Sales Tax Simplified: 3 Key Questions to Unravel Your Small Business Tax Obligations

Posted on January 31, 2024

Sales Tax – Those two words may have just given you anxiety. 

There are three critical components and questions to ask when it comes to sales tax.

  1. Do you have nexus?
  2. Is what you sell or provide taxable?
  3. How do you sell your product or service?

Getting your clients compliant with every state sales tax law is a complex task, but these three questions will give you a better picture of your client’s tax liability.

Getting compliant with every single state law can be complex but these questions will give you a much better idea of your tax liability. Lets dive into those questions!

What Is Sales Tax Nexus?

There are two important types of nexus to be concerned about: Physical Nexus and Economic Nexus.

Nexus Definition: The qualifying criteria for a seller to be required to collect and pay taxes on sales in a state.

  • Physical Nexus: locations, employees, contractors, inventory, etc.

    • Physical nexus is when your business has a physical presence in a particular state. Physical nexus enables states to tax the sales of businesses that do business in their state, even if they’re headquartered elsewhere.

    • In most cases, physical presence means an office or a retail location. But a warehouse, remote employee, payroll or even a contractor can all trigger physical nexus. You can also develop physical nexus through inventory that’s stocked in a marketplace fulfillment center.

  • Economic Nexus: Revenue and transactional thresholds set by the various states. Various states set revenue and transactional thresholds. If a company exceeds these thresholds, either through physical or online business, they are obliged to pay sales tax.

    • In 2018, the Supreme Court decision South Dakota v. Wayfair, Inc. established the concept of economic nexus. This gave states the right to force out-of-state sellers to collect and remit sales and use tax if they meet or exceed a state’s economic threshold. In the last several years, this has dramatically increased the taxability of businesses, making them liable in states where they don’t have a physical presence.

    • Every state has its own economic threshold. Some states apply the law retroactively. Some don’t. States can define their thresholds based on retail, gross, taxable or marketplace sales.

While this may appear straightforward, complexities arise when dealing with businesses that employ contractors, offer on-site services, or sell products online. It’s crucial to understand where and how you conduct business.

Is My Product or Service Subject to Sales Tax?

After you determine your “Nexus Footprint”, it’s important to understand the taxability of your products and services.

  • For some, it might be as simple as only selling tangible products that are taxable in every jurisdiction, but for some, it can be quite complex.
  • You may sell supplements, food, medical supplies, eyewear, clothing, or a number of other goods which may be taxed at a reduced rate, or not taxed at all.
  • Those selling tangible products and services will likely face a much more complex structure.
  • We recommend you reach out to a sales tax expert to do a study on your product or service to determine the taxability of it.

Each state has different taxability laws with specific categories exempted from sales tax. It’s vital to understand these nuances to avoid under or over-collection of sales tax from customers.

Also, it’s advantageous to ensure businesses aren’t unnecessarily paying sales tax on purchases.

How Do You Sell Your Product or Service?

This aspect is crucial in identifying a your tax obligation. If you sell via your own channels, you likely have responsibility for collecting and remitting state sales tax where you have nexus.

If you sell through a marketplace facilitator, the marketplace likely collects tax on all transactions. Major marketplaces collect tax according to the Marketplace Facilitator Laws in respective states. However, if you sell on smaller marketplaces, verifying tax collection is prudent.

If you sell to other businesses (like distributors, resellers, manufacturers), you might need to collect and maintain certificates (exemption/resale) instead of collecting tax on transactions.

When It Comes to Sales Tax, What Process Should I Follow?

Sales tax can be complex for some businesses, if you do not feel comfortable doing research on your own, hire a professional.

Follow These Steps:

  1. Conduct a Nexus Review
  2. Identify Your Taxability
  3. Get Registered and Address Unpaid Liability
  4. Collect & Remit Sales Tax Wherever You Have Nexus
  5. Create Your Audit Defense Plan

If you are looking for professional advice and help in this area we work directly with Peisner Johnson (Sales Tax Experts). Email us or submit a comment on our contact form and we can get an introduction out to you so you can have them take care of steps 1-5 and you can rest easy knowing you are all set!

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