By: Aaron Holland
Only two things in our lives are certain: death and taxes. One occurs at the end of our lives, and the other occurs throughout our lives wherever there is an exchange of money. Sales and use tax is a specific tax that affects every purchaser, from the middle-aged person buying a new Corvette to the 10-year-old buying a Coke from the local convenience store. All entrepreneurs, especially those selling goods online, need to understand sales and use taxes in the state(s) that they are legally connected to.
Basics of Sales and Use Tax
There are two types of taxes that every purchaser is subject to. Purchasers pay sales tax on certain goods and services when buying products within a state that imposes the tax. On top of that, purchasers may be subject to taxes even when they purchase goods in a jurisdiction that does not charge tax. Specifically, a purchaser may be required to pay a use tax to a taxing state when they use or consume taxable items they obtained from a non-taxing jurisdiction. For example, if a consumer buys manufacturing goods in Delaware (a state without sales tax) and then uses those goods to create a product in Pennsylvania, the consumer owes a use tax. In this situation, the use tax forces the consumer to pay the Pennsylvania Department of Revenue the appropriate amount since they never paid tax on the item in Delaware.
A Link Between States
Sales and use taxes are not federally adopted. Instead, individual states and their local jurisdictions decide whether these taxes will be imposed and collected. Due to the localized nature of these taxes, the United States showcases a variety of tax percentages and collection methods. As examples of the varied tax percentages, Pennsylvania has a flat 6% sales and use tax, with a few local jurisdictions, such as Philadelphia and Alleghany County, adding 1% or 2%, respectively. This percentage varies in other states, for example, California taxes 7%, Maryland taxes 6%, New York taxes 4% with an additional average local sales tax of 4%, Florida taxes 6%, and Oregon taxes 0%.
These tax percentages are important for businesses to know as they must pay sales tax to the state(s) in which they operate. For the traditional brick-and-mortar business, the state in which the business operates is easy to understand. However, determining a legal connection to a state can be more difficult when your business operates online. Typically, creating, selling, or packaging goods in a state forms a legal connection between your business and that state. Notice that a business can form legal connections to multiple states and may, therefore, be required to pay sales tax to all those states. Understanding the states that your business has connections with is especially important if your business (1) has workers that work remotely from different states or (2) utilizes a fulfillment service, such as Amazon, that houses your products and ships them from a different state. Situations like these may make your business responsible for paying sales tax to those states.
Responsibility for the Taxes
The business or individual selling goods or providing services is responsible for the sales and use tax that the taxing state charges. The sales and use tax, as seen when buying a new iPhone, is often passed on to the customer during purchase and tracked by the seller for end-of-the-year tax purposes. For certain small businesses or individuals selling goods in low amounts, not passing the tax on to the customer may be a business decision to keep the cost of your goods low. If you choose this option, you should calculate the sales tax at the end of the year to determine how much you owe your connected states.
Failing to pay owed sales and use tax to your connected states can lead to financial penalties, interest accumulation, and other fees. For example, in Pennsylvania, penalties are assessed for late filings, understating the amount of sales tax owed, and other major understatings in the filing. These penalties can account for excessive amounts levied against a business when the business fails to pay the correct sales and use tax to the state.
Is it Time to Pay?
Businesses can be required to file their sales and use tax reports at different frequencies, depending on the type of business, the goods sold, and the rules of the taxing state. Pennsylvania requires sellers to file monthly, quarterly, or semi-annually. Keeping an eye on the tax timeline is helpful as there may be discounts for filing and paying these taxes early.
There are many exemptions to the requirement to pay sales and use tax to connected states. In many states, an exemption applies to certain items, such as groceries and wearable clothing, freeing those items from sales tax. Purchasers may also be exempt from sales tax. For example, certain manufacturers and non-profit organizations are exempt from paying sales and use taxes. Common resellers of goods are also usually exempt from sales tax upon the purchase, but not the sale of, the goods they resell. Therefore, if your business sells goods to resellers, the sales tax may not apply to those sales. Reviewing the exemptions to the sales and use tax can save your business time and money if you or your purchasers fall into one of the many exemptions states provide.
Final Thoughts for Entrepreneurs
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- Keep track of the sales and use tax your business owes
- Learn what states your business has a legal connection to
- Know those states’ requirements for sales and use tax
- Understand your state’s exemptions and utilize all that may apply
- Receive legal assistance for specific sales and use tax advice
This post has been reproduced and updated with the author’s permission. It was originally authored on February 10, 2022 and can be found here.
At the time of this post, Aaron Holland was a 3L student at Penn State Dickinson Law. He had an interest in all things business law, especially in the assistance of start-up businesses and new entrepreneurs. He previously spent 6 years with the United States Marine Corps as a Military Police Officer.