What is sales tax? The basics explained

Sales tax is one of the most important sources of income for the government. A sales tax is set by your tax jurisdiction on the sale of goods and services – your local government may add further local sales tax on top of the state rate. It is charged when the sale is made, collected by the business that made the sale, and then collected by the government in the form of a tax return. Generally speaking, a fair amount of the sales tax charged by your state, as well as local sales tax, goes towards the general government funding, but a certain amount will be used for local projects too. Some states don’t charge sales tax, such as Oregon, but other taxes in these states may be comparatively higher to make up for it. Read on to find out where this money goes, when sales tax is charged, and how to calculate it.

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Essential terms

Before we look at exactly what sales tax is, and how to calculate it, here is some helpful vocabulary to help you find your feet with the subject.

Tax jurisdiction

This is an area which is subject to its own tax regulations, such as a county or a city. For example, Boulder County has different tax regulations to Larimer County, although both are in Colorado. Both counties are distinct tax jurisdictions.

Nexus

A nexus is the connection your business has with a state. This connection is created in various way, either by having a physical location in that state, or just by selling at a fair, for example.

Sales tax license

Don’t get confused if you also hear of a sales tax permit – it is the same thing as a sales tax license. Some states will require you to display your license to show that you’re authorized to collect sales tax. Some jurisdictions won’t need you have a separate license to your regular business license. Make sure you check with a local expert.

Sales tax – an important source of income for the government

Sales tax is one of the most important taxes for the government – because it is one of the most important sources of income, both for the local and statewide governments. In states that have sales tax the sales tax may be used for public pensions, police funding, foster care, environmental projects, transportation, education, and foster care, to name just a few. There may also be other projects that get funding from local government from sales tax, such as parks, libraries, museums, and zoos, for example. Oregon, Alaska, Delaware, Montana, and New Hampshire are the exceptions to this, none of these states have a sales tax.

When is sales tax charged?

Sales tax is charged on transactions for services and products that your business offers in every state you operate in. If your business has a physical location in a state, you will most likely have nexus in that state – meaning you need to pay sales tax for transactions in that state. Each state has its own list of taxable goods, but be aware that local governments may have additional lists to observe. Always check with a local tax advisor. There are some items which are commonly exempt from state sales tax, such as food, agricultural products, prescription drugs, or so called “intangible property” which is something that has no physical substance. Individual state laws can be quite complex, and something that counts as intangible property in one state, may not count as intangible property in another.

So far we have only discussed products, but services are also charged with sales tax. This happens less than with goods, but is more likely to occur when connected to products, such as a delivery charge. Some services are normally exempted from being charged sales tax, such as doctor’s services, dentist’s services, attorney services, as well as religious organization’s services. Again, make sure you check your local tax jurisdiction regulations to ensure you’re charging the right kind of tax.

Tip

Check out this article on correctly charging sales tax for detailed advice on charging sales tax correctly.

How to calculate sales tax

Calculating sales tax is simple. A pocket calculator is all you’ll need. Alternatively, there are many programs on the internet that make the process easier for you – these include doing the tax look-up for you, in case you operate in different counties and states.

The following method shows the simplest way of calculating sales tax.

Calculating the total cost of an item

  1. You sell something for $50 , so now multiply this by the sales tax rate.
  2. Just as an example, the sales tax in Niwot, Boulder County, Colorado is 5.985%, so we’ll take that as our sales tax rate.
  3. The calculation is: 50 x 0.05985 = 2.9952. This means that the sales tax is $3 (rounded)
  4. Add this to your original price, and you’ve got calculated your sales tax!

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