How Charging Sales Tax Works

In brief: 

• US sales tax rates are made up of a combination of state, county, city and other special taxing district rates
• Because of this, the US has more than 11,000 tax jurisdictions 
• Collecting the correct sales tax rate is complicated for e-commerce sellers because you are required to calculate and collect the correct sales tax rate for your buyer’s ship-to address 
• Some states require e-commerce sellers to collect sales tax on shipping charges
• Some products (such as groceries, clothing and medication) are non-taxable in some jurisdictions, or subject to special lower sales tax rates

US sales tax is a consumption tax made up of a percentage of a sale applied to the sale of a product (and sometimes a service.) Sales tax is charged to buyers by a retailer and remitted by that retailer to the state. 

For example, if you buy an iPhone in Seattle for $999, you’ll pay 8.8% of the purchase price in sales tax. If you purchased the same gadget in Savannah, Georgia you’d pay 7% in sales tax. And some combined sales tax rates make for complicated numbers. For example, but you’d pay a precise 8.125% in sales tax if you buy your phone in Beacon, New York.

The amount of sales tax you’ll pay changes from location to location because, in the United States, sales tax is governed at the state level. 

How Sales Tax Rates Work

Forty-six states and the District of Columbia all have some form of sales tax on purchases. 

Each state sets a statewide sales tax rate. This rate is generally between 4% and 7.25%. On top of that, counties, cities and other special taxing districts are allowed to set their own rates. These jurisdictions use the sales tax they collect on purchases to pay for budget items. 

For example, a state may allocate sales tax funds to support roads. A county or city may use the sales tax collected on their behalf to pay for the local school system. And a consortium of cities and/or counties may band together to create a special taxing district.

One example of this is New York’s metropolitan commuter transportation district (MCTD). A portion of sales tax collected on purchases in the MCTD goes to fund mass transit in New York city and surrounding areas. 

The fact that states, counties, cities and special taxing districts all levy a sales tax is why the sales tax you see on your receipt at the store sometimes shows a complicated number like 8.515%. 

These combinations also mean that there are more than 11,000 tax jurisdictions in the US alone.

As if that weren’t confusing enough, rates are also subject to change. States sometimes raise or lower the statewide sales tax rate, and counties, cities and other local areas sometimes pass new sales taxes. 

E-Commerce Retailers: How to Charge Sales Tax

As a retailer, it’s important to note that sales tax is levied as the sales tax rate where the sale takes place. For brick and mortar retailers, this process is fairly simple. Charge sales tax at the total combined sales tax rate where your store is located. 

But if you sell online, sales tax calculation becomes more complicated. With e-commerce sales, the buyer’s ship-to address is considered the point of sale. So while brick and mortar retailers can generally charge just one combined sales tax rate per location to all of their customers, online retailers are required to calculate sales tax rates wherever their buyer is located. (Granted that the online retailer has sales tax nexus in the buyer's state.)

An online retailer located in Marathon, Texas who has nexus in twelve states may need to be able to accurately calculate the correct combined total sales tax rates for a buyer in the rural Upper Peninsula of Michigan and in crowded New York city, where the sales tax rate can change between two blocks. 

Longmont, Colorado Combined Sales Tax Example

Let’s say you sell a product through your online store to a customer in Longmont, Colorado. This is a breakdown of the sales tax you’d be required to charge your customer: 

Sales Tax Jurisdiction	Sales Tax Type	Sales Tax Rate
Colorado (state)	State	2.9%
Boulder (county)	County	.985%
Longmont (city)	City	3.53%
Greater Denver Regional Transportation District	Special taxing district	1%
Scientific and Cultural Facilities District (SCFD)	Special taxing district	.1%
Longmont, CO Total Combined Sales Tax Rate	8.52%

Determining Sales Tax Jurisdictions

One of the trickiest aspects of collecting sales tax as an e-commerce seller is determining the sales tax rate at the buyer’s location. Sales tax jurisdiction boundaries are often not the same as city boundaries or county lines. In fact, two buyers who live on opposite ends of the exact same street with the exact same zip code+4 can fall into two different taxing jurisdictions and be required to pay two different sales tax rates!

That’s why it’s vital that your e-commerce business’s sales tax engine be able to determine sales tax rates at the rooftop level. 

Shipping Taxability

Some states also consider shipping charges taxable. For example, if you charge your customer $2.99 in shipping, states with taxable shipping will require you to charge sales tax on the products and the shipping charge. Other states do not consider shipping a taxable part of a retail sale.

Charging sales tax on shipping can get complicated when some items in a parcel are taxable and some are not.

Read more about sales tax on shipping charges here.

Product Taxability: Some Product Types are Taxed Differently

Most tangible personal property (and some services and digital goods) are taxed at the combined sales tax rate. 

But, there are exceptions. Just as states and local areas set their own sales tax rates, they can also decide which products are and are not taxable. 

For example, many states don’t tax grocery items, since these products are considered a necessity. Other states tax these items, but at a lower rate. For example, Illinois’ state-level sales tax rate for most products is 6.25%. But for grocery items, this rate is reduced to just 1%.

In yet other states, a state might decide that an item is tax exempt, but still allow local areas to tax that item. 

For example, groceries are tax exempt in Georgia, but they allow counties and cities to decide on their own sales tax on these items. So while groceries are considered non-taxable at the 4% Georgia state rate, counties are allowed to charge sales tax. If you sell a grocery product to a customer in Cherokee County, Georgia, you would only charge the 2% county sales tax rate on that item.

You’ll often find that necessities like food, clothing, and medication are not taxed or taxed at a lower rate. But states can also use sales tax to emphasize political priorities. For example, some states that do not tax groceries tax sweets like candy and soda in an effort to encourage healthy choices. 

Another type of product that is often taxed differently are digital goods, like books and ebooks, films, music and video games. Some states define these products as “tangible personal property” (even though you can’t literally touch them) and consider them subject to the same tax as their physical counterparts. Other states consider these items nontaxable. 

Sales tax exemptions are up to the individual states and local areas, and are also subject to change depending on state rules and regulations.

Sales Tax Holidays

Some states have periodic sales tax holidays. These are a period of a few days when states declare certain items sales tax free. 

Sales tax holidays are often designed to encourage consumers to make certain purchases. For example, many states have “Back to School,” “Disaster Preparedness” and “Energy Efficiency” sales tax holidays. 

For retailers, some states (and local areas) require vendor participation in sales tax holidays while others allow vendors to opt-in.  This means you’re required to understand when sales tax holidays occur in your sales tax nexus states and if any of the products you sell are subject to the holiday. From there, you’ll want to ensure that your sales tax collection engine supports the sales tax holiday. 

Read our comprehensive sales tax holidays overview here.

Common Questions about Charging Sales Tax

How do you calculate sales tax?

1. Determine the sales tax rate at the point of sale
2. Multiply the price of the item by the sales tax rate. That’s the amount in sales tax the buyer would pay.
3. Add the result from #2 to the price of the item to get the total amount of the sale

Sales tax calculation example:

You sell an item for $100 and the sales tax rate at the point of sale is 5%.

$100 x .05 = $5.00.

The total sales tax rate on the purchase is $5.00.

$100 + $5.00 = $105.00.

The transaction total is $105.00.

Are used goods subject to sales tax? 

Yes. If a product is taxable in the jurisdiction, then a retailer is still required to charge sales tax on it even if selling used or secondhand. Sales tax is a tax on the sale itself, and not the item. 

Why does sales tax vary from state to state? 

US states, counties, cities and other special taxing jurisdictions are all allowed to create their own sales tax rates. There is no uniform federal United States sales tax rate. 

Is sales tax state or local?

Sales tax can be both state and local. 

Forty-six US states and the District of Columbia all have a sales tax. Some of those states, like Kentucky, only have one statewide sales tax rate. Most states allow local areas to also require their own sales tax. 

This is why in some states retailers are required to collect a sales tax rate consisting of a state rate plus some combination of county, city and/or other special taxing district rates. 

What if I collect too much sales tax from a customer? 

If you collect too much sales tax from a customer you must either refund the excess amount to the customer or remit the excess amount to the state’s taxing authority. Whatever you do, don’t keep any excess sales tax collected! Knowingly collecting excess sales tax and pocketing it is one of the few ways a business owner can get in criminal trouble over sales tax. 

What happens if a buyer refuses to pay sales tax?

Collecting sales tax or its equivalent is part of a seller’s legal obligation to do business in a state. If a buyer refuses to pay, a seller can simply refuse the sale. Alternatively, the seller is allowed to pay the sales tax on the buyer’s behalf, but this is not recommended as a business practice since it cuts into the seller’s profit margin.

Do I charge sales tax at my state’s rate or the rate where the buyer is located?

Sales tax is charged at the point of sale. In most cases, this means the buyer’s ship-to address. There are exceptions, including intrastate sales in origin-based sales tax states. We cover that in more detail in our Origin-Based and Destination-Based Sales Tax article.

There is never an instance where you would charge another state’s sales tax rate to an out-of-state buyer. For example, say you live in Connecticut where the statewide sales tax rate is 6.35%. You’d never charge your state’s 6.35% sales tax rate to a buyer in Kansas. For that interstate transaction, you’d charge sales tax at the buyer’s ship-to address in Kansas. (This is, of course, assuming you have sales tax nexus and are required to collect sales tax from Kansas buyers.)

My customer’s billing address is different from their shipping address. Which sales tax rate do I charge? 

Sales tax is charged at the point of sale, and in e-commerce, this generally means the buyer’s ship to location. 

For example, your buyer’s billing address is in California but they are sending a birthday gift to their grandma who is in Louisiana. In this case, you would charge sales tax at the rate of the ship-to address in Louisiana.

And if you don’t have sales tax nexus in Louisiana, then good news. You are not required to collect sales tax on this purchase. (Though the recipient is technically required to pay use tax on the item.)