Top 3 Things New Business Owners Need to Know About Sales Tax

The start of a new business is an exciting time! You get to see your ideas take shape and go out into the world.

It took a lot of investment, both your time and your dollars, to reach this point. There are an awful lot of considerations – from licenses to funding to renting space to website building – to get a business up and running.

One area you cannot overlook when you start a new business is sales tax. No matter if you’re starting a new business from scratch or a new revenue stream like selling a new product or selling on a new channel, getting your sales tax obligations straight from the outset will help you avoid potential audit and penalty issues.

You should start your business without worry that sales tax issues will derail your business down the road. Let’s clear up the essentials.

First up is the tax treatment of what you sell.

The Taxability of What You Sell

Your first step is to determine how the state or states where you do business characterize your products and services for sales tax purposes. Is what you’re selling taxable or exempt from sales tax? This is critical to get right as early on as possible in your sales tax compliance journey because it sets the tone for all the steps to follow.

Sales of tangible personal property (TPP) are taxable by default in every state that imposes a sales tax. TPP describes personal property that can be seen, weighed, measured, felt, touched, or anything that is perceptible to the senses. If you sell TPP, it is most likely taxable for sales tax. However, some states exempt certain types of TPP or tax them at a reduced rate.

States frequently reduce the sales tax rate for sales of food. But category rate reductions are never that simple. For example, many states distinguish prepared foods from unprepared, grocery foods, with prepared foods being taxable and unprepared grocery food exempt or at a reduced rate.

Generally, states exempt sales of services from sales tax. However, there are a handful of states that more broadly tax services that you need to watch out for. Taxable vs. exempt classification gets messy when services and tangible products are bundled. When a service like installation or assembly is included in the sales price of TPP, an otherwise tax-exempt service may become taxable. States sometimes extend this logic to professional services like architectural services that result in the delivery of a tangible blueprint.

Regardless of what you sell, if there is the possibility of different taxability across the states, you need to make sure that you separately state your products and/or services on invoices. When you separately state invoice items, you ensure tax-exempt services aren’t included in the lump sum bundled sales price with tangible goods.

Words matter when it comes to determining taxability. Pay attention to the language and terminology you use to describe your products and services in your marketing materials, your website, contracts, and invoices. The words you choose can have a huge impact on whether a state will view your product as taxable. Consistency is key here! Describe your products and services consistently across any platforms you use.

Where You Have Nexus

Nexus is one of the most important concepts to understand for sales tax. It is all about where you create obligations to collect and remit sales tax through your business operations. Nexus defines a level of connection between your business and a taxing jurisdiction (like a state, county, or city).

If you have nexus in a state, that means that you have a “substantial presence” there and are required to collect and remit sales tax on sales made into that state. “Substantial presence” can be created either through physical presence in a state or as a remote/out-of-state seller that has nexus due to remote seller nexus rules in state.

Common ways to establish physical presence in a state:

  • You have an office, distribution center, warehouse, sample room, store, or other place of business
  • You have a representative, agent, salesperson, canvasser, or solicitor operating in a state on your behalf
  • You store inventory there
  • You make deliveries in company vehicles or perform installation, repair, maintenance, or implementation services

Both permanent and temporary physical presence in a state can create nexus for you.

After you evaluate your business’s physical presence, investigate whether you have remote seller (economic) nexus in states where you do business. Economic nexus is determined by your economic activity in a state – your sales volume and number of transactions. The historic South Dakota v. Wayfair Supreme Court decision gave states the right to require tax collection from remote sellers that exceed economic thresholds.

Most states use South Dakota’s economic nexus threshold that was scrutinized under the Wayfair case: $100,000 or 200 or more separate transactions creates economic nexus. However, each state that has passed economic nexus legislation has its own rules with key details to watch out for like the type of sales included, if its an “OR” or “AND” test, the sales periods to include, and when you need to register once you exceed a threshold. We lay out all of these details in our Economic Nexus State Guide.

If your new business utilizes a marketplace platform like Amazon or Etsy, you also need to be aware of marketplace nexus rules. This type of legislation requires an online marketplace facilitator or provider to collect sales tax on behalf of its sellers if the sales it facilitates or makes on its own behalf exceed the state’s economic nexus threshold. If you exclusively use a marketplace to make sales into certain states, you may not have to register to collect tax in those states. But, as with everything in sales tax, look at the state-specific rules to be sure of your obligations (or lack thereof).

How to Register for Sales Tax

If you have nexus with a state or other taxing jurisdiction, it’s time to register!

Part of the registration process is determining which type of tax you are required to pay. Some states differentiate between sales tax, seller’s use tax, and consumer’s use tax on both their registration application and return.

Sales tax is collected when the seller is based in the same state as the customer, typically where you have a physical location like a store. Although the sales tax is usually imposed on the customer, the seller has the collection responsibility.

Seller’s use tax is a “sales” tax collected by a registered seller for interstate sales (when the seller is based outside the state where the customer is located).

Consumer’s use tax is complementary to sales tax and is typically imposed on sales that are subject to sales tax but tax was not charged. Consumer’s use tax most commonly applies when your company purchases from an out-of-state seller that is not required to collect sales tax in your state. The seller does not collect this tax; rather, the buyer has the obligation to pay it directly to the state.

You need to register for the appropriate tax as it will impact the return you file and the tax rate you collect. If you make sales on multiple channels, such as through a physical store and online through your website, multiple types of registration may be required.

Once you settle on which tax type to register for, you’ll prepare your registration application. Here is some key information you will need to gather for most state registration applications:

  • Average annual liability. Read your application form closely to see if the state asks for an estimated tax liability or sales. This information is used to determine your return filing frequency. Some states permit less frequent filing if the liability is small.
  • The date business began in the jurisdiction. This is used to determine if returns are due for prior periods. If your entire business is new and you’ve been on top of your obligations, this date should be easily known and will not cause you any issues. If a prior period is listed, expect to receive a request to file these prior period returns, which will likely include interest and penalty notices.
  • Company information. It’s helpful to have company data like your FEIN, addresses for any partners, and your NAICS number gathered to work through the application.

We have state pages that list the link to register and other key sales tax information. Visit our Resources Page and filter by jurisdiction in the drop down on the left to find information for your state.

New Business, No Problem

If you already dipped your toes into sales tax compliance, take the time to revisit the taxability of what you sell, where you might have nexus, and where you might need to register.

Having a firm grasp of these three considerations can help you be proactive as you grow your business. If you want to introduce a new product or service, research whether each state will treat it the same for sales tax and consider if it will impact your invoice presentation of separately stating taxable vs. nontaxable items.

As sales pick up, keep a close eye on your sales volume to make sure you’re ready to register should you exceed an economic nexus threshold in a state. If it comes time to register in a new state, have a process in place that helps you make informed decisions about which tax type to register for and has all the necessary data gathered to streamline the application.

Posted on September 28, 2020