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Sales Tax for Small Business: A Complete Guide

Sales tax seems to get more complicated every year, as states, feeling the budget pinch, modify rules and more aggressively pursue all paths of revenue. In the 45 states that collect sales tax, out-of-state and small firms have increasingly become the target of collection efforts and penalties. Multi-state taxation rules can be mind-boggling, and for an added challenge, thousands of changes to these rules can happen in a single year.

Audits are time consuming and expensive. But, not to worry! We’ll help you avoid them with the right resources and a bit of advanced planning.

This quick guide aims to keep you compliant, well organized, and prepared for the ins and outs of sales tax. We’ll break down what you need to know in the simplest terms possible.

Most tangible goods, like records, are subject to sales tax

What is Sales Tax?

Sales tax is a simple concept: a tax collected from the sale of an item and then paid to the state and local jurisdiction. However, a multitude of complex variables can come into play. For starters, these 3 terms are critical to understanding sales tax:

  • Nexus – This concept is crucial because sales tax is state-driven. Nexus is the minimum connection that your business must have with a state for that state to collect sales tax on your sales transactions. If your business is considered to have a sales-tax presence in a particular state, you collect and pay sales tax in that state. In our current age of booming internet sales, determining nexus has become quite complex.

  • TPP – This stands for Tangible Personal Property. It’s generally defined as property that can be weighed, measured, touched or felt. Simple? Sort of. But, consider a digital product such as an e-book. Is it tangible? 18 states say yes, some say no, and others are working on it.

  • Exemption – Not all tangible items are taxable. These fall in the exempt category. Consider this very tangible item – food. Most states don’t apply sales tax to groceries, but a few do. Exemptions may occur for many reasons, such as if the buyer is the federal government or a non-profit, or the product will be used for manufacturing purposes. Besides food, other commonly exempt items are prescription drugs and gift cards.

While a sale is the transfer of title or possession, a sale is taxable if it involves the transfer of TPP (or performance of certain services) where 3 very minimal conditions are met. A sale must occur:

  • in a state
  • for money
  • by a person or company

A sales tax is measured based on the price of an item sold, not its cost.

Services that can be taxed vary widely by state. In fact, everything related to sales tax varies widely by state. Services generally aren’t taxed unless they’re somehow integrally involved with a product, such as manufacturing. Often such a service would be bundled into the price of the product, and the full price is taxable. However, some states, such as Hawaii, do tax all sorts of services. Interesting fact: In 2014, Washington, D.C., established a yoga tax!

The question of “is my service taxable?” has the same answer that, unfortunately, many sales tax questions have: That depends on the tax rules in your specific state.

Books stores: yes they exist and yes you'll be paying sales tax

How to Determine Nexus

Nexus is determined based on whether your business is considered to have a “business presence” in a particular state or not. A presence for business purposes could be any of the following:

  • An office or brick-and-mortar store
  • A trade show booth or booth at a craft fair
  • A warehouse in which products are stored
  • A third party who handles drop-shipping for you
  • An employee, such as a sales person
  • An affiliate who facilitates a sale for you

If you have any doubt as to whether you have a business presence in a state or not, either contact the state’s department of revenue directly to find out, or consult a tax advisor.

Online selling puts an interesting spin on the concept of nexus. Be aware that rules are quickly changing in that area. While attempts at legislation to tax internet sales have not succeeded in Congress, many states have found a way to do just that. “Economic nexus,” passed in some states, means that instead of being determined by a physical presence, nexus is now determined by the level of sales a business has done in that state.

If you find that you should have been paying taxes in a state after the fact, some states offer an amnesty program after voluntary disclosure. Find a list of current amnesties here. It’s important to realize, however, that your state and local tax liabilities are adding up whether you’re aware of them or not. In the case of sales tax, ignorance is never an excuse.

Services, like tailoring, are generally not subject to sales tax

Sales Tax Permits

Once you determine nexus for a state, you will register for a sales tax permit. You can do this online by visiting that state’s Department of Revenue. To register, you’ll usually need your business’s EIN, the SSN of all business owners, and other basic business information. You may need the NAICS code for your business as well. Generally, when you register for the state, the local jurisdictions are included.

Mistakes to Avoid With Sales Tax

When it comes to sales tax, mistakes can be costly. To avoid expensive fines and penalties, watch out for the most common errors:

  • Failure to file a sales tax return at all or failure to file on time
  • Failure to pay sales tax, pay on time, or pay the correct rate
  • Failure to verify exemption certificates or keep them up to date
  • Misuse of a resale certificate
  • Failure to record a sale
  • Failure to obtain a valid permit
  • Special Tax Considerations

Enjoy your sales tax-free coffee

Use Tax

In the simplest terms, a use tax is the tax that kicks in when sales tax has not been charged, for whatever reason, on an item sold. If you purchase an item from a seller in another state, and have the seller ship it to you, for instance. Or consider this example: a restaurant owner buys used equipment from a seller on Craigslist who isn’t registered to collect sales tax.

In some cases, the restaurant owner must calculate the amount of tax owed on the equipment, and then report and pay that amount in use tax. Usually the use tax rate is the same as the sales tax rate for that state, but not always.

Say yes to the dress - and expect to pay sales tax

For Retail Stores

Special discounts and sales can raise sales tax questions for retailers.

If an item-- let’s say a $60 backpack -- is sold at half off, then sales tax is calculated on $30. Simple. But what if the backpack is sold as part of a BOGO? Not so simple. In most states, because the second backpack is deemed “free,” rather than half off, the retailer will now be required to pay tax on the purchase price they paid for the backpack. Your state’s rules regarding discounts may determine the way you structure your sales.

Similarly for retailers, a sales-tax holiday can bring complications. Before they happen, know your state’s rules.

Want to avoid tax on your meal?  Order to go...

For Bar and Restaurant Owners

Sales tax for restaurant owners can be tricky as well. Luckily, if you operate in the state of California, this guide will help.

In California, and other states, these general guidelines usually apply:

  • Food and beverages sold to be consumed at the restaurant are taxable.
  • Cold food products sold individually to be consumed away from the restaurant are not taxable.
  • Hot prepared food delivered (to be consumed away) is taxable, including delivery fees.
  • Mandatory tips are taxable, but optional tips are not.

Your Obligations to the State

Keeping detailed records of both sales and purchases is critical to staying tax compliant and filing accurate returns. Keep all records for at least 3 years from the date of the return filed. Other obligations include:

  • Calculate accurate sales tax rates for the states in which you file.
  • Find your filing due dates. Usually your filing frequency (monthly, quarterly, fiscal yearly, or yearly) is assigned by your state based on your amount of taxable sales. Businesses in California can find filing dates here.
  • File online, on schedule. You’ll need your sales tax ID, sales and deduction figures, purchase figures for use tax, and bank account information.
  • Make your payments on schedule. Payments can usually be made online.
  • Keep your information current, and notify your state’s tax department of any changes.

Sales tax for your business can get complicated... fast

Helpful Tools for the Small Business Owner

The last thing we want to see is bureaucracy get the best of small businesses, but we do want you to take your sales-tax liability seriously. Knowing what paperwork to complete and when to file is critical. As you can see, tax rules are complex, change often, and vary from state to state.

The right tools can make a day in the life of your small business so much simpler. The more you automate your sales tax related chores, the more accurate and complete your records will be. Smart software, like Quickbooks for accounting, can be a lifesaver, and intelligent payment systems like Square are becoming a must.

If you still find tax compliance overwhelming and don’t feel up for the challenge of managing it yourself, that’s okay! You have options. LumaTax is a small business champion, offering sales tax filing software for an affordable price. By taking compliance off your plate, you’ll have time to focus on what really matters... growing a profitable business.

Never file another sales tax return.

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