What Is a Sales Tax? How to Calculate?

Sales tax sounds simple: a customer buys something for $20, several cents are added, and the state gets its share. If your business operates in one street and one state, there is no issue. But the moment you expand and operate in more than one channel or have employees in different states, this seemingly simple concept will haunt you and bite hard.

The root cause of the problem is that the US does not have a federal sales tax. However, 45 states and the District of Columbia have their own tax, and thousands of jurisdictions add their rules on top of them.

Each state decides which goods and services are taxed, who is exempt, how and when tax must be collected and reported, and what the thresholds are for out-of-state sellers.

Failure to collect sales tax correctly, as simple as it may seem, has two major consequences for businesses: extra administrative workload and lost revenue.

In addition, unlike income tax, if you make a mistake, the state will be under no obligation to return any overpaid taxes. On the contrary, you may expect a fine and a tax audit. Thus, knowledge of sales tax rules and jurisdictions is essential to avoid additional costs and protect the company’s reputation.

Expert Perspective

This guide covers how sales tax is calculated, how rates vary, when your business has nexus, how sales tax differs from VAT, excise tax, and use tax, and which items are commonly exempt.

The most common sales tax mistake I see after a business expands into new states is assuming someone else is handling it. Owners think the marketplace collects everything, or that they only owe tax where they have an office. Then a notice arrives from a state where their website sales crossed the threshold two years ago. By that point, the tax they never collected comes out of their own pocket, with penalties on top. Checking nexus once a quarter is far cheaper than cleaning it up afterward.

Anu Gupta, CA, EA, B.Tech · LinkedIn

What is Sales Tax?

Sales tax is a consumption tax charged by state and local governments on the retail sale of goods and, in some states, certain services. It's added to the price at the point of sale and paid by the customer.

The business making the sale collects the tax and sends it to the state. That's an important point for your books. Sales tax you collect isn't your revenue. It's money you're holding on the state's behalf, so it's recorded as a liability until you remit it.

Five states have no statewide sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Even there, the picture isn't always zero, since many local governments in Alaska charge their own sales taxes.

How to Calculate Sales Tax

The Basic Formula

Sales tax = Sale price × Sales tax rate

A $20 purchase in a location with an 8 percent combined rate works out like this:

$20 × 0.08 = $1.60 in sales tax, for a total of $21.60.

Building the Combined Rate

The rate you charge is usually a combination of several layers. A sale might carry a 6 percent state rate, a 1 percent county rate, and a 1 percent city rate, for a combined 8 percent. Two addresses a few miles apart can have different combined rates because they sit in different cities or special tax districts.

Working Backward From a Tax-Inclusive Price

If you have a total that already includes tax and need to separate the two, divide by one plus the rate:

$21.60 ÷ 1.08 = $20.00 sale price, and $21.60 − $20.00 = $1.60 in tax.

Which Rate Applies: Origin vs Destination

For in-state sales, some states use origin-based sourcing, which means you charge the rate where your business is located. Most states use destination-based sourcing, which means you charge the rate where the customer receives the item. For sales shipped into another state where you're registered, the destination rate generally applies.

Sales Tax Rates by State

Rates vary significantly by state and are further modified by county and city add-ons:

Understanding Sales Tax Nexus

Nexus is the connection between your business and a state that gives the state the right to require you to collect its sales tax. There are two main types.

Physical Nexus

You generally have physical nexus in a state where you have an office, store, warehouse, employees, or inventory. That includes inventory stored in a third-party fulfillment center, such as an Amazon warehouse.

Economic Nexus

Since the Supreme Court's 2018 decision in South Dakota v. Wayfair, states can also require out-of-state sellers to collect sales tax based purely on how much they sell into the state, with no physical presence needed.

Thresholds vary by state. Many use $100,000 in annual sales into the state. Some, including California, Texas, and New York, set higher dollar thresholds. A number of states originally also used a 200-transaction test, but many have since dropped it and now look at sales dollars alone. Check each state's rules rather than assuming one standard.

Marketplace Facilitator Laws

If you sell through a marketplace such as Amazon, Etsy, or Walmart, the marketplace is generally required to collect and remit sales tax on those sales in states with sales tax. That doesn't cover sales through your own website, and some states still count marketplace sales toward your economic nexus threshold.

What Nexus Means for Your Business

Once you have nexus in a state, you're generally required to register for a sales tax permit before you start collecting, charge the correct tax on taxable sales, file returns on the schedule the state assigns, whether monthly, quarterly, or annually, and remit the tax you've collected.

Sales Tax vs VAT

Sales Tax vs Excise Tax

Excise taxes apply to specific products, such as fuel, tobacco, alcohol, and certain firearms, and can be imposed at the federal, state, or local level. They're often built into the price rather than added separately at checkout, and they're usually charged per unit or per gallon rather than as a percentage of the sale.

The two can stack. A gallon of gasoline, for example, typically carries federal and state excise taxes in its price, and some states apply sales tax as well.

Sales Tax vs Use Tax

Use tax is the counterpart to sales tax. It applies when you buy taxable goods to use in a state that should have charged sales tax, but the seller didn't collect it.

For businesses, this comes up more often than people expect. A common example is buying equipment or supplies from an out-of-state vendor that isn't registered in your state. Another is buying inventory tax-free for resale with a resale certificate, then pulling some of it out to use in the business. In both cases, you're responsible for reporting and paying the use tax directly to your state, usually on your sales tax return.

Common Sales Tax Exemptions

What's exempt depends entirely on the state, but some categories come up often.

Groceries. Unprepared food is exempt or taxed at a reduced rate in many states. Prepared food and restaurant meals are usually taxable.

Prescription medications. Exempt in nearly every state with a sales tax.

Clothing. Exempt in a handful of states, sometimes only below a price threshold.

Items purchased for resale. Exempt when the buyer provides a valid resale certificate.

Manufacturing and agricultural inputs. Many states exempt certain equipment and materials used in production or farming.

Sales to exempt organizations. Sales to qualifying nonprofits, schools, and government agencies are often exempt with proper documentation.

Services are a separate question. Some states tax a wide range of services, while others tax very few. Shipping and delivery charges are also treated differently from state to state.

Whenever you make an exempt sale, keep the customer's exemption or resale certificate on file. If you're audited and can't produce it, the state can treat the sale as taxable and bill you for the tax.

Conclusion

Sales tax is a state and local obligation with no single national standard. Rates, exemptions, sourcing rules, and nexus thresholds all vary, and since Wayfair, a business can owe sales tax in states where it has never set foot. The businesses that stay out of trouble treat collected tax as money that belongs to the state, check their nexus position regularly as sales grow, keep exemption certificates organized, and use software to apply the right rates once they're selling across state lines.

Frequently Asked Questions