Posted by Tim Thompson CPA PLLC

Understanding Sales Tax

Understanding Sales Tax

A sales tax is a consumption tax exacted by the government for the sale of goods or services. An established sales tax is levied at the store, collected by the retailer, and sent to the government. A business is subject to sales tax in a particular jurisdiction if there is a connection, which may be a physical location, an employee, a subsidiary, or some other presence, in accordance with the laws of that jurisdiction. 

Understanding sales tax

Conventional or retail taxes are only billed to the end-user of a good or service. Since most products in modern economies go through a series of production steps, usually administered by different entities, a significant amount of documentation is required to prove who is responsible for the sales tax. For example, suppose a sheep farmer sells wool to a yarn company. To avoid paying sales tax, the yarn manufacturer must obtain a resale certificate from the government stating that it is not the end-user. The yarn manufacturer sells his products to a clothing manufacturer, who must also obtain a resale certificate. Finally, the clothing manufacturer sells flexible socks to a retail store, which will collect the customer's sales tax and the price of the socks.

Different jurisdictions collect different, generally overlapping, sales taxes, such as when states and municipalities impose their own sales taxes. Sales tax is closely related to the user tax, which applies to residents who have purchased items outside their jurisdiction. They are generally set at the same rate as sales taxes but are difficult to apply, which means that in practice, they apply only to large purchases of tangible goods. An example would be a resident of New York who buys a car in Chicago; such residents will be asked to pay local sales tax as if they were buying it from their state.

Specific Consumption Taxes (Excise Taxes)

In general, sales taxes represent a percentage of the price of products sold. For example, a state may have a sales tax of 4%, a municipality of 2%, and a city of 1.5%, so the residents of that city pay 7.5%. Often, certain items are exempt, such as food or below a certain limit, such as clothing purchases under $200. At the same time, certain products are subject to special taxes, called special taxes. Sin Taxes is a form of consumption tax, such as the local consumption tax of $1.50 that New York charges for each pack of 20 cigarettes, and the consumption tax of $ 4 per pack of 20 cigarettes. 


Whether a business owes a sales tax to a particular government depends on how the government defines the nexus. A nexus is usually defined as a physical presence, but this "presence" is not limited to having an office or warehouse; having an employee in a state can be a nexus, as well as having an affiliate, such as a partner site that drives traffic to your business page in exchange for a share of the profits. This scenario is an example of the tensions between e-commerce and sales taxes. For example, New York has passed "Amazon laws" that require Internet retailers such as Inc. to pay sales taxes, despite the lack of physical presence in the state.

VAT (Value Added Taxes)

The United States is one of the few developed countries where conventional sales taxes are still used. Note that, with a few exceptions, it is not the federal government that collects the taxes, but the states. In most developed countries, the value-added tax (VAT) schemes have been adopted. They charge a percentage of value-added at each level of production of an asset. In the example of long pile socks above, the yarn producer would pay a percentage of the difference between what he charges for the yarn and what he pays for the wool; the clothing manufacturer would also pay the same percentage of the difference between what they charge for the socks and what they pay for the yarns. In other words, this is a charge for the company's gross margins, not just for the end-user.

The main objective of incorporating VAT is to eliminate double taxation, which extends from production to the level of consumption. For example, a car manufacturer receives raw materials for $10, which includes a 10% fee. That means you pay a $1 tax for $9 on materials. In the car manufacturing process, add value to the original materials for $5, for a total value of $ 10 + $ 5 = $ 15. The 10% charge on the finished product will be 1.50 $. Under a VAT system, this tax can be applied to the tax previously paid to increase the effective tax rate between $ 1.50 and $ 1.00 = $ 0.50.

The wholesaler buys the car for $ 15 and resells it to the retailer for $ 2.50 markup value for $ 17.50. The 10% tax on the gross value of the goods will be $1.75, which can be applied to the manufacturer's original price tax, which is $15, the wholesaler tax rate will be $1.75 - $ 1.50 = $0.25. If the dealer's margin is $ 1.50, the actual tax rate will be (10% x $ 19) - $ 1.75 = $ 0.15. The total tax on the stunt from producer to retailer will be $ 1 + $ 0.50 + $ 0.25 + $ 0.15 = $ 1.90.

The VAT exemption system assumes that taxes are paid on the value of the goods and the margin at each stage of the production process. This would result in a higher amount than the taxes paid, which is brought to the end consumer in the form of higher costs for goods and services.

Tim Thompson CPA PLLC
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