Sales Tax Guide: How Sales Tax Works

In the United States, sales tax is when a percentage fee is applied to the price of goods and services at the point of sale. It is a form of consumption tax—a general sales tax applied to the purchase of goods or services—in which the product’s end-user is subject to the tax. Sales taxes are applicable wherever the business—whether a private small business or a delivery hub for a large corporation—has a sales tax nexus, which is a physical presence or volume of sales in a particular jurisdiction. State and local authorities levy taxes on a business location that falls within their tax jurisdiction, but sales tax is not applied at the federal level.

In states with sales tax, most consumer goods bought at retail stores are subject to sales tax. In some states, certain goods like prescriptions and groceries intended for home use are exempt from sales tax. Each state can impose its own regulations on the amount of sales tax that must be collected and remitted to the appropriate taxing authority. Outside of the US, excise taxes or a value-added tax (VAT) are applied instead of conventional sales tax.

Sales tax liability varies by state, as well as which goods are included or exempt from sales tax. In general, the seller is responsible for levying the tax on the consumer, which is then remitted to state or local tax authorities. Here are some examples of the varying state sales tax methods.

• Seller or vendor privilege tax states: States with vendor or seller privilege tax systems will tax the seller for the privilege of doing business within a state. The business can either pay their own sales tax—also known as absorbing the tax—or pass the tax along to the consumer. In vendor privilege tax states like Michigan, Missouri, and South Carolina, businesses are allowed to absorb the sales tax. However, in privilege tax states like Connecticut and Kentucky, the seller is legally obligated to tax the consumer at the point of sale.
• Consumer tax states: Consumer sales tax is when a tax is applied to a consumer during a retail sale. The customer is responsible for consumer retail sales taxes with the seller collecting the tax on behalf of the state government. In most consumer tax states like Vermont, West Virginia, and Oklahoma, sellers are prohibited from absorbing the tax.
• Transaction tax states: Transaction tax states like Colorado, Florida, Georgia, and Illinois hold both the buyer and seller responsible for paying the sales tax, though in Colorado it is illegal for the seller to absorb the tax, whereas in Georgia it is legal.
• Gross receipts tax (GRT) states: States that do not charge income tax, like Washington and Delaware, will calculate a GRT which is a state tax on the gross sales of a business rather than charge sales tax.

Once a business has obtained the appropriate sales tax permit—which allows a business to collect sales tax within a state—they are able to begin sales tax collection within a particular location. Some of the most common types of sales taxes are:

• State sales tax: State sales tax adds a percentage of the product’s price—ranging from 0.5 percent on the lowest end, and eight percent on the highest—to the final sales transaction total. Statewide sales tax is collected in every state including the District of Columbia (D.C.), with the exception of Alaska, Delaware, Montana, New Hampshire, and Oregon, each of which has its own form of local sales tax or additional regulations. State sales tax is applied statewide to most purchases, but many states provide tax exemptions for certain goods like groceries or nonprescription drugs. States that offer lower sales tax rates have to make up for that revenue in another form and may have higher income tax rates. For example, Tennessee has one of the highest state sales tax rates in the country, but a zero percent income tax rate. Conversely, Oregon has a zero percent sales tax rate, but one of the highest income tax rates.
• Local sales tax: Local sales taxes are determined by the local district governments which will levy an extra tax at the point of sale. This number is usually combined with the applicable state sales tax to determine the final tax amount.
• Use tax: A use tax is applied to a purchase made outside of the state’s jurisdiction when no sales tax was paid at the point of sale. Use taxes apply to goods that are bought from outside the state’s borders but are used, stored, or transferred within the state. The use tax rate is the same as the state sales tax rate, and both vendors and customers may have use tax obligations.
• Excise tax: An excise tax is an additional tax added on to certain specific goods, such as fuel, tobacco, and alcohol. Product suppliers or retailers are responsible for paying the excise tax but often pass the burden onto the consumer.

State sales tax compiles revenue for the state, while local sales tax collects revenue for the local area. State taxes are determined by state legislatures, and local sales taxes are determined by local governments. When a consumer buys something in a state with sales tax, the state sales tax is applied first and then the local rate is added on to determine the final sales tax rate.

For example, California’s state sales tax rate is 7.25 percent, but the local tax rate ranges anywhere from zero to three percent, which is then added to the state tax rate. This gives California a total sales tax rate between 7.25 and 10.25 percent, depending on the location of purchase.

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