As a business owner, you’ll need to think carefully about taxes. Depending on the state in which you’re operating, you may see the term “sales and use tax” when applying for a sales tax permit. But what exactly is sales tax? What is use tax? And how are they different?
Generally speaking, sales and use tax are highly similar: they’re both a percentage-based tax on the sale price of a given item. They’re both collected by a merchant (or a consumer), and then are paid to the government.
However, there are some more important distinctions to consider.Table of Contents:
- What Is Sales Tax?
- What Is Use Tax?
- Sales and Use Tax FAQs
What Is Sales Tax?
Sales tax is a percentage-based tax on the sale, transfer, or exchange of a product or service that is taxable at the point of sale. Typically, this tax is added to the total purchase price of the item and is charged to the person paying for it.
For example, if a taxable item is $5, and sales tax is 10 percent, the customer would be charged $5.50, with $0.50 being tax. This $0.50 is then remitted to the state (or another authority).
There are Multiple Levels of Sales Tax:
State, County, and Local Sales Taxes
In the United States, businesses need to think about sales taxes at multiple levels; different governmental bodies regulate the imposition and collection of sales taxes. For example, 45 states (and the District of Columbia) collect a statewide sales tax; rates vary, but each of these areas requires businesses with economic nexus in the state to charge and remit state-level sales taxes.
In addition, 38 states allow for local sales taxes to be charged and collected (at the county or city level). In some cases, the local tax rate can exceed the state sales tax rate.
As a business owner, you’ll need to consider both state and local sales tax rates. If you’re in the planning process, you should understand that high tax rates can push consumers to cross borders to buy goods. No matter what, you’ll need to ensure your sales tax compliance at the state, county, and local level.
Combined State and Local Sales Tax Rates in 2021
State and Local Sale Tax Rate data from Tax Foundation’s, State and Local Sales Tax Rates, 2021:
|As of January 1, 2021|
|State||State Sales Tax Rate||Rank||Avg. Local Sales Tax Rate (a)||Combined Sales Tax Rate||Rank||Max Local Sales Tax Rate|
|New Jersey (e)||6.625%||8||-0.03%||6.60%||30||3.313%|
|New Mexico (c)||5.125%||32||2.71%||7.83%||15||4.313%|
|South Dakota (c)||4.50%||36||1.90%||6.40%||32||4.50%|
(a) City, county and municipal rates vary. These rates are weighted by population to compute an average local tax rate.
(b) Three states levy mandatory, statewide, local add-on sales taxes at the state level: California (1%), Utah (1.25%), and Virginia (1%). We include these in their state sales tax.
(c) The sales taxes in Hawaii, New Mexico, and South Dakota have broad bases that include many business-to-business services.
(d) Special taxes in local resort areas are not counted here.
(e) Salem County, N.J., is not subject to the statewide sales tax rate and collects a local rate of 3.3125%. New Jersey’s local score is represented as a negative.
Sources: Sales Tax Clearinghouse; Tax Foundation calculations; State Revenue Department websites.
When are you Required to Collect and Remit Sales Tax?
Sales tax nexus is the term for meeting a specific threshold of sales or economic transactions within a state that requires you to collect and remit sales tax within a certain jurisdiction. This threshold can be based on total sales, a number of transactions, or both. If a business doesn’t have economic nexus, they don’t need to worry about state-level sales taxes. If they have economic nexus, they’ll need to charge state sales tax on all taxable purchases.Business Activities that can trigger Sales Tax Nexus:
- Economic Activity
- Physical Presence
- Remote Employees
- Click-through nexus
- Affiliate Relationships
- Drop Shipping
- Receiving Referrals
Learn More: Avalara’s Know your Nexus Ebook
Some businesses will also need to think about excise taxes. Excise taxes function much like typical sales taxes, but they apply to specific types of goods and are typically included in the purchase price. Businesses are responsible for paying excise taxes, but consumers may never “see” this cost—other than paying a higher price for their chosen products.
For example, excise taxes are imposed on purchases of tobacco, alcohol, and gasoline (and other types of fuel). Some excise taxes are percentage based (aka “ad valorem”), while others are charged by the unit.
Items Subject to Excise Tax
- Airline Tickets and Plane Cargo
Your business may also need to consider specific types of local taxes; for example, some cities impose additional taxes on things like restaurant dining, hotels, rental cars, parking, and other travel-centric expenses.
What Is Use Tax?
Use tax is a tax on the use, storage, or consumption of a product or service when no sales taxes have been paid. Typically, use tax is the same rate as sales tax, and is designed to complement sales tax; only sales tax or use tax will be collected, not both at the same time. States introduced use tax as a way to make up for online transactions, where typical sales taxes could be avoided by many online vendors.
How is Use Tax Assessed?
Typically, use tax is applied by a state for goods that are purchased from out of state, when the seller has not reached sales tax nexus in that area. In other words, if there are conditions where the seller isn’t responsible for collecting sales tax, but a consumer purchases a taxable item, the consumer then becomes responsible for paying an equivalent amount of “use tax.”
Use Tax Assessment Example
This is best understood through an example. In California, residents are required to pay sales taxes on clothing. If a California resident buys a jacket from a store down the street, the merchant will collect sales tax at the point of sale and provide it to the proper tax authorities. If that same California resident buys the same jacket from a retailer in Delaware, where there is no state-level sales tax, the California resident becomes responsible for paying a use tax to make up for the sales tax that was not paid.
However, this example changes when the consumer is buying something that isn’t taxable in their home state. For example, in California, there is no sales tax on groceries. Buying groceries in California would trigger no sales tax, and buying groceries from Delaware would trigger no use tax.
It’s important to note that use taxes apply to all buyers, whether the buyer is an individual, a business, or any other type of non-exempt entity.
Sales and Use Tax Frequently Asked Questions (FAQs)
Sales and use taxes can be confusing, so here are some answers to commonly asked questions:
What is the difference between sales and use tax?
Sales tax applies to taxable goods purchased within a state from a merchant with economic nexus. Use tax applies to taxable goods purchased outside a state from a merchant without economic nexus. Sales tax is collected by the seller, while the buyer is responsible for use tax. You’ll never pay both sales tax and use tax on an item, since use tax is intended to make up for unpaid sales tax.
What is an example of sales tax?
Julie is a California resident who buys a pair of leggings from the store down the street. She pays 7.25 percent in state sales taxes, which the vendor collects and remits.
What is an example of use tax?
Julie is a California resident who buys a pair of leggings from Delaware, from a vendor with no economic nexus in California. She is responsible for 7.25 percent in state use tax.
How common is use tax?
Use tax is commonly neglected and forgotten, especially by individual consumers. It’s especially important to remember for large purchases.