Do I need to charge sales tax? A simplified guide

Time for everyone’s favorite topic: taxes!

Still with us? If you’ve just launched your new business and are ready to start making sales, you might be asking yourself, “Do I need to charge sales tax?”

Knowing whether you need to charge sales tax is—no surprise—pretty complex. Especially when sales tax laws make for dry reading and can differ from state to state. Still, understanding your tax obligations is crucial for small businesses and retailers—and it doesn’t need to be quite as baffling as you might think.

In this guide, we’ll help you understand when to charge sales tax, including how much sales tax you need to collect depending on your state.

Whether or not you need to charge sales tax depends on various factors, like your business location and the type of goods or services you sell.

Most of the time, sales tax will depend on what your business offers because tax obligations differ between physical goods, services, and digital products.

If you sell physical goods, you’re more than likely required to collect sales tax. According to the Tax Foundation, only five states don’t have a statewide sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. 

So if your business location is in one of the other 45 states and you sell physical goods, you’ll need to collect sales tax from customers. However, there are also exceptions based on the type of physical goods you sell.

Each state has its own list of taxable goods. In most cases, you can find it on your State Department’s website under the Department of Revenue (sometimes called the “Department of Taxation”).

Here are some common (but not universal) exceptions to state sales taxes:

• Food, particularly from grocery stores, people prepare at home.
• Prescription drugs.
• Agricultural products, like seeds and animal food.
• Products for resale, raw materials, or inventory you will resell.

These exceptions provide a general guideline, but you’ll need to thoroughly research your state’s tax laws since they can be complex and detailed. For example, in Texas, “baked goods” such as doughnuts, bagels, and bread are exempt from sales tax. But the law explicitly excludes items like pretzels, sandwiches, or pizza from that “baked goods” classification—it’s complicated out there for a humble baker!

For a long time, sales tax applied only to tangible personal property (TPP), which are goods you can physically touch. But because the line between goods and services has become increasingly blurred, many states also apply sales tax to services.

Your business location will also play a large role in this area. Aside from the five states that don’t charge sales tax, there are also four states that apply sales tax to services by default, according to Avalara: Hawaii, New Mexico, South Dakota, and West Virginia.

The remaining 41 states might require business owners to charge sales tax on services—although plenty still don’t. Taxes will depend on the type of service they offer, so it’s best to consult an accountant for advice. 

Generally, services fall into one of the following six buckets:

• Amusement and recreation: Providing admission to recreational activities, theme parks, and other forms of entertainment and enjoyment. For example, a small concert venue that showcases local music acts.
• Business services: Providing services for other companies rather than individual consumers. An example is an extermination service that specializes in eliminating pests from office buildings.
• Personal services: Providing services to individual customers. Service-based businesses in this category typically fall into the personal grooming category. For example, a mom-and-pop barbershop.
• Professional services: Providing services that require specialized expertise, training, and, often, a license. For example, a law firm specializing in intellectual property law.
• Services to tangible personal property: Providing services to improve or fix TPP. For example, a mechanic with a small engine repair shop.
• Services to real property: Providing services to improve or repair land or buildings. For example, a custodial company that cleans and completes small repairs for various commercial buildings.

States will tax those categories differently or even not at all. For example, Alabama charges sales tax only for amusement and recreation services, while Virginia charges sales tax only for services to TPP.

Most religious and nonprofit organizations are exempt from sales tax. Check with an accountant or tax professional in your state to confirm whether your service-based business has a sales tax exemption.

In this digital age, sales tax laws get even trickier when talking about online sales of digital products, such as intangible products purchased and downloaded or accessed online.

This area continues to evolve, and several states haven’t yet clearly stated how they’ll charge digital products. Some states treat them like tangible personal property, while others treat them as tax-exempt.

Additionally, some states distinguish between software and digital products. Others tax differently depending on people accessing the product (whether it’s downloaded to a personal device or accessed online).

Considering there are 50 different states (each with its complex tax laws), it’s no surprise that business owners are daunted by out-of-state sales taxes.

Out-of-state sellers, also called remote sellers, generally won’t need to collect taxes from their customers unless they have a nexus within that state. Literally translated as a “connection,” a nexus means that your business meets one or more of the following criteria:

• Your business has a physical location in that state.
• Some of your employees reside in and work in that state.
• Your business has property (including intangible property like trademarks, copyrights, and patents) in that state.
• Your employees regularly seek or perform business in that state (for example, you have an active salesperson in that state).

So, many online sellers can ship goods out of state without charging or collecting sales tax, provided they don’t have a physical presence in that state.

There’s one more term you might come across as you research your state tax rates: use tax, a type of excise tax. The IRS defines use tax as a tax imposed on the sale of specific goods or services or certain uses. Use tax is often used for out-of-state purchases but is generally not the seller’s responsibility. In most cases, the purchaser should declare and file this tax in their home state.

If you sell goods in one of the 45 states with sales tax, you’re responsible for collecting and filing these taxes with your state government. Since the state tax rates fluctuate monthly, this can be a moving target.

State tax rates range from 0% up to 7.25%. For example, you can determine the exact tax rate for a specific address in your state with a sales tax calculator. 

You might also be responsible for local sales tax based on the city, county, or jurisdiction in which you or your customer resides. How do you know if you should charge based on the location of your business or your customer? That depends on whether you operate in an origin-based state or a destination-based state:

• Origin-based state: Sales tax rate is based on your business's location.
• Destination-based state: Sales tax rate is based on where your buyer is located (provided you ship the item directly to their home).

Origin-based states include Arizona, California (except district taxes are destination-based), Illinois, Mississippi, Missouri, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Virginia. All other states are destination-based, making it the more prevalent category.

As we mentioned, deciding if you need to charge sales tax will depend on the type of service or product you sell and your business location. Although some states don’t impose sales taxes, others have state and local tax rates. 

Here are the 2023 sales tax rules by state and the method the state uses:

Unfortunately, collecting sales tax isn’t quite as easy as taking on an extra charge to your goods or services.

To legally charge sales tax, you need a seller’s license or permit from your state. In some states, you'll also have to obtain a seller’s permit on a state level. In others, you'll also have to obtain a license from your city, county, or jurisdiction.

To apply for a sales tax permit, visit your State Department’s website. Look for the “sales tax” or “seller's permit” (or license) application under the Department of Revenue. You’ll use that application to submit some basic information about your business, including your location, business type, and taxes you intend to collect.

As you collect sales tax, you’ll have to remit it with a sales tax return to your state government regularly, such as monthly, quarterly, or annually. How often you remit taxes will depend on how many sales you’re making, as higher sales volume means more frequent filing.

When your state gives you your seller’s permit, they should also let you know your filing frequency. At that same time, it’s wise to ask about your sales tax due date. Most states expect business owners to file their sales tax return by the 20th of the month following the taxable period, but this date can vary.

It’s normal if the idea of managing your sales taxes makes you chew your nails. Figuring out all of the sales tax laws and details is intimidating. The good news is that there are qualified tax professionals and accountants for small business taxes who can help you through this process so you don’t have to keep asking yourself, “Do I need to charge sales tax?” 

Accounting software like QuickBooks will also track and manage your sales tax information, reporting, and filing. QuickBooks automatically does all the sales tax calculations, so you don’t have to worry about getting them wrong.