The Sales Tax Guide. Part I: What Sales Tax is and who it affects
What do amazon entrepreneurs do about sales tax in the US? Basically nothing! They just ignore it. Some have heard that Amazon will now pay sales tax itself, but not in all states. Some still have the “I do not pay taxes in my home country, why should I pay them in the USA if I do not even live there?
And if in the case of marketplaces such as Amazon, eBay, Walmart, Etsy such ignoring the issue of Sales Tax can be justified – marketplaces collect this tax instead of sellers (we will consider this in our article), but in the case of his own site for the sale of goods in the USA or also Shopify to ignore this issue is clearly not necessary.
Since the topic of Sales Tax is quite broad, we will cover it in three articles. In the first part, we will look at general sales tax issues. In the second, we will look at issues with marketplaces. In the third, we will cover the topic of Shopify and/or your own site for selling products in the United States, and the issue of the resale certificate, which excludes Sales Tax.
In that article we looked at the multilevel tax system in the United States. The first thing to remember is that Sales Tax does not exist at the federal level, but only at the state and lower levels. Let’s analyze everything in detail.
What is Sales Tax?
Sales Tax is a “consumption tax” that is attached to the sale of certain goods in the form of a small percentage. We say “consumer” to mean that customers pay it. It applies to most goods and some services.
In the United States, this tax applies to 45 states and the District of Columbia (Washington). In addition, it may also be levied in cities, boroughs and counties. Local sales taxes are levied in 38 states and can sometimes exceed the Sales Tax rate for the state.
Five states: Alaska, Delaware, Montana, New Hampshire, and Oregon do not collect Sales taxes at the state level, while Alaska and Montana allow sales tax to be levied locally.
The highest Sales Tax rates in these states are:
• Tennessee – 9.55%;
• Louisiana – 9.52%;
• Arkansas – 9.51%;
• Washington – 9.23%;
• Alabama – 9.22%.
In general, Sales Tax rates at the state level are not changed very often, the last change was in 2019 when Utah raised it from 5.95% to 6.1%, but periodically changes come in one county, or city.
There are over 11,000 tax jurisdictions in the United States, most of which have Sales Tax and vary in size. If you take a city in the United States, it has a combination of sales taxes, and sometimes the combination can be quite significant.
But first, let’s start with an example. Take two cities in New York State: Rhinebeck and Kingston. They are less than 10 kilometers apart, but they are located on different banks of the Hudson, belong to different counties, and have different combined sales tax rates.
For Rhinebeck we have the following picture:
|Sales tax for New York State||4%|
|Sales tax for Dutchess County||3.75%|
|Sales tax for Dutchess Transit District||0.38%|
|Sales tax for the Town of Rhinebeck||0%|
|Combined sales tax rate||8.13%|
Despite the city itself has zero sales tax, customers can pay an additional 8.13% Sales Tax on each purchase as state and county taxes apply.
|Sales tax for New York State||4%|
|Sales tax for Ulster County||4%|
|Sales tax for the City of Kingston||0%|
|Combined sales tax rate||8.0%|
As you can see the difference is not big, but it is there. Can this difference in Sales Tax affect customer behavior? Not in this case, but there are quite a few examples in the United States where Sales Tax affects the behavior of retail shoppers. For example, people in Chicago go shopping in the suburbs, because the city itself has a much higher Sales Tax. For example, in Chicago it is 10.25%, but in neighboring Rockford it is only 6.25%.
Do tax rates affect local entrepreneurs? Sure. In New England, retailers prefer to operate on the New Hampshire side, where Sales Tax rates are lower, avoiding Vermont counties, where they are higher. Statistics since the 1950s have shown that per capita sales in New Hampshire counties have tripled while Vermont counties have remained at the same level for 70 years.
To close the question of sales tax rates, here is a map from the Tax Foundation website that graphically shows the size of the Sales Tax in different states. The map shows the combined state and local average Sales Tax rates as at January 1, 2021:
And this table summarizes both Sales Tax rates by state and combined rates with local sales taxes (as at January 1, 2021):
|State name||State Sales Tax||Combined Sales Tax||Maximum Local Sales Tax|
|District of Columbia||6%||6%||0%|
Why do entrepreneurs have to pay Sales Tax?
Before we tell you what the amount of Sales Tax depends on and why you have to pay it, we will clarify an important point that many entrepreneurs miss. It’s a common question: if Sales Tax is a consumer tax, why should entrepreneurs pay it?
If you look at the whole picture from the right angle, entrepreneurs do not pay Sales Tax, they only collect it. The buyer purchases taxable goods and pays Sales Tax to the entrepreneur’s account. Then the entrepreneur has to pass this money to the US Internal Revenue Service. It is not your money from the beginning, it only “passes through your hands”. This is how Sales Tax works in the United States, you just have to accept these rules and follow them.
Until to June 2018, sales tax obligations applied only to sellers who were physically present in a particular state: did business there, had a point of sale with employees.
That all changed when the United States Supreme Court ruled in June 2018 in South Dakota opposite Wayfair Inc. This decision affected all sellers doing business remotely in the USA. In essence, this decision was to eliminate the requirement of a physical presence in the USA and allowed the states to collect sales tax on out-of-state sellers based on economic presence (which we will discuss below).
That explains why we decided to write this article and help you understand Sales Tax in detail. In the first part we will cover all the issues related to sales tax, and in the second part we will outline a plan of action for Amazon entrepreneurs (and other marketplaces: eBay, Etsy, etc.) operating in the USA market and give some practical advice. In the third, we will touch on Shopify and resale certificates.
What does Sales Tax depend on and when does it arise?
Now we’re going to dive into the maze of the USA tax system, but we will try to give lots of examples to make it easier to figure it all out.
So, Sales Tax depends on:
- What you sell;
- Who you sell to;
- Nexus with a particular tax jurisdiction;
- Economic nexus (size and number of transactions).
Let’s start with a simple one.
What exactly do you sell?
It is always important to keep in mind the 11,000 tax jurisdictions in the United States, each of which may have their own specific Sales Tax rules and their own exceptions. Here are a couple of examples for clarity.
For example, most states do not charge a sales tax on food. But Arkansas, Virginia, West Virginia, and Tennessee are exceptions.
Prescription drugs are exempt from Sales Tax in almost all states, while all states charge sales tax for non-prescription drugs. Illinois, which charges a 1% Sales Tax on non-prescription drugs, is one of the exceptions.
In some states, clothing is exempt or taxed at a reduced rate. Full sales tax exemption for clothing applies in Minnesota, New Jersey, Pennsylvania and Vermont. And in some states it depends on its price: in Massachusetts (up to $175), New York (up to $110 apiece) and Rhode Island (up to $250).
Taxable goods generally include:
- Household appliances;
- Raw materials (lumber, fabric, etc.);
- Goods for the garden, including plants.
While Sales Tax for goods in the USA started working in the 1930s, since 2007 more and more services began to be taxed. All states tax services such as dry cleaning, carpentry, and hairdressing. Some states still exclude professional services such as doctors and lawyers from the tax base, but Hawaii and New Mexico already tax almost all services.
Complicated? Confusing? In a way, yes, but you do not have to memorize it all. Understand it, yes, but no more. We will tell you why this is so.
Sales tax rates for clothing vary greatly from state to state. For example, in some states Sales Tax for clothing is fixed, in some it is canceled, and in some states it depends on its retail price.
Who do you sell to?
You can sell to buyers who are not taxed. There are a few important exceptions that you should be aware of.
Many government agencies are not required to pay sales tax on purchases. For example, it is illegal to tax sales directly to the federal government. State and local governments are also often exempt, but not always.
State and local governments are also often tax exempt, but not always.
Non-profit and charitable organizations are also often tax exempt. Examples may include schools, churches, nonprofit hospitals, and charitable organizations.
You should keep in mind that many states also offer incentives for certain industries, such as manufacturing, research and development, high technology, and many others.
At the most basic level, if the buyer is exempt from paying tax, he must declare his exemption status and provide the seller with the necessary documentation at the time of purchase. If this is not the case with a taxable sale, the seller is responsible for paying the tax.
The concept of Sales Tax Nexus and its types
And here we get to the most interesting and important point, which actually determines where the sale is made and whether it is necessary to pay Sales Tax. The concept of Nexus is quite important, try not to miss this point.
Sales Tax Nexus is a legal term to say that you have a significant nexus with a particular state (or some other tax jurisdiction) with respect to sales tax.
If you owned a physical point of sale (store), for example, in California, then you would definitely have a nexus with respect to that state and would have to collect Sales Tax in favor of California. But our case is online sales, let’s look at how sales tax might arise without a physical presence in the United States.
All of the ways in which Sales Tax can be contacted in the various states can be summarized in the following list:
- The location of the office, warehouse, store, or other physical presence of the company in this state;
- Staff: an employee, contractor, salesperson, or other person doing work for your business is in this state.
- Affiliates are in the state: those who, for example, advertise your products in exchange for a share of the profits.
- Direct shipping relationships in this state: If you have a third-party shipping service for your customers.
- Physical sale of goods at a trade show or other event: in some states you are considered to have a nexus, even if you only sell there temporarily.
- Warehouse: Most states of the USA consider storing goods for sale in that state as a connection to the sales tax, even if you do not have a job or dedicated staff to maintain that warehouse there.
- Economic nexus: you exceed the state’s prescribed dollar amount of sales in the state or make a certain number of transactions in the state prescribed by the state.
The penultimate option is exactly our case. If you use FBA warehouses, Shopify’s Fulfillment Network, or third-party prep centers to store your items, you have an inventory nexus with that state with respect to sales tax. Which means you are required to remit Sales Tax to that state.
We will cover the inventory nexus topic in more detail in parts two and three, when we talk about Amazon and Shopify in more detail.
Many states have passed Economic Nexus laws that require online sellers who operate remotely to collect and remit sales tax if they exceed certain thresholds.
What are we talking about?
If your product sales to a particular state meet or exceed the thresholds set for that state, you must register to collect and remit sales tax for that state.
Thresholds for different states often vary, then more often they are set at 200 transactions or $100,000, whichever comes first.
What you should pay attention to:
Many states base their threshold on sales OR transactions, while some states base their threshold on sales AND transactions.
A state may base its sales threshold on gross sales, gross receipts, retail sales, or taxable sales. BUT… Many states do not distinguish between taxable and nontaxable sales in determining whether the threshold is met.
It is important to understand that the economic relationship with Sales Tax can occur independently of the warehouse relationship. Here is an example, for better understanding.
You are in Ukraine, you sell to Amazon, which stores your goods in Florida. So, you already have an inventory nexus with Florida. Kentucky buyers bought 300 units of Sales Tax free goods from you for the current year worth $70,000, and California buyers bought 250 units worth $300,000. Your merchandise is NOT stored in Kentucky or California warehouses.
Economic ties thresholds for Kentucky: sales over $100,000 OR 200 transactions in the current year. Even though sales by amount have not reached the threshold, they have exceeded the threshold by number of transactions. Which means you (or Amazon) must start collecting Sales Tax for Kentucky.
When should you start doing this? According to state tax law: from the first calendar day of the month following the month in which the sales threshold was exceeded, but no later than 60 days after the event occurred.
What about the fact that purchased goods are not subject to sales tax? You don’t. For Kentucky, it doesn’t matter, gross sales are counted, which includes all sales: resale, sales of taxable and exempt goods.
Kentucky is taken care of, but what about California?
California raised the sales threshold to $500,000 and removed the transaction threshold in April 2019. So there is no economic or warehouse nexus under California and you don’t have to pay Sales Tax on untaxed items yet.
The following table shows the thresholds for economic nexus for all states.
|State Name||Sales threshold size||What period is counted||When to register (relative to the threshold)|
|Alabama||250 000$||Previous calendar year||On January 1 of the following year|
|Alaska||$100,000 or 200 transactions||Previous calendar year||1 day of the month following the threshold|
|Arizona||$150,000 for 2020, $150,000 for 2021||Previous or current calendar year||1 day of the month following the threshold|
|Arkansas||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|California||500 000$||Previous or current calendar year||Day the threshold is exceeded|
|Colorado||100 000$||Previous or current calendar year||First day of the month, which will come 90 days after the period when the threshold was exceeded|
|Connecticut||$100,000 or 200 transactions||12-month period until September 30||Starting in October 1 of the year in which the threshold is exceeded|
|Delaware||—||—||No sales tax|
|District of Columbia||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Florida||$100,000||Previous or current calendar year||Next transaction|
|Georgia||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Hawaii||$100,000 or 200 transactions||Previous or current calendar year||1 day of the month following the threshold|
|Idaho||$100,000||Previous or current calendar year||Next transaction|
|Illinois||$100,000 or 200 transactions||Previous 12-month period||Quarterly check for compliance with the threshold for the previous 12 months|
|Indiana||$100,000 or 200 transactions||Previous or current calendar year*||Immediately after reaching the threshold|
|Iowa||$100,000 or 200 transactions*||Previous or current calendar year||1 day of the month following the threshold|
|Kansas||$100,000||Previous or current calendar year||Next transaction|
|Kentucky||$100,000 or 200 transactions||Previous or current calendar year||1 day of the month following the threshold*|
|Louisiana||$100,000 or 200 transactions||Previous or current calendar year||Within 30 days of exceeding the threshold|
|Maine||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Maryland||$100,000 or 200 transactions||Previous or current calendar year||1 day of the month following the threshold|
|Massachusetts||$500,000 or more transactions||Previous calendar year||If the threshold is exceeded by October 31 – registration from January 1 of the following year. If the threshold is exceeded from November 1 to December 31 – registration on the first day of the month following 2 months after exceeding the threshold|
|Michigan||$100,000 or 200 transactions||Previous calendar year||On January 1 of the following year|
|Minnesota||$100,000 or 200 transactions*||12-month period*||The first taxable sale after exceeding the threshold. There are exceptions*.|
|Mississippi||over $250,000||Previous 12-month period||Next transaction|
|Missouri||$100,000||Previous 12-month period||Not more than three months after the close of the previous calendar quarter|
|Montana||—||—||No sales tax|
|Nebraska||$100,000 or 200 transactions||Previous or current calendar year||The first day of the second calendar month after the threshold is exceeded|
|Nevada||$100,000 or 200 transactions||Previous or current calendar year||1 day of the month following the threshold*|
|New Hampshire||—||—||No sales tax|
|New Jersey||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|New Mexico||$100,000||Previous calendar year||On January 1 of the following year|
|New York||$500,000 or more transactions||Four previous tax quarters||30 days after reaching the threshold|
|North Carolina||$100,000 or 200 transactions||Previous or current calendar year||60 days after reaching the threshold|
|North Dakota||$100,000||Previous or current calendar year||Next year or 60 days after reaching the threshold (whichever comes first)|
|Ohio||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Oklahoma||100 000$*||Previous or current calendar year||1 day of the month following the threshold|
|Oregon||—||—||No sales tax|
|Pennsylvania||100 000$*||Previous 12-month period*||June 1 of each calendar year or earlier*|
|Rhode Island||$100,000 or 200 transactions||Previous calendar year||On January 1 of the following year|
|South Carolina||$100,000||Previous or current calendar year||The first day of the second calendar month after the establishment of the economic tie|
|South Dakota||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Tennessee||$100,000||Previous 12-month period||The first day of the third month following the month in which the threshold is reached|
|Texas||500 000$||Previous 12-month period||The first day of the fourth month after the month in which the seller exceeded the threshold|
|Utah||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Vermont||$100,000 or 200 transactions||Previous 4 calendar quarters||The first day of the month 30 days after the end of the quarter in which you exceeded the threshold|
|Virginia||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Washington||$100,000||Previous or current calendar year*||1 day of the month following the threshold*|
|West Virginia||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
|Wisconsin||$100,000||Previous or current calendar year||Next transaction|
|Wyoming||$100,000 or 200 transactions||Previous or current calendar year||Next transaction|
* The table indicates cases where reservations exist. We recommend you to check the respective state websites for more information.
This whole economic nexus regarding sales tax began back in 2005 with the state of Ohio, which passed the Commercial Activity Tax Law (CAT Law). This law stated that any retailer whose sales in Ohio exceed $500,000 was subject to Ohio sales tax collection laws.
Later, other states followed Ohio’s example and passed similar laws. It is likely that many of these laws were aimed at e-commerce giants such as Amazon. But as a result, they also affected online sellers, both independently and on marketplaces.
Conclusions to Part I
So, what you need to remember after reading this material:
- The sales tax is not your money, you only collect this tax from buyers of your goods for the benefit of one state or another;
- The obligation to collect this tax arises when you sell goods that are subject to this tax and/or when one of the nexuses with the sales tax in one of the states arises;
- There are 2 types of nexuses that apply to online sellers selling remotely in the USA: inventory nexus (you collect Sales Tax in favor of the state where you or Amazon keeps your product) and economic nexus (you collect Sales Tax in favor of the state where your sales exceed a certain threshold set by the state).
- Most states have required marketplaces (Amazon, eBay, Etsy) to collect Sales Tax from third-party sellers and remit it to the budgets of the respective states. At the same time, some states have a requirement to file a “zero declaration” on Sales Tax, which leads the online seller to register with the tax authorities of each state where he has a tax nexus.
We can tell you that the more you learn about the USA tax system, the more complicated your questions will become. The USA tax structure is unlike any other, as it is greatly complicated by state and local laws.
In the next article we will try to simplify things as much as possible and give a clear plan of action for online sellers working with Amazon and other popular marketplaces.