Do I Need to Pay Sales Tax?

by | Mar 25, 2022 | Taxes

Dealing with taxes is an important part of any business, whether you are running a service-based business or are a merchandiser. One tax issue you may not have given much thought to is the sales tax. The sales tax is required in some states after selling goods and certain services. In this article, we will discuss how to determine if you need to pay sales tax.

What Is the Sales Tax?

As a business owner, sales tax is meant to cover taxes imposed by the relevant taxing authority (usually a state, but sometimes a locality). The tax is added to customer transactions so when customers make purchases they pay the purchase price and additional sales tax.

Sales tax applies to cash purchases, credit purchases, and installment purchases such as items placed on layaway or bought via a payment plan.

Another important characteristic of the sales tax is there is no federal sales tax. This means that each state has its own tax rules. You can probably guess that each state having its own sales tax rules means calculating and sending in the right amount of sales tax can become complicated. Thankfully we can help guide you in the right direction.

Does My Business Owe Sales Tax?

Because most states have sales tax requirements, the easiest way to check if you need to pay sales tax is to check your state’s website or to do an internet search. For example, Alaska, Delaware, and Montana do not have a statewide sales tax, but Alaska and Montana do allow localities to impose sales tax.

Sales tax is commonly applied to purchases of goods, but some service-based businesses need to pay sales tax as well. For example, Hawaii and New Mexico tax nearly all services, so businesses such as dry cleaners and barbershops collect sales tax in those states.

The next step is checking if your business has a sales tax nexus to the state.

A sales tax nexus basically means that your business has an economic presence in the state, such as employees, warehouses, or other operational resources that helps your business generate revenue. If your business has a sales tax nexus in a state that collects sales tax, you will likely need to pay sales tax.

Do Service-Based Businesses Collect Sales Tax?

We have discussed how merchandisers and businesses who sell goods likely need to pay sales tax, so let’s discuss service-based businesses.

Collecting taxes for service-based businesses is a relatively new development. States began requiring sales taxes on services around 2007, and more and more services are subject to sales tax as time goes on.

One way to help determine if a service is taxable is whether it is considered a pure service or a service/product hybrid. For example, suppose you run a service-based business that helps customers manufacture products. Even though you are providing a service, because the service is part of creating a product, you may need to pay sales tax in certain states.

If your service-based business in the above example was located in Michigan, the state would require you to pay sales tax, as a service that includes creating or manufacturing a product is likely considered to be taxable in Michigan.

Let’s look at a table for more examples of what is taxable in Michigan

 

Amazon PurchasesTaxable
CateringTaxable
Grocery PurchasesExempt
ClothingTaxable
Machinery/Raw MaterialsExempt
Janitorial ServicesExempt
Transportation ServicesExempt

You can see from the above table that the pure services and some goods purchases such as groceries are exempt.

Because sales tax rules vary in each state, the best suggestion is to visit the state’s website for more information, especially if you own a service-based business.

My State Requires Sales Tax, What Next?

After determining you need to pay sales tax in a state, your next step is to apply for a sales tax permit. There are three requirements to apply:

  • Business information such as address, ownership, and EIN
  • Business registration with the state
  • Application fees

After receiving your permit you can begin to collect sales tax.

Sales Tax Rate

Calculating proper sales tax amounts requires multiplying the purchase price of the product or service by the state’s sales tax rate. Because these rates vary, it is important to check your state’s website to get the correct rate.

For example, California has a 7.25% sales tax rate. In addition, counties and districts can impose additional sales tax amounts. For Los Angeles County this includes a .25% county tax rate and 2.25% district tax rate.

You can see how important it is to check the sales tax rules of the locality where you are doing business to ensure you end up with the correct amount of sales tax collected.

Record and Remit Sales Tax

After collecting sales tax, the next step is to record receipt of sales tax in your accounting books and to remit the proper amount to the relevant taxing authority. This is where the right accounting software can save a ton of time and stress.

For example, QuickBooks has features that automatically calculates the proper amount of sales tax, records each transaction, and gives you reminders of when to send in sales tax payments. Recording and calculating sales tax transactions by hands requires a good deal of time and effort.

 

Sales tax can seem like a complicated topic, but once broken down into manageable ideas the process becomes easier to understand. We hope this article has given you a useful overview of sales tax requirements and whether your business needs to pay sales tax.