According to William Fox, Professor of Economics at the University of Tennessee, the development of sales tax arose out of the Great Depression. In the 1930s, 24 states and the District of Columbia began imposing sales tax, and since then the number as grown to forty-five states. The remaining five states that do not have sales tax are Alaska, Delaware, Montana, New Hampshire and Oregon. However, local municipalities in those states may, and often do, impose surcharges on businesses.
The complexity of state sales tax can cause tremendous headaches for any small business owner. The system, if not understood, can also create extra costs for any company whether they’re doing business in one or multiple states.
On a basic level, the idea is that every business needs to file and remit sales taxes for any state it has a presence in. If the company has physical presence, then the business owner needs to determine the tax rates at the state and local level. Tax rates can vary based upon the item sold and the location of the business or the customer.
The following are three key questions every small business owner should ask as they start navigating the complexities of sales tax.
- How does my state define my business’s physical presence?
For a state or local jurisdiction to require a company to file and remit sales tax, the company must have a sufficient physical presence, or “nexus.” The definition of physical presence is loosely defined and varies by state, but at a basic level, is whether there is a temporary or permanent presence. Independent sales representatives within a state may also establish nexus.
2. How does my state tax my specific products or services?
Sales tax rates can differ based upon the products or services sold. Prepared food may be subject to sales tax in one state but not in another. The same applies to different types of groceries, prescription drugs, clothing and other goods for sale.
3. Is my state sales tax based on the location of my business or my buyer?
In destination-based states, businesses charge sales tax based on the location where goods are being sent. With destination-based taxes, businesses are responsible for tracking and reconciling different state and local tax rates. If the destination’s state tax rate is four percent but the business is shipping to a customer in a city with a local tax rate of three percent, the business must charge a total sales tax of seven percent. Currently, the following states use destination-based taxes: Alabama, Arkansas, Colorado, Connecticut, District of Columbia, Florida, Georgia, Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nebraska, Nevada, New Jersey, New York, North Carolina, North Dakota, Oklahoma, Rhode Island, South Carolina, South Dakota, Vermont, Washington, West Virginia, Wisconsin, Wyoming.
States with origin-based laws tax customers based on the location of the business as opposed to that of the consumer. For example, if the company is located in a state with a four percent sales tax rate, all customers are taxed at a rate of four percent no matter where in the country they are located. Currently, the following states use origin-based taxes are: Arizona, Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Tennessee, Texas, Utah, Virginia, and California.
For sales tax advice and guidelines specific to your business, be sure to contact your Certified Public Accountant.