If you’ve read our general article on taxes, you know that a business has to deal with a lot of different types of taxes. One of these taxes is the sales or use tax (and their international equivalent—the VAT). These taxes come into play when you sell goods and, sometimes, services. If you sell only locally, then sales and use taxes can be fairly easy to handle. But if you sell to other states or outside the country, then collecting sales tax, use tax, or VAT can get complicated. We’ll go over the complications in this article and suggest various ways to deal with them.
Our readers are mostly in the US, so this article is written for a US-based business. If you’re located in another country, be sure to check your country’s tax laws instead.
Let’s start with some definitions.
- Sales Tax vs. Use Tax vs. VAT
- Your First Step is to Decide if Your Product or Service is Taxed at All
- If You Sell Locally, Then You Only Collect Sales Tax for Your Location
- If You Sell in Multiple Locations or Out of State, Then Collecting Sales Tax Becomes More Complicated
- You Might Have to Collect VAT for International Sales
- Strategies for Simplifying Collecting Sales Tax, Use Tax, and VAT
- If You Fail to Collect and Pay the Sales and Use Tax, You Will be Penalized
Sales Tax vs. Use Tax vs. VAT
Strictly speaking, the sales tax, use tax, and value-added tax (VAT) are different types of taxes. But, in many ways, they’re very similar. Just so that we’re on the same page when discussing these taxes, let’s first define each type of tax.
A Sales Tax is Collected from the Final Purchaser
A sales tax is a state and local level tax. There is no federal sales tax.
The sales tax is added to the end of each purchase and collected from the final purchaser. If you sell goods—including digital goods—you will almost always be collecting a sales tax. But if you provide services, you may or may not have to collect a sales tax. Your state and local government decide the sales tax percentage and the type of goods or services subject to a sales tax.
The sales tax is based on the location of the purchaser. So, if you sell into different states, you’ll have to find out the sales tax for each state you sell into, so you can charge the purchaser the right amount.
People Tend to Use Sales Tax and Use Tax Interchangeably
People tend to mention sales tax and use tax together. They also often use the two terms interchangeably. But, technically, there is a difference between a sales tax and a use tax.
A use tax is similar to a sales tax, but, while the seller collects the sales tax from the end-user, the seller is the one who pays the use tax. Of course, sellers typically add the use tax to the sticker price, so the final purchaser ends up paying the tax.
So, the practical effect of the use tax is the same as the sales tax. But, with the use tax, the end user never sees that they’re being charged a tax. It won’t be a line item on their receipt.
A Value-Added-Tax (VAT) is Similar to a Sales Tax but Used by Other Countries
The value-added-tax (VAT) is similar to the sales tax, but the VAT is imposed on the country level while the sales tax is imposed by the state and local governments. There’s no VAT in the US—we have sales tax instead. But VATs are common in many other countries like the UK and Canada.
If you sell into the EU, you’ll have to pay attention to VAT. There used to be an exemption from VAT for non-EU merchants selling lower-priced items. But this exemption is gone. Every US seller selling into the EU will have to worry about the EU VAT.
Your First Step is to Decide if Your Product or Service is Taxed at All
Depending on the type of goods or services you sell, you may or may not have to collect a sales or use tax.
You Collect a Sales Tax for Physical Goods and Some Services
A business can sell a service, physical goods, or digital goods (e.g. eBook, podcast, photo download). With very few exceptions, you’ll have to collect a sales tax for physical goods. Collecting sales tax for different types of services or digital goods will depend on each state.
Always check with your state’s tax collection authority (often it’s the Comptroller’s office) to find out which goods or services you sell are subject to a sales and use tax. If you sell into several states, you’ll have to do the same for each state.
If you do have to collect a sales tax, then you have to apply for a sales tax permit. You’ll use the information on the permit to remit the sales or use tax to your state.
You might want to apply for a resale certificate at the same time. This way, you can avoid paying a sales tax when you buy items that you will sell (and collect a sales tax on) later.
Send the Collected Tax to Your Taxing Authority from Time to Time
Whether you have to collect sales tax, pay use tax, or collect VAT, you first hold on to the amount collected. Then, at the appropriate time, you send the money to the appropriate taxing authority.
How often you have to remit the taxes depends on the taxing authority. You could be required to remit the taxes monthly, quarterly, or even yearly. In fact, for example, Texas has all three options. Each taxing authority will tell you which schedule to follow.
If You Sell Locally, Then You Only Collect Sales Tax for Your Location
With sales tax, your location matters. If you have one location and sell just to those who physically walk in, then you only have to deal with one sales tax percentage.
You figure out your sales tax percentage before you make your first sale and, unless your local or state government changes it, you pretty much never have to think about it again. You just have to collect the tax with every sale, set it aside in maybe a separate bank account so you don’t use it, and then send the tax to your state’s tax collection authority at the appropriate time.
If You Sell in Multiple Locations or Out of State, Then Collecting Sales Tax Becomes More Complicated
The amount of sales tax you charge depends on your buyer’s location, not your location. So, if your business is in one state but you sell into another state, then you have to collect that state’s sales tax for the customer in that state.
If this is the case, things can be manageable if, for example, your business sells only to your state and your neighboring states. But if you sell all over the country, then all the tax percentages and your collections will be difficult to keep track.
Fortunately, there are several ways to deal with this problem. We’ll go over VAT issues next, but then we’ll talk about your possible solutions.
You Might Have to Collect VAT for International Sales
Many countries around the world collect VAT for goods and some services. The process is roughly similar to that of the sales tax. You must register your business with the country, collect the tax, and then remit the tax to the country’s taxing authority.
It is, to say the least, hard to keep track of which country charges what VAT, let alone keep up with collecting and remitting the taxes. If you’re curious, here’s a list of countries that charge VAT, along with the percentage of the VAT. This list is kept up-to-date by the big accounting and consulting firm PwC.
One of the biggest VAT collectors is the European Union. It’s probably one of a few regions that our small business readers might sell into.
The EU VAT rules are complicated, and, while they have exemptions for small businesses within the EU, these exemptions do not apply to businesses outside the EU. In other words, most of our readers who sell to the EU will be on the hook for EU VAT.
Strategies for Simplifying Collecting Sales Tax, Use Tax, and VAT
Below are some strategies you can use to simplify collecting the sales tax, the use tax, and the VAT. To some extent, they’ll cost you sales, fees, or maybe even both. Sometimes, you can use two strategies together. So, pick carefully, depending on how you wish to run your business.
To Avoid Paying Sales Tax, Use Tax, or VAT, Simply Do Not Sell into a Particular Territory
As we mentioned earlier, sales tax, use tax, and VAT are based on the location of the purchaser. So, one easy way to avoid having to collect and pay the tax is to refuse to sell to customers outside of the areas where you are willing to collect and pay the tax.
If you provide services, you’re probably already limited by geographic location anyway. If you sell goods or a digital product, you can control your shipping or product download.
Of course, limiting your sales territory will limit your total revenue. But, for some types of businesses—for example a food business where you have to have USDA or FDA approval to sell outside of your state—this is a fairly easy way to comply with several regulations at the same time. With other types of goods or services, it might be easy to limit your sales to your state and your neighboring states. This way, you can control delivery costs and delivery times. So, limiting the geographic areas you’re willing to sell into might make a lot of sense for some small businesses.
You Can Sell Through Online Marketplaces
If you do not wish to give up sales but are willing to pay a platform fee, you could sell your goods or services through online marketplaces like Amazon, Walmart, Etsy, eBay, and similar. Here’s our intro article on setting up online stores. There, you’ll find links to several of our articles on online marketplaces.
In the US, most states require online marketplaces to collect sales tax on behalf of their vendors and remit the tax to the proper authorities. The EU requires these marketplaces to do the same. And, we suspect, as long as the marketplace is accessible in other countries around the world, the marketplace will collect and pay the country’s sales tax/VAT too.
So, while it usually costs money to list an item for sale on these online marketplaces, they will take care of the sales tax details for you. It might save you some headaches if you set up a shop through one of these online marketplaces and then always point potential customers to your shop to complete the purchase.
If You’re a Very Small Online Seller, You Might be Exempt from Collecting Sales Tax in Some States
Sometimes, if you’re a very small business that doesn’t sell much into a particular state, you can be exempt from collecting sales tax in that state.
This exemption applies only to remote sellers. A remote seller is usually a business that doesn’t have an economic nexus with a particular state. A nexus typically means you have a physical location, an employee, or do a lot of business in that state. The rules are slightly different for each state, but not having a physical location or employee almost always means there’s no nexus. The only question is whether you’re doing a lot of business in that state.
As a rule of thumb, “not doing a lot of business” means you sell less than $100,000 or 200 transactions per year in that state. Some states have higher thresholds, so this is just an easy-to-remember minimum.
To be clear, this threshold is a per state number. So, if you sold 199 times into California for a total of $80,000, 180 times into Texas for a total of $95,000, and 50 times into Illinois for a total of $50,000, you won’t have to collect sales tax in any of those states.
When you do get close to the $100,000/200 transactions minimum in any state, check this table to figure out the exact threshold for that state. Some states like Texas, California, and New York have very generous thresholds of $500,000. But other states like Florida have a lower threshold. And some states look at your gross revenue, while others look at your taxable sales of personal property (Florida).
If your collections exceed the threshold, you’ll have to analyze whether and on what types of items you’ll need to collect sales tax in that state. And then collect the tax.
You Can Spend Some Money and Use a Sales Tax Collection Service
But maybe you don’t want to use an online marketplace and you don’t qualify as a remote seller for lots of states. Or maybe you wish to sell outside the US. There’s still a fairly easy way to keep track of all the sales or use tax or VAT.
For a fee, you can sign up with a tax service that will handle the sales and use tax and VAT for you. Some of them will remit the taxes for you. Others will give you a summary of the amounts owed in each jurisdiction. You’d have to file the taxes yourself.
Here are three reputable tax services we found:
These services tend to charge by the number of transactions performed. So, before you sign up with one of these services, be sure to understand your costs and add that to your margin. Otherwise, they can eat up a chunk of your profits.
If You Fail to Collect and Pay the Sales and Use Tax, You Will be Penalized
Collecting and then paying the sales and use tax can be simple or complicated, depending on your type of business and where you sell to. But what if you fail to collect and remit the tax? How would the state even know you’re not collecting or not collecting the right amount?
Sometimes, a state will randomly select you for a sales tax audit. Other times, they look at your business’s income tax returns. If they see something strange, they might audit you. (If you’re curious about how a sales tax audit starts, here’s an article from Thomson Reuters on more details.)
If you fail the audit, in most states like California, Texas, and Florida, you’ll have to pay a fine. But in other states like New York, you might go to jail. So, do keep up with collecting sales tax, use tax, and VAT, and make sure you remit them on time. Don’t get into trouble because of this entirely avoidable mistake.
DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.
We give unbiased advice, so we don’t do affiliate marketing. We limit the ads we run to give you a better reading experience. So, we need your help to keep going. Please consider sending us a $3 one-time tip through Ko-fi (or support us on Patreon). We appreciate every dollar!
Questions? Comments?
