How to Calculate Sales Tax for Your Small Business

As a business owner, it’s your responsibility to collect the correct amount of sales tax when selling goods or providing services to your customers. In addition, you should also remit the correct amount of sales tax to your state and local government agencies.

Understanding how sales tax works is the fundamental responsibility of a small business owner and since the sales tax rules are different for each state or local government, and it also depends on the type of goods and services you are offering to your customers, it’s important to learn how to calculate sales tax properly and accurately for your business, big or small.

What is Sales Tax?

A sales tax is a type of consumption tax imposed on the sale of goods and services by the state or local governments. As a seller, you are responsible for collecting the sales tax from your customers at the time of the sale and remitting it to the relevant state and local agencies. In simpler terms, a sales tax is a pass-through tax, which is collected from the customers and forwarded to the government. The sales tax is not included in the seller’s revenue.

The sales tax percentage varies depending on the location of your business and the type of goods or services being sold. The rate of sales tax is typically expressed as a percentage of the purchase price and is set by the state or local government. It is important to note that sales tax rates can change over time, so it is crucial to keep yourself up-to-date with any changes that may impact your business.

When Are You Liable To Collect Sales Tax?

Your business may be liable for sales tax in a particular jurisdiction if you have a physical presence, employees, or affiliates there, according to the laws of that jurisdiction. This is commonly known as having “nexus” in that jurisdiction. Nexus can be established through a physical location, such as a brick-and-mortar store or warehouse, or through other means, such as having employees or affiliates who conduct business in that jurisdiction.

Why Sales Tax Is Collected?

The collected sales taxes are used to support various government functions at the local, county, and state levels. These funds are used to pay for public services such as roads, schools, law enforcement, and healthcare. Failing to collect and remit sales tax can result in penalties and interest charges, so it is important for any business owner to understand sales tax obligations and comply with them accordingly.

How Sales Tax Calculation Works?

In the United States, sales tax is typically collected by three levels of government: the state, the county, and the local government. Each level is permitted to set its own sales tax rate, which can be added to the base rate set by the state. For instance, if the state sets a base rate of 4.00%, the county may add an additional 1.25% and the local government might add another 0.75%, bringing the total sales tax rate to 6%.

If you are a seller, it is your responsibility to calculate and collect the correct amount of sales tax from your customers based on the applicable tax rates. Additionally, you must remit the collected sales tax to the appropriate tax agencies. This requires accurately dividing the total tax collected and allocating the correct portion to each level of government.

How to Calculate Sales Tax?

When it comes to sales tax calculation, it’s important to know the rates imposed by your state, county, and city. To calculate the total sales tax rate for a specific location, you must add all of the rates together. For instance, if you want to find the sales tax rate for Fort Collins, Colorado, you would need to know that the state sales tax rate for Colorado is 2.9%, the county sales tax rate for Larimer County is 0.80%, and the city sales tax rate for Fort Collins is 4.35% as of 2024.

By adding all these rates together, you can determine that the total sales tax rate for Fort Collins, Colorado is 8.05%.

Sales Tax Formula

To accurately calculate the sales tax on your goods or services, follow these steps:

STEP 1:

Add up all the applicable sales tax rates for your location. This includes state, county, and city sales taxes. For your understanding, we will calculate the sales tax for Fort Collins, Colorado.

Sales Tax = State Sales Tax + County Sales Tax + City Sales Tax
Sales Tax = 2.9% + 0.80% + 4.35% = 8.05%

STEP 2:

Convert the total sales tax rate into decimal form. To do this, simply divide the percentage by 100.
8.05/100 becomes .0805 in decimal form

STEP 3:

Use the sales tax formula to calculate how much sales tax you need to charge your customers. Multiply the product or service cost by the sales tax rate (in decimal form) to get the total sales tax amount.

Total Sales Tax: Goods or Service Cost x Sales Tax (in decimal form)
Total Sales Tax: $75 (Goods/Service Cost) x .0805 (Sales Tax) = $6.0375

STEP 4:

Add the total sales tax to the original cost of your goods or services to get the total cost.
Total cost of your product/service = $75 (Original Goods/Service Cost) + $6.0375 (Sales Tax) = $81.0375

It’s important to accurately calculate and collect sales tax to avoid potential legal and financial consequences. Make sure to regularly check for any changes in sales tax rates for your location to ensure you are always charging the correct amount.

To ensure accurate and efficient sales tax calculation, we highly recommend utilizing the best accounting software available for your small business needs.

When Do You NOT Need To Collect Sales Tax?

As a business owner, it’s important to know when you are required to collect sales tax and when you are exempt. Here are some situations when you don’t need to collect sales tax:

State Exemptions:

If you’re operating in Alaska, Delaware, Montana, New Hampshire, or Oregon, you’re in luck! These states do not impose any state taxes on the sale of goods or services. However, please be aware that local jurisdictions may still require you to collect and remit county or local taxes.

Exempted Goods and Services

Some goods or services may be exempt from sales tax based on state, county, or local government regulations. For example, in some states, groceries or prescription drugs may be exempt from sales tax.

Sales to Resellers

If you sell goods or services to resellers; you don’t need to collect sales tax from them if they have a valid resale certificate. Resellers are responsible for collecting and remitting the taxes on their own when they sell your goods or services to their customers.

Tax-Free Days

Several states have designated tax-free days during the year, typically around the back-to-school or holiday season. On these days, certain products may be exempt from sales tax. As a seller, you need to ensure that you don’t collect sales tax on these days.

Remember, sales tax regulations can vary greatly by state and local jurisdictions, so it’s important to know how to calculate sales tax accurately and stay up-to-date on any tax changes or exemptions that may apply to your business. Be sure to check with your state tax office or consult with a tax professional to learn about sales tax exemptions.