As a tax professional that services retailers, I hear the phrase “but, I can’t afford to pay the sales tax” often. These retailers fall into the trap thinking that the sales tax they collect on their product or service belongs to them. Unfortunately, that is not the case and not paying the full amount of taxes collected from consumers will be considered a criminal act. The business owner, who does not pay the full amount of taxes collected, is basically stealing funds from the state or local government imposing the sales tax requirement.
In other words, the business owner is assisting the government in collecting their funds. Therefore, to make the process easier on the business owner, and to avoid any audit issues with the state or local government, the sales tax collected should be looked at as a cost of sales and removed from sales income and put aside. For example:
Company A has sales income of $1100. Company A does business in Illinois and is required to assess a 10% tax on each sale. Of that $1100, $100 is the sales tax collected. As a result, Company A’s actual sales income is $1000, which can be used for the business. The $100 should be put aside to be sent to the state or local government.
Let’s break down this complicated issue and try to alleviate some of the confusion…
What is sales tax?
This is a tax that is imposed by a state and/or a local government that is paid by the purchaser for goods and, at times, services. As a business owner, you may be required to assess this tax on your products or services, collect it and then send it to the appropriate state or local government within a prescribed time determined by the appropriate authority.
Sales tax rates and laws will vary from state to state. This will often add to this tax dilemma, especially if you sell to customers in more than one state. On the other hand, there are some states that do not impose a general sales tax but may have localities within the state that do.
The state or locality that imposes this tax requirement will inform the business when to pay the collected taxes, be it monthly or quarterly. Each state will have a special tax return to report ALL sales, taxable sales, exempt sales and the amount of tax due. It would be a mistake to think that you would only report taxable sales. ALL sales should be reported because when you file your annual income tax returns, you will include ALL revenue. If the state or locality compares total revenue on the annual income tax return to the sales tax returns, and they detect a difference, that may trigger a state audit. To avoid any red flags, it is best to report ALL sales and use the proper sections on the sales tax return to show what is taxable sales and non-taxable sales.
For a business to collect sales tax, it may be required to obtain a sales tax permit. It is best to seek the advice of a tax professional when setting up your business to make sure that you have all the information you need to successfully operate your business without missing or ignoring the business’s tax obligations.
Who determines the sales tax rate?
The tax rate is determined by the state or local government where the business plans to operate. When the business goes through the registration process with the state or locality, the business owner will be informed of the tax rate. At times the business may have multiple tax rates depending on the products being sold.
Are there any business transactions that are exempt from sales tax?
Which goods or services are imposed this tax will vary from state to state, but in general a business will not be required to collect sales tax on resale items, raw materials and non-profits.
Resale items are basically items purchased at wholesale to be resold. Sales tax is not typically paid on these items because it is assumed that the consumer will pay the tax on the items when purchased from the retailer. Raw materials are materials a business uses to produce and sell a product. If your business sells these raw materials you will typically not be required to collect this tax. Lastly, sales to non-profit organizations are exempt from this tax requirement.
Most importantly, if a business is involved in any of the above-mentioned transactions, it is important to have or request a copy of the buyer’s tax-exempt or reseller certificate. You will always need documentation to prove why sales tax collection was not required.
What happens if you sell to consumers in different states?
This is where “sales tax nexus” comes into play. Nexus, also referred to as “sufficient physical presence,” is a legal term that refers to the requirement for companies doing business in a state to collect and pay sales tax in that state. This is a complicated, gray area of this tax law and is common for e-commerce and online business owners; however, other businesses may fall into this as well. This creates extra confusion because the business owner wonders which state rules to follow and whether, or not, a sales tax should be charged.
Nexus happens when a business has a connection to a state, be it by physical or economic presence. Physical presence can include having an office, employee, warehouse, affiliate or inventory warehousing in a state. Economic presence can create nexus in a state when a seller reaches a certain amount of sales, either through dollar amount or the number of sales transactions, to customers located in that state.
The subject of sales tax can be very overwhelming since business owners would rather focus on growing their business and increasing their profits, not wonder what taxes should be charged and paid. To help alleviate some of the stress that comes with handling the business’s tax requirements, seek the advice and assistance of a qualified tax professional.
It is of utmost importance to subtract the amount of sales tax collected from a consumer from the daily sales and put it aside. This is critical because it would be a major disappointment for a business owner, who includes the tax collected in his or her total revenue, to realize that he or she did not make as much money as first perceived. Creating the habit of separating the taxes collected from total sales will help the business owner realize their actual sales and avoid spending money that does not belong to the business in the first place.