Calculating Sales Tax

Calculating Sales Tax

Deskera Content Team
Deskera Content Team
Table of Contents
Table of Contents

Sales tax is a tax levied on the customer for the consumption of goods and services by the government. Traditional sales tax is levied at the time of sale, collected by the retailer, and passed to the government.

Point 1 - Several goods must pass through different stages in the modern economy to reach the end customer and a large amount of documentation is needed.

Howard is a shepherd sells who sold wool to an NYC company to make yarn. To avoid sales tax payments, as a yarn manufacturer, NYC will obtain a resale certificate from the government indicating that they are not the end-users. NYC further sells to product to an Apparel showroom, but again the business will obtain a resale certificate based on the same grounds. Finally, the apparel company sells a shirt of the product to Mr. Bing who is the end-user now. The retailer charges the customer a sales tax along with the price of the shirt.

So, this is clear that traditional sales tax is only charged to the end consumer of the goods or services.

Point 2 - If you belong to a particular jurisdiction, it may be a physical location, employee, affiliate, or other entity, sales tax computation and application could be different depending on the law of that jurisdiction.

Susan, a Georgia resident buys a luxury car in Florida. She had to pay local sales tax as if she had bought it at her home.

So, let us understand what sales tax is, and how it is calculated.

Table of Contents

What is Sales Tax

Sales tax is levied by the Government that is charged to the end-user on the sale of goods and services. Sales tax is a point-of-sale fee paid by consumers who purchase taxable goods or services within the scope of the tax authorities. This tax is closely related to the consumption tax that applies to residents who purchase goods outside their jurisdiction. These are usually set at the same rate as sales tax, but they are difficult to enforce. Different jurisdictions have different sales taxes and every state, county, or municipality collects its own sales tax.

Generally, sales tax is applicable when someone buys a tangible product (what you can see, weigh, measure, feel, or touch) at a retail store, but the type of sales tax in the state. It varies greatly from one to another and can cover services. The purchaser has a legal obligation to pay sales tax, but it is the seller's responsibility to collect the tax and transfer the collected tax to the state and, if applicable, the county or municipality.

  • In the United States, the agency is a state, sometimes a county or city. Taxes are added to the price of the goods or services and are included in the total cost of the purchaser
  • Except as expressly excluded, sales tax is levied on all credit sales, cash transactions, pre-sales, installment sales, and sales related to transaction or exchange of assets, if valid
  • One important thing to keep in mind is that the Internal Revenue Service has little to do with sales tax, but its non-profit guidelines are used to set some exceptions
  • At first glance, the calculation of sales tax seems easy. But when it comes to sales tax, it's not that easy. All you must do is to get the price of taxable goods or services and multiply it by the sales tax rate. There are over 12,000 tax jurisdictions in the United States, depending on how you run your business

Example:

Mrs. Smith shops for $100 at a departmental store. If the applicable sales tax rate is 8%, it means she would have to pay 8 dollars as sales tax with a total cost to the customer of $108.

What are Taxable goods?

The list of a few common categories that can be expected to be taxed unless tax exemption is granted is as follows:

  • Furniture
  • Automobile
  • Apparels
  • Computers
  • Household appliances
  • Electronics
  • Books
  • Toys
  • Raw materials (wood, cloth, etc.)
  • Gardening supplies including plants
  • Rental properties etc.

What are Taxable Services?

Services may also be subject to sales tax and the most common are:

  • Immovable property services such as item installation, inspection, maintenance, and repair for customers
  • Real estate maintenance services related to customer assets such as snow removal, mowing, landscaping, and utility repairs
  • Business or marketing-related services such as consulting, advertising, recruitment, public relations, and human resources development
  • Personal services such as pet grooming, dry cleaning, cosmetology, travel, and outdoor guides

How Sales Tax works

Sellers acquire sales tax for the end consumer and transfer them to states and/or local governments based on where they belong. The tax is then used by state and local governments to fund the operations of various governments.

All states don’t charge sales tax

For example, Alaska, New Hampshire, Montana, Delaware, and Oregon, don’t charge sales tax but allow “selective sales taxes,” on services such as boarding and lodging. In Alaska, the state also permits specific jurisdictions to collect their own sales tax.

  • The most important consideration when calculating sales tax is whether you need to tax what you are selling. What is taxed in one state may not be taxed in another. Generally, tangible items are subject to sales tax. Some items such as groceries are exempt from sales tax. Even services may be taxed in some states or jurisdictions
  • In the country of origin, sales are taxed according to the location of the seller. However, these rules have different capabilities in remote sellers. Generally, if you are a resident of one state and sell to another state that owns Nexus, the sale is based on your goals
  • In most states, the base tax rate is collected by the state, and cities or other jurisdictions may impose additional taxes in addition to that rate

For example:

  • In Washington, Seattle people pay a 10.1% tax rate on taxable items, even though the base tax rate is 6.5%
  • King County imposes a 3.5% tax, and Seattle also has its own 0.1% tax
  • Meanwhile, the total tax is 8.9%, just below the I-5 in Olympia, Washington. The city charges a 2.4% tax in addition to the state's base rate, but Thurston County has no additional charges

In some states (Washington, D.C., and Puerto Rico), the basic rate is the only rate. Additional sales taxes are not allowed. These include the following

  • Indiana
  • New Jersey
  • Massachusetts
  • Michigan
  • Kentucky
  • Maine
  • Maryland
  • Rhode Island

Home-rule States

A handful of states not only add percentages to the rate of state but also create their own rules even if you can control specific objects that are taxed elsewhere.

This also means that you must sign up in various jurisdictions to collect state and jurisdiction tax. For example, if you have nexus in Denver, Colorado, you may have to collect and remit taxes separately for both the city and the state.

According to the home-rule states, the locations that are included are Colorado, Alabama, Louisiana, Idaho, and Alaska. Arizona is another one, but the state treats all jurisdictions except for American reservations.

About ZIP Codes

It is important to note that many companies use ZIP codes to search for sales tax rates, but the jurisdiction of sales tax is not assigned to the zip code. Two people living in the same area with the same zip codes could pay different sales tax rates. It is the geolocation that matters and not the zip code to analyze the rate of sales tax applicable.

Sales Tax Collection Process

Sales tax applicability primarily depends on the state and local sales tax of a location. If sales are made remotely, you must consider the following:

  • Your subject is taxed within the state or jurisdiction where your customer is in the jurisdiction (or where they are in the original state)
  • If so, the sales tax depends if the business has Nexus in this state or this state or jurisdiction
  • If you have a Nexus, the final consideration would be the total tax rate that needs to be charged
  • If applicable, consider state tax rates and additional local taxes

For small and medium-sized enterprises, management is difficult, especially when transferring money and filing in combination. Also, the sales tax law is constantly changing, so what you had to calculate last month could be completely different in just a few months.

Automating the entire process, always calculating the right percentages, transferring the right amount, and sending the right documents becomes essential while computing sales tax. And you don't have to worry about sales tax, but you can focus your energy on the right things to grow your business.

  • Sales tax collection, calculation, reporting, and payments continue to be one of the most confusing and sometimes monotonous parts of running a small business
  • There is no federal sales tax in the United States, but 45 states, the District of Columbia, and Puerto Rico have their taxes
  • In addition, 38 states also allow local sales tax, which often exceeds the state tax rate. Local sales tax is allowed in Alaska and Montana, where there is no state sales tax. Each taxing authority, state or local, has its laws, tax rates, schedules, and tax exemptions

How companies calculate sales tax

The costs that a customer pays when purchasing goods or services from a company include both the company's selling price and the applicable sales tax costs. Most states have a sales tax, but some do not.

Companies use the following steps to calculate sales tax:

Step 1 - Gather information about local sales tax rates

Gather information about local sales tax rates as they vary from location to location. Some regions apply a combination of city, county, and state sales taxes, while others only apply state sales taxes. Start by determining if the state in which your business is located has a state sales tax and then identify the sales tax rate.

Step 2 - Calculate the total sales tax rate

The total sales tax rate is a single number that represents the total sales tax for a region, including city, county, and state sales taxes. Companies calculate the total sales tax rate by summing these individual consumption tax rates. Companies with more than one location need to calculate the total sales tax rate for each region in which they do business to ensure that they collect the correct amount of sales tax according to the location.

Example: The city of Tampa is in Hillsborough County, Florida. Florida has a sales tax rate of 6% and Hillsborough County has a sales tax rate of 2.5%. When these sales tax rates are added together, the total sales tax rate in Tampa, Florida is 8.5%. However, the counties around Hillsborough (Pinellas, Pasco, Polk) each have a sales tax rate of 1%, so the total sales tax rate for these areas is 7%.

Step 3 – Analyse the taxable goods or services

Classify a company's goods or services according to taxable and non-taxable. Understand the sales tax rules for each city, county, and state where you operate, and when each rule applies. Don't forget to check if the area where your business is located has the following tax exemption items:

  • Food
  • Clothing
  • Prescription drugs

Also, knowing when sales tax holidays will occur, which items are tax exempt on those holidays, and which rules apply to certify items as tax-exempt at those times.

Step 4 - Find the total selling price of taxable goods and services

When calculating the sales tax amount, add the listed selling prices of each taxable item to get the total taxable selling price. Remember to exclude tax-exempt items from this calculation and calculate their total selling price individually.

Step 5 - Use the sales tax formula to evaluate the sales tax amount and a final selling price that the customer should pay.

Knowing the total sales tax rate for the region where your business is located plus the taxable selling price for your purchases will help you calculate the amount of sales tax your customers will have to pay.

The sales tax formula is:

[Total taxable sales price] x [Sales tax rate in decimal form] = Sales tax amount

After calculating the sales tax amount, add it to the total taxable and non-taxable sales price to calculate the final sales amount. At this point, be sure to add the total duty-free retail price.

The formula for calculating the final sales amount is as follows:

[Total taxable sales price] + [Sales tax amount] + [Total non-taxable sales price] = Final sales amount

Example - Calculation of sales tax for taxable and non-taxable products

Mr. Stewart buys food, care products, school supplies, apparel, and electronic devices from a store in Tampa, Florida.

  • He Eats out: $200.00
  • Toiletry: $28.87
  • School supplies: $22.98
  • Clothes: $46,01
  • Electronics: $70.07

The sales tax rate is 6% for the state's sales tax rate, and the sales tax rate of Hillsborough County is 2.5%. The food purchased by the customer is exempt from sales tax. So, you must calculate the following.

  • Non Taxable Goods: $200.00
  • Taxes Sales Price: 167.93 USD ($28.80 USD + $22.98 + $46.01 + $70.07 = $ 167.93)
  • Sales Tax Amount: $14.27 ($167.93 x .085 = 14.27405)
  • Total Bill including sales tax: $387.20 ($200.00 + $167.93 + $14.27 = $382.20)

Conclusion

Small business owners need to be prepared and informed about sales tax liability. If you fail to report or transfer sales tax, or if you miss a scheduled payment, you may still be subject to fines and criminal liability.

Some many pitfalls and obstacles can confuse sales tax, so it becomes imperative to understand the terms, and the procedure to calculate the sales tax according to the applicable rate. Your state determines your sales tax rates and rules It is a common misconception that companies that do not collect and report sales taxes are subject to IRS inspection.

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Key Takeaways

  • The sales tax rate is the rate at which the end consumer is taxed when he/she buys a product or a service from the vendor or a business
  • The United States imposes a sales tax depending on the state or location, not on the zip code. There are certain home rules applied to many states which decide the sales tax be charged
  • The IRS has little to do with sales tax because the sales tax is not a federal tax. The reporting and enforcement agency is the tax office of the state in which the company is located
  • A sales tax holiday is a sales-tax-free day for a short period during which customers are exempt from paying sales tax. These holidays vary in length but are often one day, on weekends, or on a week. All states in the US don't have access to sales tax holidays
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