Sales Tax

DEFINITION of '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.

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