A Quick Guide to US Sales Tax

Expanding your business across borders can be an exciting opportunity, especially when it comes to tapping into the vast consumer market of the United States. However, for foreign businesses venturing into the US market, it's essential to understand and comply with the complex system of sales tax regulations. Navigating the intricacies of US sales tax can seem daunting at first, but with the right knowledge, you can ensure compliance and avoid potential pitfalls. Here's our quick guide to US sales tax to get you started.

Key takeaways

• US sales tax varies by state and locality, with different rules, rates, and registration requirements depending on where your customers are.
  
• Economic nexus laws mean you may owe tax even without physical presence, especially if you sell online and meet certain thresholds in a state.
  
• Staying compliant requires accurate registration, timely filing, and up-to-date tracking, often best handled with sales tax automation tools.

What is sales tax?

Sales tax is a consumption tax imposed on the sale of goods and services at the state and local levels in the United States. Unlike Value Added Tax (VAT), which is also a consumption tax, US sales tax is typically not included in the displayed price and is added at the point of sale.

Widely used outside the United States, VAT operates quite differently from the US sales tax system. While US sales tax is typically imposed only on the final sale of goods and services to the end consumer, VAT is assessed at each stage of production and distribution. This means that every business in the supply chain pays tax on the value they add to the product or service, and can usually claim a credit for the VAT paid on their own purchases.

For example, in the European Union, VAT rates range from 15% to 27% and are applied to most goods and services at every step, from manufacturer to retailer. In contrast, US sales tax rates generally range from 0% to 10%, and the tax is only imposed once, at the point of sale to the final consumer. This fundamental difference means that VAT is collected incrementally throughout the supply chain, while US sales tax is collected in a single transaction. 

For businesses operating internationally, understanding these differences is essential for compliance, pricing strategies, and managing tax obligations across different jurisdictions. Recognizing how value added tax and US sales tax are imposed can help businesses avoid costly mistakes and ensure they are meeting all relevant tax requirements.

State sales tax

Most states in the US impose a statewide sales tax, making it a common revenue source. Each state in the US has the authority to set its own sales tax rates and regulations. State sales tax rates range from zero to nearly 8%, depending on the state. For example, the five states—Alaska, Delaware, Montana, New Hampshire, and Oregon—do not impose a statewide sales tax. However, in states like California, Indiana, and Rhode Island, state sales tax rates currently exceed 7%. Washington has one of the highest combined state and local sales tax rates in the country. In comparison, Colorado has a relatively low state sales tax rate of 2.9%.

Local sales tax

In addition to state sales tax, many local jurisdictions, such as counties, cities, and districts, may impose their own sales tax. These local sales taxes are added to the state sales tax, resulting in the total sales tax rate for a particular area. In some jurisdictions, both state and local sales taxes are applied at the same rate to all taxable transactions, ensuring consistency in tax application. It’s essential to be aware of both state and local tax rates to accurately calculate the sales tax owed, as combined they can reach over 10%.

Economic nexus

The term ‘economic nexus' refers to the connection a business has with a particular state that requires it to collect and remit sales tax. If a business has a physical presence, such as a brick-and-mortar store, office, or warehouse, in a state, it's generally required to collect sales tax from customers in that state. However, in recent years, due to the growth of e-commerce, economic nexus rules have become more complex, and businesses may have economic nexus in a state even without a physical presence.

Sales tax and online sales

Because of this rise in e-commerce, online sales tax has become much more relevant for businesses. In 2018, the US Supreme Court ruling in South Dakota v. Wayfair expanded the ability of states to collect sales tax from online retailers, even if they don't have a physical presence in that state. As a result, many states have implemented economic nexus laws, requiring online sellers to collect and remit sales tax if they meet certain thresholds in terms of sales volume or number of transactions.

Registering for sales tax

To comply with US sales tax requirements, foreign businesses need to register for sales tax permits in each state where they have economic nexus. This involves submitting an application, providing necessary business information, and obtaining a unique tax registration number. Once the application is approved, taxpayers receive notification and can begin filing and paying sales tax according to the state's requirements. 

Taxpayers are responsible for ensuring their registration is complete and up to date in each relevant state. It’s crucial to research and understand the US sales tax registration process and the specific requirements of each state, as they can vary.

Determining taxable goods and services

In the US, the taxability of items can vary from state to state. While some states have a broad range of taxable items, others may exempt certain goods or services from sales tax, such as groceries, prescription medications, or medical devices.

It’s also worth noting that not all US states that have a sales tax apply it to digital services. The taxability of digital services—including things like streaming subscriptions, SaaS, downloadable content, and cloud storage—varies significantly by state.

It’s essential to consult each state’s Department of Revenue or seek the advice of a tax professional to determine if your specific products or services are liable for US sales tax.

US sales tax collection and filing

Businesses are responsible for collecting sales tax from customers at the point of sale and remitting it to the appropriate tax authorities. Depending on the state, sales tax returns may need to be filed monthly, quarterly, or annually. It’s important for businesses to maintain accurate records of sales and track US sales tax collected to simplify the reporting process. Late or incorrect filings can result in penalties and interest charges, so it’s vital to stay organized and meet the filing deadlines. For this reason, it’s recommended to use automated sales tax software to ensure your data and calculations are accurate.

Conclusion

Expanding your business into the United States can be a rewarding venture, but it requires a solid understanding of US sales tax regulations. By grasping the fundamental concepts, such as economic nexus, taxability rules, registration, and filing requirements, e-commerce businesses can navigate the challenging landscape of US sales tax compliance.

To find out more about how our automated sales tax software can help your e-commerce business succeed in the US, head over to the LumaTax website. Alternatively, you can book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.

Frequently Asked Questions

Do I need to register for US sales tax if I don’t have a physical presence in the US?

Yes. Under economic nexus rules, you may be required to register if your sales exceed certain thresholds in a state, even without a physical presence.

How do I know which states I need to register in?

You’ll need to track your sales volume and/or transaction count in each state. If you meet or exceed a state’s economic nexus threshold, you must register there.

Are all products and services subject to sales tax in the US?

No. Taxability varies by state. Some items—like groceries, medications, or digital goods—may be exempt or taxed at a reduced rate in certain jurisdictions.

How often do I need to file sales tax returns?

Filing frequency depends on the state and your sales volume. It can be monthly, quarterly, or annually.

What’s the difference between VAT and US sales tax?

VAT is collected at every stage of the supply chain and allows input tax credits. US sales tax is only charged at the final point of sale to the end consumer.

Can I automate US sales tax compliance?

Yes. Many businesses use sales tax software to track nexus, calculate tax, manage exemptions, and file returns accurately across multiple states.