Sales tax is a nightmare!
But if you're reading this, you probably know that already.
The reason it's such a nightmare is because every state within the United States is like an entirely different country when it comes to sales tax.
They have their own rules, regulations, and permits. They have their own ways of doing business, and they can be dramatically different state-to-state.
Just because you've got it figured out in California, that doesn't mean you're even close to figuring it out in Florida.
And that's exactly why I've written this article — to give you a fighting chance of understanding how it works, and pointing you towards some useful tools and resources.
In this post, I'm going to cover:
By the end of this piece, you should have a good idea of how sales tax works, and what you need to do to keep on top of it for your business.
Need help working out the sales tax for your company? Book a free consultation to see how TaxValet can step in as your fractional sales tax team.
Before we go into tips and tools, we first need to understand exactly why sales tax is such a headache.
In the United States, we have states, counties, city districts, and special districts. And you have to look at the combination of all these to determine the tax rate you need to be using.
Unfortunately, there's so many that no-one actually knows exactly how many tax jurisdictions there even are. This is because, due to politics, the boundaries for these jurisdictions are constantly changing from one month to the next.
And the tax rate you're going to be charging is based on all those constantly changing factors.
But that's not all...
You also need to work out whether or not what you're selling is even taxable in the state or jurisdiction you're trading in.
There are thousands of different types of products that could be taxed differently depending on the state or locality's specific statutes. That's because each state has their own unique list of what types of products are exempt from their definition of taxable tangible personal property.
Let's say you live in Colorado, and the state decides not to tax something. That's great, but the city you live in could still tax that product. This happens a lot with grocery items where the state doesn't charge sales tax negotiations, but the locality does.
And to make things even more confusing, how each state defines what a product is can also differ state-by-state.
For example, there's a handful of states that don't charge sales tax on clothing. Which seems pretty straightforward.
But what about a Halloween costume? Does that count as clothing? What about swimwear, gym wear, belts, football pads, etc?
The answer is...it depends.
It depends, because the way states define each of these things is totally different.
One of the biggest challenges you're going to face while dealing with multi-state sales tax is determining which states you even need to pay tax in. Or put another way, determining where you have sales tax nexus.
Nexus is just a legal phrase that means that a business has sufficient presence in a state that the state can enforce sales tax collection responsibilities on that business.
So if you have nexus in a state, you now need to pay sales tax.
To put it in oversimplified terms, there are two primary ways a business can get sales tax nexus. The first is through having a physical presence in the state. and the second is by having 'economic nexus'.
What constitutes a physical presence? It's time to go back to those magic words — it depends
There are simple things most states agree on, like having a store, an office, a warehouse, etc. But there is A LOT of gray area where there's no consensus. This includes things like:
All those rules are going to be different for what constitutes a "physical presence". And we’re really just scratching the surface, because there’s a dozen other factors that also need to be considered.
The second way to qualify for a nexus is by having certain economic nexus thresholds in the state
Of course, those thresholds also vary state by state.
Usually the threshold is something like $100,000 in sales or 200 separate transactions. But even with these thresholds, there are a load more questions to answer.
Which transactions should be considered in this threshold? What's the timeframe we're looking at? Is it the calendar year? The last four financial quarters? Is it this year, or the year before? Are we looking at total sales or retail sales?
Oh, and some sales will be exempt due to the state's specific taxability rules. But as I mentioned earlier, those exemptions will change from state-to-state.
There's an illusion of conformity around nexus. But even on something that's supposed to be relatively uniform, states can't get aligned on all these questions.
For more information, take a look at my article What's Each State's Economic Nexus Thresholds for Sales Tax?
The last big difference state-by-state is whether it's considered an origin or a destination state when it comes to sales tax.
Many states are going to be destination states — which means you're shipping something to a customer within that state. For destination states, you need to use the address of where you're shipping the item to. Which is the destination.
There are some states that are origin-based, which means if you're shipping from within that state, you need to use the address of where it's being shipped from.
And so if you have multiple warehouses that you're shipping inventory from, you have to track and keep up with that.
If your company can afford it, you should 100% pay for expert help to calculate and file your sales tax. We typically find that this is a great option for businesses making over $5 million dollars a year in sales.
But I appreciate that not everyone can afford this, especially smaller businesses. So if you're in that boat, there are two tools you need at the bare minimum:
The first thing you need is a tax calculation tool. This will automatically determine the correct amount of sales tax to charge customers at the point of sale, based on the specific tax rates and rules applicable to the location of the sale and the type of product or service being sold.
If you're selling products on Shopify, it has tax calculations built in. But sometimes you'll need to use your own third-party calculator.
When you're looking for a tax calculation tool, you need to make sure it will work for the specific products or services you sell. It also should integrate easily with the sales channels you use.
The second tool you need is a filing engine. These are specialized tools designed to streamline the process of preparing and submitting sales tax returns. It automates the calculation of taxes owed across various jurisdictions to determine the correct amount of tax to be remitted to each.
These tools reduce the manual effort involved in breaking down your sales tax collections by state, county, city, and special jurisdictions.
But different filing engines work in different ways. So you need to look at what each software does, and if it ticks all your boxes. This includes making sure it can handle more complex types of returns like E-waste returns in California for anything with batteries or screens.
As well as using the right tools, you also need to take a strategic approach in order to stay on top of your sales tax.
This strategic approach comes in three parts. Let's break it down...
Even if you feel like you knew where you were a year ago, a lot can change in a year:
So at least once a year, you should take some time to make sure you know exactly where you've got nexus.
Then once you know where you stand, you need to make sure you're reflecting these changes in your filings
If you are a business that is introducing new products, you need to have a system and process in place for when you set up the product in your sales channel.
Someone needs to go in and manually check these settings, and then do some testing. This will include things like testing transactions to verify the tax that's been collected is the right amount.
It's easy to set and forget these settings, but all it takes is a plugin update, or a junior member of staff to change one thing, and it's all screwed.
Whoever is ultimately responsible for sales tax within your business needs to have a rock solid record keeping system.
You need to be able to easily pull up all of the returns for a particular period in a particular state and have all the transactions for that particular return. This includes having all of your permits, login information, correspondences, and filing frequencies organized and easily accessible.
This might sound over the top, but when you're inevitably audited, the first thing the auditor will do is ask to see all the returns for these periods, the transactions, and how you got to your numbers.
Because of the complexities and inconsistencies from state-to-state of sales tax, it's never too soon to get some help with your sales tax.
Even if it's just an hour of a consultant's time, it's well worth it for the peace of mind it gives you.
But from our experience, it's when sales goes over $5 million that companies start seeing complexity creep into their sales tax. Above this amount, you absolutely need to have a bona fide tax expert on call for when you need them.
Because you will need them!
Even if you're doing less than $5 million, but sell products that have mixed taxability like clothing, dietary supplements, etc, you'll also need somebody to support you in working it all out.
The same is true for international sellers who are expanding into selling into the United States. The rules, requirements, and processes are different enough to warrant getting some extra help.
And that's just talking about retail.
Sales tax can be way more confusing and messed up for other industries like utilities, manufacturing, oil and gas, hotels, alcohol, etc.
For these sectors, you need an expert before you make even one dollar in sales.
To put it in the simplest terms — If you know you're not doing it the right way, or you're not sure if you're doing everything the right way, you need help regardless of the size of your business.
If you're looking for an introduction to sales tax, there are a few resources worth checking out:
But the problem with sales tax is that the devil is in the details. So no matter how many general guides you read that try to explain the landscape and the territory, it's never really going to be good enough.
That's because as we covered earlier, definitions vary wildly from state to state. So a blog post, article, or forum discussion could be valid to them, but not to you.
Really, to get accurate up to date sales tax information, you need to be looking at the statutes, tax bulletins, and other publications from the Department of Revenue.