What are sales taxes?
If you’ve been shopping lately, there’s a decent chance that you paid more at the register than your purchase price. If you’re in Colorado, you paid 7.65% on top of the retail price. In Alaska, you paid 1.76% extra, and in Tennessee, 9.53%. In most other states in the U.S., you spent some amount within this range — a retail sales tax tacked onto most purchases you make. While most people are familiar with sales taxes, few of us spend too much time thinking about what they are, what they pay for, who collects them, and what controversies and difficulties they create. Let’s look at this important topic so vital to our everyday life.
What is sales tax?
Sales tax is a direct tax on the purchase of goods and services. Buyers might pay sales taxes at the national, state, county, or city government levels or all of the above. The tax you pay is typically figured as a percentage of the sale price and added on top of the sale price. If you are paying taxes at multiple levels, all of these percentages will be added to create one total percentage of sales tax. The U.S. is among a shrinking cohort of countries worldwide that continues to charge conventional sales taxes instead of an alternative to sales tax called value-added tax (VAT). Residents in more than 160 countries worldwide pay VAT, including all countries in Europe.
What is VAT?
VAT is a consumption tax. It considers the value added to a product at each stage of the production chain and taxes that entire amount at the end of the chain — to be paid by the final buyer or consumer. For example, say a logger sells wood to a woodworker for $50. The woodworker makes the wood into a box and sells it to a customer for $100. The woodworker’s craftsmanship has added $50 in value to the wood. Before that, the logger’s labor added $50 of value by turning a tree into saleable lumber. The entire value-added to create the box is reflected in the retail price of the box — $100. The VAT is levied as a percentage of that $100 value.
Who collects sales tax?
Governments at various levels — national, state, and local — might levy a sales tax. The businesses that sell goods to customers are deputized by authorities to collect sales tax on the government’s behalf at the point of sale. For example, the cashier at the grocery store is the one who collects the sales tax from you when you’re stocking up on your chocolate supply. The cashier will add the appropriate percentage of the purchase price onto your bill. The grocery company will then send that amount to the tax authorities on your behalf. Businesses must keep strict sales tax records collected and periodically submit tax payments to state and local governments. In the U.S., 45 states, the District of Columbia, and many counties and cities enforce sales tax. Only Delaware, Montana, Alaska, Oregon, and New Hampshire have no sales tax.
Why do I have to pay sales tax?
Have you ever driven on the road, called 911, or attended a public school? Have you ever appreciated the streetlights, sidewalks, or parks? You likely have sales tax to thank for all or some of this generosity. Sales tax is a crucial funding source for state and local priorities that enhance the common good, like schools, roads, and fire departments. As of 2016, sales tax revenue comprised an average of 34% of all state tax revenues in the U.S. It’s been a prominent source of funding for states since early in the last century — retail sales tax was first levied on shoppers during the Great Depression, and by 1947 it was the largest source of tax revenue for states. So you have to pay sales tax because states need you to — that is the money they use to create a good quality of life for you and your fellow state residents.
How much is sales tax?
Retail sales tax is the same in a given place no matter who purchases a product, accounted for as a set percentage of the final sale price. The sales tax or VAT percentage varies widely from place to place, and in some areas, it is so high that it makes many items painfully expensive. Tennessee currently has the highest combined state and local sales tax rate, at 9.53%. Alaska has the lowest, at 1.76%. The majority of other states have combined sales taxes between 6% and 8%. Some of the highest taxes in the world are found in Western Europe, especially in Scandinavian countries. Norway, Denmark, and Sweden charge a VAT of 25% — enough to make you think twice about buying that chocolate bar. When multiple levels of government impose sales taxes, shoppers must pay all of these at the point of sale. For example, in New York, shoppers pay a total of 8.875% in sales tax, which is made up of 4% state sales tax, 4.5% city tax, and a 0.375% Metropolitan Commuter Transportation District surcharge.
What is use tax?
You may have heard the words “sales tax” lumped with another term — “use tax.” Most people are far less familiar with use tax than sales tax, though consumers are more immediately responsible for use taxes. Use tax is a tax that a consumer is supposed to pay directly to a government body. It only applies to the purchase of goods or services that are eligible for taxation but on which the consumer did not pay sales tax for some reason. An example would be an item the customer purchased from a seller in another state. States that charge sales tax often also have use taxes on the books, but these are notoriously difficult to track and enforce. As a result, customers usually only end up paying to use taxes to purchase large goods like cars and boats.
Why is sales tax “regressive”?
Taxes are generally lumped into two categories: progressive and regressive. Progressive taxes change based on the taxpayer’s income or wealth. Regressive taxes do not. That means that everyone pays the same amount of a regressive tax regardless of how much money they make. Criticism of regressive taxes is based on their inequity — lower-income people pay a larger share of their earnings in regressive taxes than higher-income people do. Many say it is unfair that such taxes hit lower-income individuals harder. Efforts to mitigate this problem usually involve exempting certain necessary expenses such as food, medicine, and clothing from taxation.
What are sales tax exemptions?
To make sales taxes affect everyone more equally, laws often exempt particular goods and services from these taxes. That means that you don’t have to pay sales taxes when you buy certain items, usually considered necessities of life. Exemptions vary among states and local areas. Food, medical, and educational expenses are exempt from sales tax in many states. Some states have unusual or surprising exemptions, such as Garters and garter belts in Vermont, Twix bars in Illinois, human body parts in Washington, and donkeys in Texas. Goods that a buyer plans to turn into another product or resell are usually exempt from sales tax. For example, a boutique that buys shirts from a wholesaler will be exempt from sales tax. Only the final buyer who purchases one of the boutique’s shirts will have to pay sales tax on that item. A buyer who wants to avoid tax on items they plan to resell will need to apply to their taxing authorities for a resale certificate. The buyer then needs to provide a copy of this certificate to the seller to certify that the sale is tax-exempt.
What is a sales tax nexus?
While sales tax doesn’t frequently make for enthralling headlines, a hot little topic called “nexus” has kept sales tax ins and outs in the news over the last few years. Nexus means a substantive connection to a particular jurisdiction. Specifically, if you have nexus in a place, then that means your relationship to that location is strong enough that the jurisdiction sees fit to have you collect sales tax on its behalf there. In the era of e-commerce, the question of when a company has a substantial presence in a state is a growing concern. As more and more out-of-state sellers began making sales all over the country, states found themselves losing out on bucketloads of sales tax revenue. The customers who were buying from out-of-state sellers and not paying sales tax on their purchases still technically owe their state use tax, but they rarely pay them in reality.
They don’t even realize they’re supposed to pay them in most cases. And states find it virtually impossible to enforce their payment. Naturally, states wanted to find a way to recoup this lost revenue. Each state makes its own rules on what it takes to establish nexus there, and many of them began broadening their regulations to put more companies in this category. Traditionally, a business had to have a physical presence such as an office, warehouse, or employee to establish nexus in a given state. Some states considered selling at a trade show, working with an affiliate, or maintaining a drop shipping relationship in the state as triggers for nexus. But states were interested in collecting sales tax on as many sales as possible. Some began incorporating an idea called “economic nexus” into their laws; the idea is that a company gains nexus when it reaches a certain number of sales or revenue in the state. For example, South Dakota requires sellers with more than $100,000 in sales or at least 200 transactions in the state to register to collect sales tax there. Whether economic nexus rules are permitted went all the way to the U.S. Supreme Court, where the South Dakota v. Wayfair, Inc. decision upheld the fairness of these laws. That outcome transformed the sales tax situation for many companies, giving them nexus in new places overnight and requiring them to track and pay much more sales tax. Companies had to register to collect taxes in new states and research the rates and rules in all those places where they had newly established nexus. Once a company has nexus in a given state, it must register with that state and get a sales tax permit. Then they need to charge sales tax on any sales to customers in that state and remit those taxes to state authorities periodically.
Do online sellers collect sales tax?
Online retailers are responsible for collecting sales tax on sales only in states with nexus. Now that the Wayfair decision has upheld the validity of economic nexus, it’s possible to have nexus in a given state without ever setting foot there. Since every state has different nexus rules, online sellers must check the laws in every state they sell. This can be a lot of work if they sell in many places; automated services can help keep everything straight. For example, some point-of-sale platforms track tax liabilities. Online sellers who have nexus in a given area must still file a sales tax return even if they didn’t collect any tax in the period in question. Sellers must know that a given state in which they sell is its sourcing. Sourcing rules indicate where the state believes sales should be taxed. Some states (called “origin-based”) tax the sale at the seller’s location, while others (“destination-based”) tax the sale at the buyer’s location. Most states and Washington, D.C., are destination-based. Origin-based states are Arizona, Illinois, Mississippi, Missouri, New Mexico, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Virginia. California is considered a “mixed-sourcing state” since the state, city, and county taxes are origin-based, but the district sales taxes are destination-based.
What are sales tax holidays?
Many states set aside special periods called “sales tax holidays,” during which specific purchases are exempt from sales tax. Usually lasting a long weekend, these holidays allow shoppers to buy specific items up to a particular amount without paying taxes. States create these holidays to help residents get cheaper access to things they need and give an economic boost to local retailers. It is common for states to offer these holidays for school supplies, disaster preparedness gear, clothing, computers, and eco-friendly appliances. There’s even a sales tax holiday for firearms, ammunition, and other hunting gear in Mississippi.
Sales taxes: Everybody’s favorite topic
If you’ve read this far, you genuinely have an interest in sales taxes. Either that or you’re in trouble. Blink twice if you need help. In all seriousness, sales taxes aren’t exactly the belle of the ball, but they are far more interesting than most give them credit for. Especially in the last few years, as the questions about e-commerce and nexus have been at the center of much discussion, this topic has held many on the edges of their seats. Now that the new rules have been established, with economic nexus as the show's star, we can settle into thinking about sales taxes a little less and charging it a little more.