How to calculate, collect, and pay sales tax

Calculating and collecting sales tax can be a confusing time suck for many small businesses. It has to be done, and it has to be done right, but the requirements are so vast and varied that it can quickly become overwhelming. Plus, the only reward for getting sales tax right is not being penalized for getting sales tax wrong.

If you only do business in one of the handful of states with no sales tax (New Hampshire, Oregon, Montana, Alaska, or Delaware, also called the NOMAD states) you may be able to breathe a sigh of relief. There are other tax obligations in those states, to be sure — and Alaska has local sales taxes — but you may not have to keep sales tax at the very top of your list of priorities. 

However, if you’re required to collect and remit sales tax in any of the 45 states with general sales taxes (plus Washington, D.C., Puerto Rico, and parts of Alaska), you need to know how to get sales taxes right.

The first step is to learn where to register for a sales tax permit; you shouldn’t collect sales tax from customers unless you have one in hand. Once registered, you must apply the correct sales tax rate to each taxable transaction, collect the tax from your customers, and remit and report sales tax to the appropriate taxing authority for each state or local jurisdiction. 

You’ve also got to keep accurate records, in case an auditor comes knocking. 

It’s a lot, so let’s break it down with a helpful FAQ:

• How do you know where you’re required to collect sales tax? 
• How do you register for sales tax? 
• How do you know how much sales tax to charge? 
• What states have the highest and lowest tax rates? 
• What happens when a business doesn’t pay sales tax? 
• How do you remit sales tax? 
• Do I need to file a return even if no tax is due?

Whether a business has to collect sales tax in a particular state depends on sales tax nexus, which is a connection that allows a taxing authority, like a state or a city, to tax a business.

Sales tax nexus used to be solely dependent on physical presence: A state could require a business to register for sales tax if the business had a physical connection to the state, but not if it didn’t.

Having a presence in a state still establishes nexus, but it’s no longer requisite because the Supreme Court of the United States overturned the physical presence rule in 2018 with its decision in South Dakota v. Wayfair, Inc.

Thanks to the Wayfair ruling, online sales and mail-order sales can be subject to sales tax even if the business is located out of state. States can require remote sellers to register for sales tax if their sales into the state exceed a certain sales threshold (e.g., $100,000 in taxable sales in the current or previous calendar year). Basing a remote sales tax obligation on economic activity is known as economic nexus.

Economic nexus was a real game changer because it freed states to tax goods sold online by out-of-state sellers. Every state with sales tax now has an economic nexus law.

Sales tax nexus can also be created through:

• Ties to affiliates in a state (affiliate nexus) 
• Referrals from in-state entities (click-through nexus)

Learn more about sales tax nexus.

If you have nexus with a state, you must register with the state’s taxing agency and obtain a sales tax permit. Some states require remote sellers to register as soon as they establish economic nexus (as in, before the next transaction), so it’s important to monitor your sales activity in all states.

Sales tax registration is generally handled by the state tax department, such as the California Department of Tax and Fee Administration, the Florida Department of Revenue, the New York State Department of Taxation and Finance, or the Texas Comptroller. However, there are a few exceptions. For example:

• The Alaska Remote Seller Sales Tax Commission (ARSSTC) oversees registration for remote sellers; local businesses register through local tax departments

• Some home-rule jurisdictions in Colorado require remote sellers to register with them, although the Colorado Department of Revenue encourages all jurisdictions to participate in the state’s Sales & Use Tax System (SUTS); local businesses register through local tax departments

• The Louisiana Sales and Use Tax Commission for Remote Sellers handles registration for remote sellers; businesses located in Louisiana file state sales tax with the Louisiana Department of Revenue and local taxes with individual parishes

For the 24 states that are members of the Streamlined Sales and Use Tax Agreement (SSUTA or simply SST), businesses can register through the Streamlined Sales Tax Registration System. One benefit to registering through SST is that you can register in any or all 24 SST states with one application. If you’ve never heard of SST, check out What is Streamlined Sales Tax, and why should you care?

A lot of information goes on the application for a sales tax permit, including your Federal Employer Identification Number (EIN) or Tax ID number; the name, address, and social security numbers of business owners; and an estimate of your annual sales in the state. It’s helpful to have all necessary information at your fingertips before you fill out the application.

Once you’re registered, you’ll receive a sales tax permit (also called a sales tax license or seller’s permit) and a sales tax number. Sales tax permits never expire in some states but must be renewed every one to five years in other states.

As a general rule, you shouldn’t start collecting sales tax unless you’ve obtained a sales tax permit. But once you have a sales tax permit, you must collect and remit sales taxes as required by law — including on your online sales.

Sales tax is based on a percentage of the sales price of taxable goods and taxable services, but the percentage varies depending on the location, and sometimes on the product or service sold.

For example, the tax rate for most retail sales of tangible personal property is currently 6.25% in Massachusetts and between 7.25% and 10.25% in California, depending on the location of the sale. The general sales tax rate in Connecticut is currently 6.35%, but the rate for software sold to a business for business purposes is 1%. Some states, like Alabama, have a reduced sales tax rate for food.

The first step is to determine whether your customers have to pay sales tax on their purchases. Then you can figure out which rate you should use.

Step 1: Determine which goods and services are subject to sales tax

Most tangible personal property is subject to sales tax in most states, but many states provide sales tax exemptions for essential items like groceries and prescription drugs. A growing number of states now exempt diapers and feminine hygiene products too.

In some states, certain transactions are subject to state sales tax but not local sales taxes. Alternatively, items may be subject to local taxes but not the state sales tax; that’s how it is with clothing in New York.

How services are taxed can be even tougher to decipher. States may tax services related to tangible personal property, like car repair, but not professional services, like accounting. They may tax some personal services, like pet grooming, but not others, like therapeutic massage. Amusement and recreation services can be taxed differently than services performed on real property. It all depends on the state.

Then there are digital goods and services. Most sales tax laws were developed long before the World Wide Web, online sales, and intangible goods came to be. States are working to update their policies to keep pace with evolving technology, but the taxability of digital products remains unclear in many parts of the country.

Sales tax holidays complicate taxability by temporarily turning normally taxable transactions into exempt transactions for a day, week, weekend, or longer. Though popular among consumers, tax holidays create more work for retailers, especially those selling goods into more than one state with a tax-free weekend.

So, how can you determine whether you need to be collecting taxes on your sales? Most state tax departments publish guidance on product taxability, and there’s a handy taxability matrix for each of the 24 states participating in the Streamlined Sales Tax program. Unfortunately, it can be hard to find accurate information on state tax department websites, and more than 20 states with a general sales tax don’t participate in SST.

In any event, once you know there’s tax owed on a transaction, you’re responsible for finding the right sales tax rate for each transaction.

Step 2: Determine the sales tax rate(s) to use

Rates are generally governed by destination sourcing or origin sourcing rules. Most states use destination sourcing, meaning the sales tax rate is based on the location where the customer takes possession of the product or service sold. With online and mail-order sales, this is typically the delivery address.

If you sell online and remit sales taxes to all states with a sales tax, you could have customers in more than 13,000 different U.S. sales and use tax jurisdictions. That’s a lot of rates to keep track of, especially given that sales tax rates and jurisdiction boundaries can and do change.

It’s pretty easy to figure out the sales tax rate in the states with no local sales taxes, but in states like Missouri and Texas, which have thousands of local jurisdictions, it can be extremely difficult. Sales tax rates can vary from city to city or street to street, so basing sales tax rates on ZIP codes doesn’t provide the rooftop-level accuracy required. Working with a trusted sales tax advisor or automating tax calculation can help.

It may be helpful (or at least interesting) to know which states have the highest business taxes and which have the lowest. Sales tax is just one of many business taxes, of course, but for the purposes of this post, we’ll stick with it.

The prize for the lowest sales taxes has to go to four of the five states with no general, statewide sales tax: Delaware, Montana, New Hampshire, and Oregon. In Alaska, which also has no state sales tax, local sales tax rates can be as high as 7.5%.

Arkansas, Oklahoma, Louisiana, Arizona, and Colorado win the dubious distinction of having the highest combined rates of sales tax.

As a business owner, you have zero control over sales tax rates. It’s your job to ensure the taxes collected from your customers are the taxes they owe. If your customers have to pay sales tax, they shouldn’t pay more than required. And if they pay too little tax, you can be liable for the difference.

As noted above, some products and services are statutorily exempt from sales tax, either all the time or temporarily as during a sales tax holiday. State tax laws also allow businesses to purchase taxable items and services tax free under certain circumstances.

For example, the purchaser could qualify for an exemption, as often happens with government or religious institutions. A taxable good could be purchased tax free by a reseller for resale. Or raw materials could be purchased without sales tax by a manufacturer for incorporation into a final product, which will be sold and taxed.

If you’re not collecting sales tax on a taxable transaction, you must collect a valid exemption certificate or resale certificate from your customer. Since such sales tax exemptions are based on the customer, the seller has to maintain accurate and detailed records showing the buyer qualified for the exemption.

Tax authorities tend to be keenly interested in exempt transactions and therefore often want to verify that exemption certificates contain accurate, up-to-date information. Thus, business owners need to have a system in place to securely store certificates that may contain sensitive business information. It’s also important to be able to retrieve the documents quickly: If you’re unable to produce a valid exemption certificate during an audit, you could be held liable for the unpaid local and state taxes.

All sales tax collected from consumers must be remitted to the proper taxing authority along with a sales tax return. Filing sales tax returns correctly by the due date is critical, as is turning over the collected tax. Failure to file and pay sales taxes as required can result in the imposition of penalties and interest fees.

Sales tax return due dates vary from state to state, and in some states, from jurisdiction to jurisdiction. Depending on the type of transaction and the local tax requirements, it may be necessary to file local returns instead of or in addition to a state return. 

How often a business must file returns often depends on sales volume: Most businesses are required to file on a monthly basis, but small businesses may be put on a quarterly or annual schedule. Learn more about sales and use tax returns.

Many states require businesses to file returns even if no sales tax is due for the collection period. If you neglect to file a zero return, as these are sometimes called, you may have to pay a fee. Oh, the irony.

Getting sales tax right is critical. According to the National Conference of State Legislatures, “After personal income taxes, general sales tax collections account for the second largest portion of state revenues.” State and local governments rely on general sales tax revenue to fund a host of essential services, including education, medical services, and roads.

With sales taxes accounting for so much state tax revenue, state tax authorities have good reason to ensure businesses are collecting and remitting it as required. That’s why businesses need to know which sales are subject to tax, how to calculate and collect the tax due on each transaction, how to validate exempt sales, and how to file returns and remit sales tax. 

The good news is: You don’t have to manage sales tax compliance alone. Avalara can help.

This post has been updated. It originally published October 10, 2022.