The Anatomy of a Sales Tax Rate

July 11, 2016

As an online seller, sales tax rates anomalies can cause a huge headache when you’re trying to figure out how much sales tax to charge your customers! In this post, I’ll detail why sales tax rates in the U.S. vary so much and how you can solve the problem of which sales tax rate to charge your customers once and for all.

What is a Sales Tax Rate Made Of?
Sales tax is a small percentage of a transaction charged to a consumer by a merchant. Merchants remit sales tax back to states, counties, cities, and even “special taxing districts” where the money is used to fund public budget items like schools and roads. Merchants are required to collect sales tax in states where they have sales tax nexus. (Not sure what that is? You can read a whole lot more about sales tax for Magento sellers here.)

Forty-five U.S. states and Washington D.C. all have a sales tax. This statewide sales tax rate generally varies from 4-8%.

Example: Connecticut is an example of a state that only has a state sales tax rate. If you have sales tax nexus in Connecticut and make a sale to someone living in Connecticut, then you’d charge that person Connecticut’s 6.35% sales tax rate.

But unlike Connecticut, thirty-six of those states with a sales tax also allow local areas like counties and cities to have a sales tax.

Example: If you have sales tax nexus in Georgia and sell to a buyer in the 30303 zip code of Atlanta, you’d charge them the 4% Georgia rate, the 3% Fulton County rate and the 1% city of Atlanta rate for a total of 8% sales tax.

Some areas are even more complicated. They have a state sales tax rate, local rates and a special taxing district. Special taxing districts generally span over several localities, and the money collected is used to fund something that serves the entire district (like public transportation.)

Example: If you have sales tax nexus in New York and sell to a buyer in Mahopoc, you would charge the 4% New York state sales tax rate, the 4% Putnam County rate and a .0375% Metro Commuter Transportation District (MCTD) tax because Mahopac falls into one of these special taxing districts.

At last count, there are about 13,000 taxing jurisdictions in the U.S. As an online seller, you need to be prepared to charge your buyers the correct amount of sales tax in their location.

Why?

Origin-Based and Destination-Based Sales Tax, Explained
When it comes to making a sale and shipping it to a customer, some states are origin-based sales tax states and some are destination-based.

If you are based in an origin-based state, sales tax is fairly simple. You charge all of your buyers the sales tax rate at your business’s location.

Example: You live and run your online store in Irving, Texas where the sales tax rate is 8.25%. You would charge that 8.25% in sales tax to all of your customers in Texas, no matter the sales tax rate at your customers’ locations.

But in destination-based states, your life is a bit more difficult. For example, the point of sale is considered your buyer’s shipping address. So you are required to charge sales tax at the correct sales tax rate based on your buyer’s location. Remember, you must take your buyer’s state, county, city, and other special taxing district rates into account. With over 13,000 taxing jurisdictions in the U.S., this gets complicated.

To make matters worse, if you are not based in a state but have sales tax nexus there for some other reason (such as having an employee or third-party affiliate there), then you are required to charge sales tax based at the rate of your buyer’s ship to address. That’s even if the state is “origin-based” for in-state sellers.  You can read a whole lot more about origin-based and destination-based sales tax here.

To make a long story short, as an eCommerce seller, you are required to determine the sales tax rate at your buyer’s location when charging sales tax on nearly every sale.

Exactly WHAT is Taxable?
But wait. There’s more. Not every transaction is taxable in the same way. There are a couple more factors at play here.

Sale Tax on Shipping
If you charge your customers for shipping, you also need to determine whether or not your nexus state requires sellers to charge sales tax on shipping charges. Some states consider shipping to be part of the transaction, while others consider it separate and non-taxable. These rules are totally up to the states, so some states tax shipping and some don’t. Here’s a list of states that require merchants to collect sales tax on shipping charges.

Product Taxability
Some states and local areas also tax some items differently. For example, many states don’t require sales tax on grocery items. Others don’t consider textbooks taxable. Clothing is another category that can be taxed differently in different states. In New York, clothing items under $110 are exempt from state tax. But some local areas may still require tax charged on these items.

Example: A pair of pants less than $110 is exempt from the New York state sales tax rate of 4%. But some areas, like Mahopoc, require local tax on clothing. So if you sold a pair of $100 pants to a buyer in Mahopoc, you wouldn’t charge them the 4% New York state sales tax rate, but you would charge them the 4% Putnam County rate and the .0375% Metro Commuter Transportation District rate.

How to Make Magento Sales Tax Collection Simple
I know what you’re thinking.  With all these arcane rules, it sounds impossible to charge the right amount of sales tax to the right customers, but, luckily there are many great tax management extensions and services available for Magento 1.x and Magento 2 stores. Look for extensions that take all of these factors into account:

  • State, city, county and special taxing districts

  • Shipping taxability

  • Product taxability

  • Nexus in multiple states

  • International rates in the EU, Canada and Australia 

With the right technology in place, you can focus your energy on your brand and growing your business, and you’ll never have to think about origin vs. destination based sourcing rules, shipping taxability or which states tax clothing ever, ever again.

About TaxJar
A Magento PremierTechnology Partner, TaxJar makes sales tax calculation, reporting and filing simple for online sellers in more than 30 countries (and growing), and their extension is absolutely free for Magento merchants! TaxJar will also save you hours in filing by simplifying your sales tax returns for your Magento store, and you can connect a TaxJar account to other marketplaces (like Amazon or eBay) for automated multi-channel reporting and filing. Get started at TaxJar.com.

Find out more about TaxJar for Magento merchants and developers in our webinar, How to Charge the Right Amount of Sales Tax