Sales taxes are so commonplace in the US that we may not realize just how unique of a tax it is compared to the rest of the world. Other countries do things a bit differently than we do. Here in America, sales and use taxes are charged to the end user of a product. In many other countries, they instead have a “value-added tax” that is charged at all levels of the transaction, not just at the end.
While sales taxes may seem like a more straight-forward way of levying a transactional tax, there are still many confusing aspects about it that a lot of our clients ask us to explain. Let’s go over the basics of sales and use taxes to give you good base knowledge of the subject, and when you have further questions about how your business should apply these rules, we can help.
What is sales tax?
Sales tax is levied on the sale of a good or service. A sale occurs when a good or service is exchanged for some sort of consideration. The sale of a physical item, where the purchaser takes ownership of the new asset, is a clean-cut example of a sales transaction. However, transferring the title of an asset is not the only way to make a sale. A sale can occur when the right to use an asset has transferred, like an equipment lease or a car rental. It can also occur when a service is performed, like when labor is charged on a construction product. Whether that sale is taxable, however, is a decision left to the government.
Sales taxes are not levied by the Federal government – rather, they are levied by state and local governments. This means that every state and locality can charge its own tax rate and determine what transactions are taxable.
Who is liable for sales taxes?
The purchaser and end user is responsible for paying sales tax on the product, but the seller is responsible for collecting and remitting it. If a seller makes a sale and fails to collect sales tax, they will be responsible for paying the sales tax out of their earnings.
Another key concept to understand about sales tax is “nexus.” According to the US Constitution, a business is subject to a state’s tax laws when it has a “minimum connection” with that state. This “connection” is what we call nexus. Each state can determine what activities establish nexus, and once this connection is established, a business will be required to file sales tax returns with that state.
What sales are taxable?
To know what sales are taxable and which are exempt, you have to look at each jurisdiction’s laws. Some states include reference materials on their websites to help taxpayers determine what sales are taxable, but if your state does not have something like this available, you would have to look to the tax code. New Jersey, for example, declares that all sales of property and services are taxable unless otherwise stated, and they have a helpful list of taxable and exempt transactions on their website that you can see here. Another thing to note is that NJ sales tax is being reduced on January 1, 2018, from 6.875% to 6.625%.
How does “use tax” factor in?
Use tax is a complimentary tax to sales tax. Use tax is imposed on the purchaser and end user of a product or service, just like sales tax. It will be levied when a taxpayer purchases a good from out of state, was not charged sales tax, and then uses the good in their home state. If the purchaser did pay sales tax on the item, then use tax may not necessarily be assessed – some states require the difference between the sales tax rate charged (if lower than the home state) and the home state to remit use tax.
What is a sales tax exemption?
Some purchasers can apply for an exemption certificate that would excuse them from paying tax on purchases. A very common exemption certificate is a “resale exemption certificate” which would be awarded to a taxpayer who is not the end user of the product. The purchaser may, for example, have plans to resell the product to another customer or use that product when building another product that will ultimately be sold. In these cases, the taxpayer would pass along the liability to that end user and charge the applicable sales tax when they make the final sale.
How are sales and use tax liabilities reported and paid?
Use tax liabilities for individuals are reported and paid on the home state’s annual income tax return. Sales and use tax returns for businesses may be necessary wherever the business has nexus and can be required to be filed monthly, quarterly, or annually depending on dollar threshholds.
Contact your Spire Group professionals to discuss more questions you have about sales tax – we are here to help.