Sales Tax 101: Determining When Sales Tax Applies

If you’re newer to sales tax, and you’re not sure how to approach all the decisions you need to make… you’re not alone. Even people who have been doing sales tax for a while get overwhelmed with how to approach decision making related to sales tax. Don’t sweat! Novices and sales tax nerds alike continue to ask this question every day.  

The truth is… 

There are many different factors that go into answering this question depending on what you sell. However, there are some trusty general guidelines to follow that will help you determine whether something is taxable or exempt. 

What should you know to best understand when a sale is taxable or exempt? And what should you know to ensure that a customer (or you) can claim an exemption? Ask these 4 questions to help find the answers you’re searching for. 

Where Did the Sale Occur?

Sales tax is imposed on sales where the transfer of title or possession occurs within the taxing jurisdiction. Therefore, if a sale occurs in interstate commerce, the origin state where the sale occurs cannot tax the transaction.  

However…  

The destination state will likely subject the transaction to its use tax. If the vendor is registered to collect the destination state’s tax, the seller’s use tax should be collected and remitted to that state. If the vendor is not registered, the purchaser has the responsibility to remit the consumer’s use tax. 

Interstate transactions get complicated quickly because you don’t always have a simple pick-up at the seller location or a direct ship of tangible goods. 

Many interstate transactions also tend to involve more parties than just the seller and end customer. This is where drop shipments come in.  

A drop shipment is a transaction where a seller accepts an order from a customer, then places the order with a third-party supplier – typically a manufacturer or wholesale distributor – and directs the manufacturer to ship the goods directly to the customer. 

Drop shipments create challenges when a seller isn’t registered in the customer state, but the shipper might be.

If you sell services, should the state where the service is performed have the right to tax the transaction or is it where the customer is located? Does it matter based on the type of service?  

It can.  

With remotely provided services, this becomes a real challenge. As the seller, you might not even know where the customer is located. So, then what happens? Some states have default logic which could result in using a customer billing address and if no address is available at all, it might be sourced to the seller’s location. 

This brings us to the next item related to where your sales occur… Do you have physical or economic nexus? Nexus, or the level of connection between a taxing jurisdiction and an entity, can be created through physical presence or economic activities. Long story short, you might owe sales tax in states where you don’t have any physical presence because you have made sales into that state.  

There are different steps to be taken depending on the type of nexus you have. If you have physical presence in a state (such as activities of individuals or presence of property), you have nexus which starts on the date the physical presence started. If you don’t have physical presence in a state, things get a little bit more complicated. You have economic nexus if your sales into a state exceed their sales and/or transaction threshold. You can find a state-by-state Economic Nexus State Chart here. This chart includes (for every state) the thresholds, measurement date, includable sales, when you need to register, and more.

One more detail to consider is… Are you the one making your own sales or are you selling through a marketplace? Marketplace nexus requires online marketplace facilitators to collect tax and remit tax on behalf of sellers operating through their systems. If you’re using a marketplace, make sure you confirm who is collecting the tax so that it doesn’t end up over or under collected. 

 

 

What Are You Selling?

Classification of your product or service is a key item to consider when determining if a sale is taxable or exempt. Sales of tangible personal property (personal property that can be picked up and moved) are typically subject to sales tax unless specifically exempted. But as you may know, in some states, certain services are also subject to sales tax. If you only sell services, your sales might be exempt.

You’ll need to consult the tax law in the states where you sell services to find out if the services you sell are taxable there.

Watch out for bundling if you combine any tangible property with a service for a single charge. This could change the taxability of the entire transaction. Check out this video to see how two differently formatted invoices for the same transaction (one bundled, one itemized) impact the taxability of the services you provide. 

The taxability of your service could also vary based on some very discrete distinctions. For example, if you’re a repairman, the tax treatment of the services you provide may vary based on whether you are doing “repair services” or “maintenance services.” You should check the specific tax laws for a state to see what are considered taxable services.  

Who Are You Selling To?

You might find yourself selling to purchasers that are exempt. There are a few critical exemptions you should know about. 

Many governmental entities are not required to pay sales tax on purchases. For example, states are prohibited from taxing sales directly made to the Federal Government. State and local government entities are also often exempt – but not always. 

Nonprofit and charitable organizations are also often exempt. Examples can include schools, churches, nonprofit hospitals, and charitable organizations.  

Here’s the tricky thing about non-profits: 

For most states that grant an exemption to non-profit organizations, the exemption only applies to their purchases of items used in conducting exempt activities. If the organization makes sales that compete with for-profit companies, their sales are generally subject to sales tax which would require them to be registered for sales tax. 

You should keep in mind that many states also offer exemptions focused on specific industries such as manufacturing, research & development, and hi-tech, among many others. If you make sales to purchasers in these industries, an exemption may apply.

Remember that proper exemption documentation must be provided in order to claim an entity or type of use exemption. These vary by state – as you might have guessed! You can use this tool for guidance. 

At the most basic level, if the purchaser is exempt, it is their responsibility to declare their exempt status and provide the required documentation to the seller at the time of the purchase. If this doesn’t happen on an otherwise taxable sale, the seller is liable for the tax. 

 

 

What is the Price?

The last key item you should consider what is included in the “sales price” that is subject to tax. You might wonder, is a discount included in the sales price subject to tax or is it excluded from the tax base? Is a coupon included in the sales price? Are delivery charges included? 

Whether or not these items are considered to be part of your taxable “sales price” can vary from state to state. 

 

 

Sales Tax: Getting it Right

Taxability determination for sales tax is like writing a story. As you’ve seen, it’s all about the who, what, when, where, and why.  

Keep this checklist close: 

• Who: Who is your customer?
  • Are they exempt because of their entity type? (Government, nonprofit, charity, etc.) 

• • Are they exempt because of their industry? (Such as a manufacturer) 
  • Are they exempt because of how they plan to use the product? (Like a sale for resale.) 
  • Who has the responsibility to provide exemption documentation? 

• What: What are you selling?
  • Are you selling tangible personal property?
  • Are you selling a service that is subject to tax in your state? 

• • Are you bundling tangible property with services? 

• Where: Where did your sale occur?  

• • Are the seller and customer in different locations?  
  • Does the transaction involve a drop shipper? 
  • Which jurisdiction has the right to tax the transaction?  

• When: What is included in the sales price at the time of the sale? 

• • Are discounts included? 

• • Are coupons included in the sales price? 
  • Are delivery charges included? 
• Why: Your “why” is to get sales tax right to stay compliant!