If you’re like many small business owners, you need to collect sales tax on some of your offerings. Your sales tax responsibilities depend on your location. This fact surely begs the question: do I charge sales tax for out-of-state customers? To stay compliant, understand which sales tax laws apply to your business. And, you need to know the difference between origin vs. destination sales tax states.
Sales tax basics
State and local governments impose a sales tax on certain products and services. If you operate your business in a location that enforces sales tax, you must collect and remit the tax.
Every state has different rules for collecting sales tax. Not all states enforce sales tax laws. In some locations, the state does not enforce sales tax, but local governments within the state do.
Pass-through tax
Sales tax is a pass-through tax. With pass-through taxation, the seller is the middle man for handling and remitting tax money. The seller does not pay the sales tax out of pocket. Instead, the seller collects the tax as a percentage of a customer’s total amount due. Then, the seller sends the sales tax to the appropriate government authority.
The right (and wrong) time to collect sales tax
Sometimes, you need to collect sales tax while other times you do not. Double-check with your state tax agency and an accountant before collecting sales tax.
Don’t collect if you do business in a state that does not enforce sales tax. There are five states without a sales tax:
- Alaska
- Delaware
- Montana
- New Hampshire
- Oregon
Note that while there is no state sales tax enforced, there might be local sales tax laws that you must follow. Check the localities within these states to be sure you do not need to collect sales tax.
Don’t collect during a sales tax holiday. Some states have a sales tax holiday where items you normally charge sales tax on are tax exempt. The sales tax holiday date and the items that are temporarily tax exempt are different for every state.
Don’t collect when you sell items in a state that you have no physical presence in. For example, you run your business in Illinois. You sell to a customer in Pennsylvania. No aspects of your business exist in Pennsylvania, so you do not collect sales tax.
Do collect if you sell to a customer in a state that your business has a presence in. Determining your business’s presence is a little easier said than done. States have different definitions for a business presence.
Determining your business’s presence: Nexus
Nexus for sales tax helps you determine your business’s presence in an area. Your business can have different kinds of presences in several locations.
Whether you run a brick-and-mortar store or operate an online business, you have nexus in the primary state you run your company. The state you live and run your business from is called your home state nexus. If you sell to a customer in your home state, collect sales tax for that state.
For example, you own a sporting goods store in Ohio. When you sell products to Ohio customers, collect sales tax according to your home state laws.
Secondary business presences
Your business might have more nexus than just your primary location. If you have any of the following types of business presences, you might need to collect sales tax for other states.
Inventory
In some states, locations where you store inventory or assets are considered nexus. For example, if you keep inventory in a warehouse in a state other than your home state, you might need to collect sales tax from customers located in that state as well.
Employees
You have nexus in certain states if you employ out-of-state workers. You might have to collect sales tax from customers in states where you have an employee, contractor, or salesperson working for your company.
Drop-shipping suppliers
If you use a third-party provider to ship orders to customers, you might have nexus in the provider’s state. Check with the drop-shipping supplier’s state to see if nexus rules for third-party suppliers apply.
Trade show attendance
In some states, you also have nexus if you or an employee attended a trade show in that state within the last 12 months.
Origin vs. destination sales tax
Determining your business’s nexus will tell you where to collect sales tax from. But, states collect sales tax in different ways.
There are two methods for determining and collecting sales tax: destination and origin based sales tax. Origin vs. destination sales tax comes down to whether sales tax is collected according to the location of the seller or buyer. Let’s break down the origin based and destination based sales tax rules.
Origin-based method
In an origin-based state, sales tax is collected based on the seller’s location. As a small business owner, that means you collect sales tax based on your state and local tax rates. You also remit the tax to your home state and locality.
Origin state = Seller location’s tax rate
For example, you operate your business from Virginia. Since your state is origin based, you collect origin-based sales tax at the Virginia rate and your local tax rate.
The following states use the origin-based method:
- Arizona
- California*
- Illinois
- Mississippi
- Missouri
- Ohio
- Pennsylvania
- Tennessee
- Texas
- Utah
- Virginia
*California is a little tricky when it comes to the origin-based method. In California, city, county, and state taxes are based on your location (the seller). But, district sales taxes are based on the customer’s location.
Destination-based method: do I charge sales tax for out-of-state customers?
In a destination-based state, sales tax is collected based on the buyer’s location. That means you collect sales tax based on your customer’s state and local tax rates. You also remit the tax to your customer’s state and locality.
Destination state = Buyer location’s tax rate
For example, you operate an online business from Maryland and sell a product to a customer in a different part of the state. Since your state is destination based, you collect destination-based sales tax at the customer’s local and state tax rates.
If a state is not origin based or sales tax exempt, it is a destination-based state. The following states use the destination-based method:
- Alabama
- Arkansas
- Colorado
- Connecticut
- District of Columbia
- Florida
- Georgia
- Hawaii
- Idaho
- Indiana
- Iowa
- Kansas
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Minnesota
- Nebraska
- Nevada
- New Jersey
- New Mexico*
- New York
- North Carolina
- North Dakota
- Oklahoma
- Rhode Island
- South Carolina
- South Dakota
- Vermont
- Washington
- West Virginia
- Wisconsin
- Wyoming
*Some services and transactions may be origin-based in New Mexico.
Because a state can have hundreds of different tax rates from locality to locality, the destination-based system is a little more complicated than origin based (where you use the same rate for every sale).
Most states follow the destination-based method. State governments want to circulate tax dollars within their jurisdictions. The destination-based method keeps a consumer’s money in their own locality.
Remote seller sales tax rules
Many brick-and-mortar small businesses hold all their nexus in one state. But, some businesses have nexus in several states, especially when it comes to sales tax on internet sales. If you have nexus in more than one state, you might be considered a remote seller.
If you have nexus in a state other than your home state, you are a remote seller in that state. For example, you operate your business in Mississippi, but you have nexus in Louisiana. You are a remote seller in Louisiana.
Remote sellers collect sales tax differently than sellers in their home state. For remote sellers, there are only a few origin-based states. Remote sellers in Arizona and California (with some exceptions) use the origin-based system.
For, example, you live in Georgia and have additional nexus in Arizona. The nexus in Arizona is not your business’s primary nexus, making you a remote seller in Arizona. Since Arizona is origin based for remote sellers, charge sales tax according to Arizona’s rates.
Usually, remote sellers use the destination-based system. If you sell to a customer in a state where you are a remote seller, you charge according to the customer’s state rate.
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