Unless you live in one of the five states that don't impose sales taxes, you have had some experience with paying sales tax as a customer. However, as a small business owner you need to be aware of your sales tax obligations: what is taxable; how the tax is computed and calculated; and how sales tax is reported and paid
Congress has debated imposing a national sales tax since at least the Civil War days. However, to date (knock on wood!), the federal government has exhibited a modicum of restraint and limited federal sales-type taxes to excise taxes on specific commodities, such as motor fuels and tires. So for now, general sales taxes remain the province of your state and local government authorities. (Looking to do business internationally? See our article on differences between VAT and sales tax.)
Unless you happen to live and do business exclusively in one of the five states that do not impose general sales taxes, you've probably had some exposure to state and local sales taxes. You realize that a $5.00 purchase will cost more than $5 because of the sales tax that is added to the sale.
Yet, what do you really know about these taxes, apart from the fact that they get added to the bill on some of your purchases? Perhaps the better question for the small business owner is, what should you know about these sales tax rules?
To help ensure that you don't pay any more sales taxes than you're absolutely required to pay or that you don't receive an unexpected visit from an assessment-waving sales tax auditor, you should have some knowledge of the following areas:
- What are sales taxes? And, how are they different than "use" taxes?
- Who is the taxpayer for sales tax purposes?
- What types of transactions are taxable?
- What role does a seller have in collecting sales tax? Does the buyer has any responsibility?
- How the tax is generally computed?
- How are sales taxes reported and paid to your state government?
What are sales taxes?
Sales taxes are imposed by the states for transactions that occur within their borders. In most states, sales tax kicks in when there is a triggering event. Most often this event is the consummation of a retail sale. Initially, the states were content to limit their taxes to retail sales of tangible personal property. However, in recent years, most states have expanded the scope of their sales taxes to encompass leasing transactions and at least some services.
Generally, each retail sale is presumed to be taxable. However, most states allow some exemptions from sales tax, usually based on the type of item sold (or service provided) or upon some characteristic of the purchaser. As the business owner, you are responsible for knowing what items are taxed at which rates. However, in most cases, the purchaser must affirmatively establish his or her right to claim the exemption. For example, the purchaser may provide evidence that he is making the purchase for a tax-exempt organization.
There are actually several different types of sales tax systems in use throughout the United States. The biggest difference is whether the seller or the purchaser is the main taxpayer. In some states, the tax is imposed on sellers, who then have the option of passing the tax along to their purchasers. In other states, the tax is imposed on the purchaser, with the seller being responsible for collecting the tax and remitting it to the state. And then there are other states where the liability for the tax is shared by sellers and purchasers.
In general, sales taxes are computed on some measure of gross receipts. In other words, the tax generally applies to the full amount a seller receives from a purchaser as opposed to the net profit the seller realizes on the sale.
What are the different sales tax systems?
When we use the term "sales taxes" in a generic sense, we're referring to the taxes that states impose on retail sales. However, states differ in whether the tax is imposed upon the seller, the purchaser or on the transaction itself. Knowing the taxing rules in your state is important because the type of sales tax regime determines
- who can be liable for the tax,
- who can sue on the tax, or
- who can make a claim for refund of the tax.
There are the three general types of sales taxes:
- Seller (vendor) privilege taxes. These taxes are imposed on retailers for the privilege of making retail sales in the state. Retailers usually have the option of absorbing the tax (that is, paying the tax out of their own pockets) or passing it along to their purchasers.
- Consumer excise (sales) taxes. A consumer sales tax is imposed on the person who makes retail purchases in the state. In the states that impose this type of tax, sellers serve purely as agents who must collect the tax on the state's behalf. Because the tax is primarily the purchaser's responsibility, sellers don't have the option of absorbing the tax and usually must separately state the tax on the receipts or invoices they provide their purchasers.
- Retail transaction taxes. These taxes are imposed on the retail sale transaction itself, with the primary liability for paying the tax falling upon both the sellers and the purchasers. Sellers are responsible for collecting and paying the tax, and purchasers are responsible for paying the tax that the sellers must collect and pay. In essence, this type of sales tax is a hybrid of the other two types. Operationally, however, it's closer to a consumer excise tax because sellers are not given the option to absorb the tax.
The vast majority of states have a consumer sales tax, where the buyer bears the legal burden of the tax and the seller is required to collect and remit the tax to the state. Fewer states have the seller privilege tax option.
From your perspective as a purchaser, knowing the type of sales tax with which you're dealing will help you properly handle sales taxes that are not billed. If you're dealing with a vendor privilege tax, you should never voluntarily pay a tax that hasn't been billed to you, because the tax is the seller's responsibility. In contrast, if you're dealing with a consumer excise or retail transaction tax, you shouldn't ignore any unbilled tax. Unless you have some written proof that you paid the tax, you can be held personally liable for the unpaid tax. If the unbilled tax wasn't caused by a seller's oversight that can be corrected with a new receipt or invoice, you have an obligation to pay use tax on the purchase and you should remit the tax directly to the state.
What are use taxes
As a general rule, a state's taxing power reaches only as far as its borders. What this means for sales tax purposes is that a state cannot impose its sales tax on retail sales that are consummated in other states. Because states can tax only transactions within their borders, there is a big loophole from the perspective of the State Department of Revenue. A state's residents could avoid paying a state's sales tax by making their purchases outside the state, either by crossing the border to an adjoining state or by making purchases via the Internet. (Until a U.S. Supreme Court decision in 2018 states could not require out-of-state sellers without a physical presence in the state to collect sales taxes on Internet sales.) To close this loophole, each state that has a sales tax also has a complementary "use" tax. The use tax applies to the "use, storage, or other consumption" within the state of tangible personal property, the purchase of which would have been subject to the sales tax had the transaction occurred within the state.
Example
You operate a commercial photography studio in State A (which has a state tax of 8.25 percent.) You regularly go to neighboring State B (which has no sales tax) to purchase all the cameras you use in your business. State A can't impose its sales tax on your camera purchases, because those purchases were made outside the state. However, State A can subject the cameras to its use tax once you bring them into the state.
Use tax is a complementary tax. A state's use tax is designed to be no broader in scope than its sales tax. For the most part, exemptions are the same for both of the taxes. In our example, if you could have purchased the cameras in State A free of sales tax, then your use of the cameras you purchased in State B would have been exempt from use tax. Similarly, the basis for computing the use tax is generally the "selling price" of the property, just as it is for purposes of computing the sales tax. Finally, a state's use tax rates are identical to its sales tax rates.
Use taxes are self-assessed. Perhaps the biggest difference between a state's sales tax and its use tax is the manner in which the taxes are assessed and paid. For the most part, sales taxes must be paid or collected by the seller. In contrast, the responsibility for reporting and paying use taxes generally falls on the purchaser. This is commonly the case because the triggering event for the tax—the taxable "use" of the property in the state—occurs after the sale is completed and because the state may not have the power to force the out-of-state seller to collect its use tax.
Purchaser is entitled to credit for sales tax paid. Purchasers are generally allowed a use tax credit for sales taxes paid to another state with respect to the same property. In our example, you would be able to offset your State A use tax liability on the cameras by any State B sales tax you paid on the purchase.
Use tax may be owed on property purchased within a state. In some situations, use tax liability may arise with respect to property that was not purchased in another state. Perhaps the two most common of these situations arises when you:
Example
You operate a computer store where you sell computers that you personally construct and peripherals such as printers that you purchase from others under the resale exemption.
If you were to start using for business or personal purposes one of the printers that you purchased tax-free, you would be liable for use tax with respect to that printer. This is an example of the first situation.
If you were to start using in your business or for personal purposes one of the computers you built, this would also subject you to use tax in many states. This is an example of the second situation.