The cost a customer pays when purchasing goods or services from a business includes both the company's sales price and the cost of applicable sales taxes. Businesses and their employees need to know what sales tax is, why they must collect it and how to calculate the correct sales tax amount on each purchase.
Thoroughly understanding this information helps ensure they comply with their state and local sales tax rules and regulations. In this article, we discuss how sales tax is calculated, what it is and answer other frequently asked questions employees have about sales tax.
What is sales tax?
Sales tax is an amount that state and local governments charge consumers for the purchase of certain goods and services. Each individual state and local government establishes their sales tax rate, with typical rates ranging between 4% and 8% of the taxable product's sales price. Sales tax is a pass-through tax because businesses do not contribute to the sales tax cost, and they do not keep any money they collect from charging it. Instead, they add the sales tax amount to the customer's total sales price and then pass the sales tax on to their state or local governments.
Why is sales tax collected?
Businesses collect sales tax when their customers purchase taxable goods or services because their state and local governments require them to do so. These governments then use the money they receive from the sales tax to fund public schools, emergency services, healthcare, road construction and maintenance and public transportation.
Being informed about state and local sales tax rules helps businesses ensure they charge customers the right amount and makes it easier for employees to explain why their company collects sales tax to customers who may not understand it.
Related: How To Become a Tax Preparer
What items have sales tax?
Most products available for purchase in a retail setting are taxable goods. Certain services, such as utility and phone services, are also taxable. However, every state recognizes there are certain items every consumer must buy to survive. In many states, products such as food and prescription medications are exempt from sales tax. In some states, clothing is also tax-exempt. States that don't exempt these products from sales tax may offer a reduced sales tax rate for certain items.
Do all states have sales tax?
While most states have a sales tax, some states do not. These states are Alaska, Delaware, Montana, New Hampshire and Oregon. Businesses operating in these states only add sales tax to their customers' purchases if they need to collect it for the city or county. Hawaii and New Mexico also don't have a state sales tax, but they have general excise and gross receipts taxes similar to sales tax.
What are sales tax holidays?
Sales tax holidays are short-term periods in which consumers are exempt from paying sales taxes. These holidays usually exist to provide additional savings that encourage consumers to make purchases for back-to-school shopping or hurricane preparedness during a specific time. The length of a sales tax holiday also varies, but it is often a day, weekend or one week.
Not every state has a sales tax holiday. States that have a sales tax holiday usually identify specific items and a maximum sales price for each item that qualifies for the sales tax exemption.
Are resellers exempt from sales tax?
Since the end-user of a taxable good or service pays the sales tax, people who purchase goods and intend to resell the product to the end-user are exempt from paying the sales tax. The reseller usually needs a resale certificate that proves their exemption to the businesses they are purchasing the goods from. The reseller then becomes responsible for collecting the sales tax from the end-user with the final sale of the product and passing it on to their state and local government.
How does a business calculate sales tax?
Businesses use the following steps to calculate the amount of sales tax a customer owes. They:
- Gather local sales tax rate information.
- Calculate the combined sales tax rate.
- Determine which goods or services are taxable.
- Find the total sales price for taxable goods and services.
- Use the sales tax formula to find the sales tax amount and the final sales price the customer owes.
1. Gather local sales tax rate information
Since sales tax rates vary by location, some areas have a rate that is a combination of city, county and state sales taxes, while other areas have only a state sales tax. In areas that don't have a state sales tax, cities and counties within the state may or may not have one.
Begin by determining whether or not there is a state sales tax in the state your business is in. If so, determine what the state sales tax rate is. This is known as the base tax rate. Then, determine whether or not the city or county has a sales tax rate and what the rate is.
2. Calculate the combined sales tax rate
The combined sales tax rate is a single figure that represents an area's total sales taxes, which includes city, county and state sales taxes. Businesses calculate the combined sales tax rate by adding these individual sales tax rates together. Businesses with two or more locations need to calculate the combined sales tax rate for each area they do business in to ensure they collect the correct amount of sales tax from consumers at each location.
For example: The city of Tampa is in Hillsborough County in the state of Florida. Florida's base sales tax rate is 6%, and Hillsborough County has a sales tax rate of 2.5%. When you add these sales tax rates together, the combined sales tax rate in Tampa, Florida is 8.5%. But counties surrounding Hillsborough—Pinellas County, Pasco County and Polk County—each have a sales tax rate of 1%, making the combined sales tax rate in these areas 7%.
3. Determine which goods or services are taxable
Categorize your business's goods or services based on which are taxable and which ones are tax-exempt. To do this accurately, you need to know the sales tax rules for each city, county and state your business has a location in and when each rule applies.
Remember to check whether the areas your business is in have specific items that are tax-exempt such as food, clothing or prescription medications. Make sure you also know when sales tax holidays occur, what items are tax-exempt during these holidays and what rules apply for qualifying an item as tax-exempt at these times.
4. Find the total sales price for taxable goods and services
When you calculate the sales tax amount for a single taxable item, the total sales price is the price listed on the product. When you calculate the amount of sales tax a customer owes for the purchase of several goods or services, add the listed sales price of each taxable item together to find the total taxable sales price.
Remember to keep non-taxable items out of this calculation and calculate their total sales price separately. Completing this step before you calculate the sales tax amount simplifies the number of calculations you need to make.
5. Use the sales tax formula to find the sales tax amount and the final sales amount the customer owes
Once you know the combined sales tax rate for the area your business is in and the total taxable sales price for the customer's purchase, you can calculate the amount of sales tax the customer owes. The sales tax formula is:
[Total taxable sales price] x [Sales tax rate in decimal form] = Sales tax amount
After you find the sales tax amount, add it to the total taxable and non-taxable sales price to calculate the final sales amount. Be sure to add the total non-taxable sales price back in at this point. The final sales amount formula is:
[Total taxable sales price] + [Sales tax amount] + [Total non-taxable sales price] = Final sales amount
The resulting sum is the total amount the customer owes your business for their purchase.
Sales tax calculation examples
The following sales tax calculation examples show how to use city, county and state tax rates and rules to calculate the total amount a customer owes for the purchase of specific goods and services in various scenarios.
Calculating sales tax for the combined purchase of taxable and non-taxable items
This example shows how to calculate the sales tax amount and the total amount a customer owes for the purchase of various items from a supermarket. Some of the items the customer is purchasing are taxable, while other items are non-taxable. The customer is purchasing food, toiletries, school supplies, clothing and electronics. The following list shows the supermarket's total sales price for each of these categories:
- Food: $205.00
- Toiletries: $28.87
- School supplies: $22.98
- Clothing: $46.01
- Electronics: $70.07
The supermarket is in Tampa, Florida. The cashier knows the state sales tax rate is 6% and the sales tax rate in Hillsborough County is 2.5%. They also know the food items the customer is purchasing are all tax-exempt. The cashier uses this information to make the following calculations:
- *Sales price for non-taxable goods: $205.00*
- *Sales price for taxable goods: $167.93 ($28.87 + $22.98 + $46.01 + $70.07 = $167.93)*
- *Sales tax amount: $14.27 ($167.93 x .085 = 14.27405)*
- *Total amount the customer owes: $387.20 ($205.00 + $167.93 + $14.27 = $387.20)*
Calculating sales tax during a tax holiday
This example shows how to calculate the sales tax amount and the total amount a customer owes for purchases made during a sales tax holiday. Some of the customer's items are taxable because they do not qualify for the sales tax exception, while other items are non-taxable because of the exception. The customer is purchasing new clothes, shoes, a backpack and school supplies, tissues and cleaning wipes, a laptop and makeup. The following list shows the store's total sales amount for each of these categories:
- Clothes: $155.95
- Shoes: $85.00
- Backpack: $20.00
- School supplies: $75.00
- Tissues and cleaning wipes: $12.26
- Laptop: $400.00
- Makeup: $35.00
The store is in Nashville, Tennessee. The cashier knows the state sales tax rate is 7% and Davidson County's sale tax rate is 2.25%. They also know that clothing, shoes and school supplies that cost $100 or less per item and computers that cost less than $1,500 are tax-free during the sales tax holiday. The cashier uses this information to make the following calculations:
- *Sales price for tax-exempt goods: $735.95 ($155.95 + $85.00 + $20.00 + $75.00 + $400 = $735.95)*
- *Sales price for taxable good: $47.26 ($12.26 + $35.00 = $47.26)*
- *Sales tax amount: $4.37 ($47.26 x .0925 = 4.37155)*
- *Total amount the customer owes: $787.58 ($735.95 + $47.26 + $4.37 = $787.58)*