Sales Tax

What is a 'Sales Tax'

A sales tax is a consumption tax imposed by the government on the sale of goods and services. A conventional sales tax is levied at the point of sale, collected by the retailer and passed on to the government. A business is liable for sales taxes in a given jurisdiction if it has a nexus there, which can be a brick-and-mortar location, an employee, an affiliate, or some other presence, depending on the laws in that jurisdiction. 

BREAKING DOWN 'Sales Tax'

Conventional or retail sales taxes are only charged to the end user of a good or service. Because the majority of goods in modern economies pass through a number of stages of manufacturing, often handled by different entities, a significant amount of documentation is necessary to prove who is ultimately liable for sales tax. For example, say a sheep farmer sells wool to a company that manufactures yarn. In order to avoid paying the sales tax, the yarn maker must obtain a resale certificate from the government saying that it is not the end user. The yarn maker then sells its product on to a garment maker, which must also obtain a resale certificate. Finally, the garment maker sells fuzzy socks to a retail store, which will charge the customer sales tax along with the price of said socks.

Different jurisdictions charge different sales taxes, which often overlap, as when states, counties and municipalities each levy their own sales taxes. Sales taxes are closely related to use taxes, which governments charge residents who have purchased items from outside their jurisdiction. These are generally set at the same rate as sales taxes, but are difficult to enforce, meaning they are in practice only applied to large purchases of tangible goods. An example would be a Georgia resident who purchases a car in Florida; she would be required to pay the local sales tax, as though she had bought it at home.

Nexus

Whether a business owes sales taxes to a particular government depends on the way that government defines nexus. A nexus is generally defined as a physical presence, but this "presence" is not limited to having an office or a warehouse; having an employee in a state can constitute a nexus, as can having an affiliate, such as a partner website that directs traffic to your business' page in exchange for a share of profits. This scenario is an example of the tensions between e-commerce and sales taxes. For example, New York and other states have passed "Amazon laws" requiring internet retailers such as Amazon.com Inc. (AMZN) to pay sales taxes despite their lack of physical presence in the state.

Excise Taxes

In general, sales taxes take a percentage of the price of goods sold. For example, a state might have a 4% sales tax, a county 2% and a city 1.5%, so that residents of that city pay 7.5% total. Often, however, certain items are exempt, such as food, or exempt below a certain threshold, such as clothing purchases of less than $200. At the same time, some products carry special taxes, known as excise taxes. "Sin taxes" are a form of excise tax, such as the $4.35 New York State charges per pack of cigarettes.

Value-Added Tax

The U.S. is one of the only rich countries where conventional sales taxes are still used (note that, with limited exceptions, it is not the federal government that charges sales taxes, but the states). In most of the developed world, value-added tax (VAT) schemes have been adopted. These charge a percentage of the value added at every level of production of a good. In the fuzzy sock example above, the yarn maker would pay a percentage of the difference between what they charge for yarn and what they pay for wool; similarly, the garment maker would pay the same percentage on the difference between what they charge for socks and what they pay for yarn. Put differently, this is a tax on company's gross margins, rather than just the end user.

RELATED TERMS
  1. Use Tax

    A sales tax on purchases made outside one’s state of residence ...
  2. Consumption Tax

    A tax on the purchase of a good or service. Consumption taxes ...
  3. Tax Rate

    The percentage at which an individual or corporation is taxed. ...
  4. Net Of Tax

    An accounting figure that has been adjusted for the effects of ...
  5. Indirect Tax

    A tax that increases the price of a good so that consumers are ...
  6. Excise Tax

    1. An indirect tax charged on the sale of a particular good. ...
Related Articles
  1. Taxes

    Internet Sales Tax Vs. Brick & Mortar Sales Tax

    Learn about the differences between sales taxes and Internet sales taxes, and the goods and services that typically incur each type of tax.
  2. Taxes

    U.S. Sales Tax Rates Hit Record High

    Shopping blues: Top tax 12%. Chicago's 10.25% highest big-city rate. More Internet tax fights loom.
  3. Taxes

    How Much Tax Do You Really Pay?

    When you add direct and indirect taxes together, your real tax rate is much more than you expected.
  4. Taxes

    Do Tax Cuts Stimulate The Economy?

    Learn the logic behind the belief that reducing government income benefits everyone.
  5. Economics

    The Court Cases That Have Shaped US Sales Tax Law: How They Apply Today

    Explore two Supreme Court cases that established legal precedent for the treatment and apportionment of sales taxes at the state level.
  6. Taxes

    5 Most Taxing Taxes for Americans

    There’s not much that unites Americans like their hatred of taxes. Here's a list of taxes we dislike the most.
  7. Taxes

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  8. Economics

    Calculating Net of Tax

    Net of tax is a figure that has been adjusted for taxes.
  9. Taxes

    Understanding Excise Taxes

    An excise tax is an indirect levy charged for the sale or use of a particular item.
  10. Taxes

    What's an Indirect Tax?

    An indirect tax is levied on goods or services rather than on an individual or a company.
RELATED FAQS
  1. Does location matter for taxes when calculating gross sales?

    Learn more about gross sales taxes and how merchants are impacted by them. Find out if different business locations are impacted ... Read Answer >>
  2. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
  3. What are the differences between regressive, proportional and progressive taxes?

    Understand the differences between the most common tax systems including regressive taxes, proportional taxes and progressive ... Read Answer >>
  4. What is the difference between a regressive tax versus a progressive tax?

    Determine how progressive and regressive taxes impact your personal finances, and learn more about how you pay both types ... Read Answer >>
  5. What's the difference between the marginal tax rate system and a flat tax?

    Find out about the difference between marginal tax rates and flat taxes. Gain insights on both systems and the arguments ... Read Answer >>
  6. Who first came up with the idea of a progressive tax?

    Learn how the progressive income tax system developed in the United States and became the federal government's primary revenue ... Read Answer >>
Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center