, be sure to learn the sales tax rules of every state in which you have a nexus. Each state has different laws, which makes this research imperative. Go directly to your state’s official sales tax agency for the most accurate information.
Again, here is a list of all 50 states’ tax agencies. As I mentioned above, for most states, the appropriate tax agency will be the Department of Revenue. If you operate out of California, you’ll want to go to the Board of Equalization.
Take note of the state sales tax rate, county sales tax rates, city sales tax rates, and sales tax exemptions. Check and see if your state offers an online “lookup sales tax by address” tool. And don’t forget to make sure you’re up-to-date on your state’s specific sales tax laws.
Many of these cites will also have small business learning resources about sales tax. Be sure to take advantage of the resources offered by each state.
Step 2: Register For A Sales Tax Permit
You’ll need to register for a sales tax permit everywhere you have a business nexus. To register for a sales tax permit, go to the appropriate tax agency.
Some states may charge a fee for a sales tax permit. Read this post, Which States Charge A Fee to Register for a Sales Tax Permit?, to get an idea of how much you’ll be expected to pay.
If you need additional help, TaxJar has a comprehensive How to Register for a Sales Tax Permit post where they break down the registration process state by state. The post covers how to apply, the information you’ll need to apply, the cost of the application, the state’s sales tax permit renewal policy, and more.
Step 3: Collect & Record Sales Tax
Once you’re officially registered to collect sales tax in a state, you can start collecting and recording sales tax. We recommend talking to your accountant about using accounting software to keep track of your sales tax records.
Accounting software can help you:
- Keep good records
- Charge sales tax to customers
- Automatically calculate sales tax totals on invoices
- Provide important sales tax reports
Many accounting software programs also integrate with key tax software players like Avalara and TaxJar.
If you need help deciding on an accounting software, check out the top-rated accounting software programs in our accounting comparison chart or visit our comprehensive accounting software reviews for more details.
Step 4: Pay Your Sales Tax
Depending on the state(s) in which you’re registered to collect sales tax, you may be paying your sales tax monthly, quarterly, or yearly. After you complete your Sales Tax Permit registration, you should receive information about when sales tax payments are due and where to go to make these payments.
If you are unsure, contact your state’s sales tax agency directly.
We know that was a lot of information, but sales tax is one topic you don’t want to play fast and loose with. That’s why, when it comes to sales tax, we recommend that you consult your accountant.
While online resources and accounting programs can help point you in the right direction, your professional accountant is the ultimate authority on sales tax. Your accountant knows how to properly prepare your small business to collect sales tax and will ensure that you’re charging the appropriate rate.
We hope this overview gives you a basic understanding of sales tax and a clear idea of how to get started collecting it. Best of luck and happy selling!