How to Calculate Sales Tax for Small Businesses (Simple Guide for Online and Remote Seller)

If you are an online business owner, you need to understand how to calculate sales tax correctly and, generally, how it works. Sales tax can be complex and confusing, especially if you sell to customers in different states or countries. You need to know the applicable sales tax rates, exemptions, and compliance requirements for each jurisdiction where you do business.

In this blog post, we will explain the basics of sales tax, how to determine the state sales tax, how to calculate sales tax using a simple formula, and how to handle sales tax for online transactions.

We will also provide some examples of sales tax calculations and some tips on how to manage sales tax for your e-commerce business, especially those who have stores on platforms such as Amazon, Shopify, etc. Firstly, let’s do a quick run-through of what sales tax is and how sales tax works

How Sales Tax Works in the United States

In the United States, sales tax is not a federal tax; it is primarily governed by individual states. Each state has its own rules and regulations regarding sales tax, which can lead to significant variation in rates, exemptions, and reporting requirements. This decentralized system can be quite complex, especially for businesses operating in multiple states. Thus, it’s essential to recognize that sales tax rates and laws can change, and staying compliant is an ongoing process that requires keeping a constant watch for possible sales tax law changes.

What is Sales Tax

Sales tax is a percentage of the price of a taxable good or service that is added to the final amount paid by the buyer. The seller is responsible for collecting and remitting the sales tax to the appropriate tax authority

Sales tax is usually imposed at the state level, but some states also allow local governments (such as counties, cities, and special districts) to impose their own sales taxes. The total sales tax rate is the sum of the state and local sales tax rates.

Sales tax rates vary widely across the US, ranging from 0% in some states (such as Delaware, Montana, New Hampshire, and Oregon) to over 10% in some localities (such as Chicago, Illinois and Birmingham, Alabama).

Not all goods and services are subject to sales tax. Some states exempt certain items (such as food, clothing, medicine, and education) from sales tax, while others tax them at a reduced rate. Some states also provide exemptions for certain buyers (such as nonprofit organizations, government agencies, and resellers) or certain transactions (such as interstate sales, exports, and trade-ins).

Sales tax compliance is the process of collecting, reporting, and remitting sales tax to the relevant tax authorities. Sales tax compliance can be challenging for online businesses, as they may have to deal with multiple tax jurisdictions, varying tax rates and rules, and changing tax laws and regulations.

How is State Sales Tax Determined

The state sales tax rate is determined by the location of the seller and the buyer. There are two main methods for determining the state sales tax rate: origin-based and destination-based

Origin-based sales tax means that the sales tax rate is based on the location of the seller. This means that the seller charges the same sales tax rate to all buyers, regardless of where they are located. Origin-based sales tax is simpler for the seller, as they only have to deal with one tax jurisdiction and one tax rate.

Destination-based sales tax means that the sales tax rate is based on the location of the buyer. This means that the seller charges the sales tax rate that applies to the buyer’s address, which may vary depending on the state and local sales tax rates. Destination-based sales tax is more complicated for the seller, as they have to keep track of the tax rates and rules for each jurisdiction where they sell.

Most states use destination-based sales tax for interstate sales, meaning that the seller has to charge the sales tax rate of the buyer’s state. However, some states use origin-based sales tax for intrastate sales, meaning that the seller has to charge the sales tax rate of their own state. Some states also have a hybrid system, where they use different methods for different types of sales or sellers.

To determine the state sales tax rate for a given sale, you need to know the following information:

The location of the seller
The location of the buyer
The type of good or service sold
The method used by the state to determine the sales tax rate (origin-based or destination-based)

You can use online tools such as this one to find out the sales tax rate for any state or locality in the US.

Sales Tax Calculation and Formula

Once you know the sales tax rate for a given sale, you can use a simple formula to calculate the sales tax amount and the total amount due. The formula is:

Sales Tax Amount = Sales Tax Rate x Taxable Amount
Total Amount Due = Taxable Amount + Sales Tax Amount

The taxable amount is the price of the good or service before applying any discounts, coupons, or exemptions. The sales tax rate is expressed as a decimal (for example, 6% is 0.06).

For example, if you sell a product for $100 and the sales tax rate is 6%, the sales tax amount is:
Sales Tax Amount = 0.06 x 100
Sales Tax Amount = 6
The total amount due is:
Total Amount Due = 100 + 6
Total Amount Due = 106

Example of Sales Tax Calculations

Let’s look at some examples of sales tax calculations for different scenarios.

Example 1: Origin-Based Sales Tax

Suppose you are a seller located in Texas, which uses origin-based sales tax for intrastate sales. You sell a product for $100 to a buyer located in Dallas, which has a local sales tax rate of 1%. The state sales tax rate in Texas is 6.25%. What is the sales tax amount and the total amount due?
Since Texas uses origin-based sales tax, you have to charge the sales tax rate of your location, which is 6.25%. The local sales tax rate of the buyer’s location does not matter. The sales tax amount is:
Sales Tax Amount = 0.0625 x 100
Sales Tax Amount = 6.25
The total amount due is:
Total Amount Due = 100 + 6.25
Total Amount Due = 106.25

Example 2: Destination-Based Sales Tax

Suppose you are a seller located in New York, which uses destination-based sales tax for intrastate sales. You sell a product for $100 to a buyer located in Buffalo, which has a local sales tax rate of 4.75%. The state sales tax rate in New York is 4%. What is the sales tax amount and the total amount due?
Since New York uses destination-based sales tax, you have to charge the sales tax rate of the buyer’s location, which is 4% + 4.75% = 8.75%. The sales tax amount is:
Sales Tax Amount = 0.0875 x 100
Sales Tax Amount = 8.75
The total amount due is:
Total Amount Due = 100 + 8.75
Total Amount Due = 108.75

Example 3: Interstate Sales Tax

uppose you are a seller located in California, which uses destination-based sales tax for interstate sales. You sell a product for $100 to a buyer located in Florida, which has a state sales tax rate of 6%. What is the sales tax amount and the total amount due?
Since California uses destination-based sales tax for interstate sales, you have to charge the sales tax rate of the buyer’s state, which is 6%. The sales tax amount is:
Sales Tax Amount = 0.06 x 100
Sales Tax Amount = 6
The total amount due is:
Total Amount Due = 100 + 6
Total Amount Due = 106

How to Calculate Sales Tax Rates in eCommerce

Calculating sales tax rates for online sales can be more complicated than for physical sales, as you may have to deal with multiple tax jurisdictions, varying tax rates and rules, and changing tax laws and regulations.
One of the main challenges for online sellers is determining whether they have nexus in a state. Nexus is a legal term that means a connection or presence in a state that requires you to collect and remit sales tax to that state.
Nexus can be established by various factors, such as having a physical location, an employee, an inventory, an affiliate, or a significant amount of sales in a state.
If you have nexus in a state, you have to register with the state tax authority, collect and remit sales tax to that state, and file regular sales tax returns. If you do not have nexus in a state, you do not have to collect or remit sales tax to that state.
However, nexus rules vary from state to state, and some states have enacted new laws that expand the definition of nexus to include online sellers who exceed a certain threshold of sales or transactions in a state.
These laws are known as economic nexus laws, and they are based on the 2018 Supreme Court decision in South Dakota v. Wayfair, which overturned the previous physical presence requirement for nexus.
As of 2021, 43 states and the District of Columbia have adopted economic nexus laws, and more states are expected to follow suit. The thresholds for economic nexus vary from state to state, but they are typically based on either annual gross sales or number of transactions in a state.
For example, in South Dakota, the threshold is $100,000 in sales or 200 transactions in a year.

To calculate sales tax rates for ecommerce sales, you need to know the following information:

The location of your business
The location of your customers
The type of goods or services you sell
The nexus rules and sales tax rates for each state where you do business

Mistakes to Avoid When Calculating Sales Tax

Not registering before collecting sales tax. If you have nexus in a state, you need to register with the state tax authority before you start collecting sales tax from your customers. Otherwise, you may face fines, penalties, and interest for uncollected or unremitted sales tax
Not knowing the taxability of your products or services. Different states have different rules and exemptions for what is subject to sales tax. For example, some states tax food, clothing, medicine, or digital goods, while others do not. You need to research the taxability of your products or services in each state where you make sales and apply the correct sales tax rate
Not verifying the validity of exemption or resale certificates. If you sell to customers who are exempt from sales tax, such as non-profit organizations, government agencies, or resellers, you need to obtain and verify their exemption or resale certificates. These certificates prove that the customers are eligible for sales tax exemption and the reason for the exemption. If the certificates are missing, expired, or invalid, you may be liable for the sales tax that you did not collect.
Not tracking changes in sales tax rates, rules, and boundaries. Sales tax laws and regulations are constantly changing in the US. There are over 11,000 jurisdictions that may have different sales tax rates, rules, and boundaries. You need to keep track of these changes and update your sales tax calculations accordingly. Otherwise, you may undercharge or overcharge your customers and face audit risks
Not understanding the difference between sales tax and use tax. Sales tax is the tax that is charged on the sale of goods and services by the seller to the buyer. Use tax is the tax that is charged on the use, storage, or consumption of goods or services that were purchased from another state or country and brought into the state. Use tax is usually the same as the sales tax rate and is paid by the buyer directly to the state tax authority. You need to know when to charge sales tax and when to report use tax on your purchases or sales.
Not using an automated solution to calculate and file sales tax. Calculating and filing sales tax manually can be time-consuming, error-prone, and tedious. You need to collect and remit sales tax to multiple state and local tax authorities, usually on a monthly, quarterly, or annual basis. You also need to fill out the correct forms and pay the taxes on time. Using an automated solution, such as Sales Tax Management Software, can help you simplify and streamline the sales tax process and avoid costly mistakes

How to Handle Sales Tax for Online Transactions

Handling sales tax for online transactions can be a daunting task for online sellers, as they may have to deal with multiple tax jurisdictions, varying tax rates and rules, and changing tax laws and regulations.
Here are some tips on how to handle sales tax for online transactions:

Use a reliable sales tax software or service that can automate the process of calculating, collecting, reporting, and remitting sales tax for your online sales. A sales tax software or service can help you determine your nexus status, sales tax rates, exemptions, and compliance requirements for each state where you do business. It can also integrate with your ecommerce platform, shopping cart, or payment processor to automatically apply the correct sales tax amount to each sale. Some examples of sales tax software or services are [Avalara], [TaxJar], [Quaderno], and [TaxCloud].
Keep track of your sales and transactions in each state where you do business, and monitor the changes in the sales tax laws and regulations. You may need to register with the state tax authority, collect and remit sales tax, and file regular sales tax returns if you exceed the threshold for economic nexus or other nexus factors in a state. You may also need to update your sales tax rates and rules if the state changes its sales tax policies or rates.
Collect and maintain accurate and complete records of your sales and sales tax transactions, and keep them for at least three years. You may need to provide these records to the state tax authority in case of an audit or a dispute. You should also keep copies of your sales tax registrations, returns, payments, and exemptions certificates.
Seek professional advice from a tax expert or an accountant if you have any questions or doubts about your sales tax obligations or calculations. Sales tax can be a complex and confusing topic, and you may need expert guidance to ensure that you are complying with the sales tax laws and regulations in each state where you do business.

How to Calculate Sales Tax

To calculate the sales tax amount for a transaction as a business owner, you can follow a straightforward formula:

Sales Tax Rate: The sales tax rate is the percentage imposed by the state or local jurisdiction. It can vary depending on the type of product or service and the location.

Sales Tax Amount = Taxable Sales Amount x Sales Tax Rate

Taxable Sales Amount: This is the total price of the goods or services sold that are subject to sales tax. Some items may be exempt from sales tax, so it’s important to accurately identify taxable sales.

I. Determine the sales tax rate for each state in which you are registered to pay taxes.

II. Transform the tax rate in percentage into a decimal, i.e. 7.25% / 100 becomes 0.0725

III. Multiply the price of product or service (taxable sales amount) by tax rate. See formula below

(Product price or Taxable Sales Amount) * (Sales Tax Rate) = Total Sales Tax

Let’s see this practical illustration

For example, in New Jersey, the sales tax rate is 6.625%. Calculating the sales tax for a product that costs $80 would result to:

80 [Product price] * 0.06625 [Sales Tax Rate] = $5.3 [Total Sales Tax]

How to calculate the total transaction amount for a purchase

Next, to calculate the total transaction amount for a purchase, you’d need to add the selling price of the product to the total sales tax required.

(Product price) + (Total Sales Tax) = Total Transaction Amount

Let’s use the same example from above where the price of the product is $80, and the total sales tax we got was $5.3

80 [Product price] + 5.3 [Total Sales Tax] = $85.3 [Total Transaction Amount]

Another method to calculate the total amount of a purchase without having to first calculate the total sales tax is to multiply the product price by 1 plus the sales tax rate, see formula below:

(Price of the product) * (1 + Sales Tax Rate) = Total Transaction Amount

Example: 80 [Product price] * 1.06625 [1 + Sales Tax Rate] = $85.3 [Total Transaction Amount]

Methods of Calculating Sales Tax for Online Sales

1. The Percentage Method
The percentage-based approach is the most common method of calculating sales tax. It involves applying a specified tax rate to the total sale amount. Here’s how it works:

Determine the applicable tax rate for your location.
Multiply the total sale amount by the tax rate.
Add the calculated tax amount to the sale total.

For example, if your business is in a state with a 7% sales tax rate and a customer makes a $100 purchase, the calculation would be: $100 * 0.07 = $7.00 in sales tax

2. The Destination Based Method
The destination-based approach is used when your business has multiple locations or sells to customers in different locations. It calculates sales tax based on the buyer’s location, not the seller’s. This can be more complex, as tax rates can vary significantly between jurisdictions.

Sales Tax Calculation Mistakes to Avoid

Not registering before collecting sales tax. If you have nexus in a state, you need to register with the state tax authority before you start collecting sales tax from your customers. Otherwise, you may face fines, penalties, and interest for uncollected or unremitted sales tax
Not knowing the taxability of your products or services. Different states have different rules and exemptions for what is subject to sales tax. For example, some states tax food, clothing, medicine, or digital goods, while others do not. You need to research the taxability of your products or services in each state where you make sales and apply the correct sales tax rate
Not verifying the validity of exemption or resale certificates. If you sell to customers who are exempt from sales tax, such as non-profit organizations, government agencies, or resellers, you need to obtain and verify their exemption or resale certificates. These certificates prove that the customers are eligible for sales tax exemption and the reason for the exemption. If the certificates are missing, expired, or invalid, you may be liable for the sales tax that you did not collect.
Not tracking changes in sales tax rates, rules, and boundaries. Sales tax laws and regulations are constantly changing in the US. There are over 11,000 jurisdictions that may have different sales tax rates, rules, and boundaries. You need to keep track of these changes and update your sales tax calculations accordingly. Otherwise, you may undercharge or overcharge your customers and face audit risks13.
Not understanding the difference between sales tax and use tax. Sales tax is the tax that is charged on the sale of goods and services by the seller to the buyer. Use tax is the tax that is charged on the use, storage, or consumption of goods or services that were purchased from another state or country and brought into the state. Use tax is usually the same as the sales tax rate and is paid by the buyer directly to the state tax authority. You need to know when to charge sales tax and when to report use tax on your purchases or sales.
Not using an automated solution to calculate and file sales tax. Calculating and filing sales tax manually can be time-consuming, error-prone, and tedious. You need to collect and remit sales tax to multiple state and local tax authorities, usually on a monthly, quarterly, or annual basis. You also need to fill out the correct forms and pay the taxes on time. Using an automated solution, such as Sales Tax Management Software, can help you simplify and streamline the sales tax process and avoid costly mistakes

Dealing with Sales Tax Rates

Sales tax rates can vary widely, not only from state to state but also within states. In some cases, businesses may operate in areas with different sales tax rates. This can be due to various local jurisdictions within a state, each having its own tax rate. To accurately calculate sales tax, it’s important to determine the specific rate applicable to each transaction based on the customer’s location.

Here are some important considerations:

State Sales Tax Rates

Every state has its own sales tax rate, which can range from 0% in states like Delaware to over 10% in others.

County and Municipal Sales Tax

Some local jurisdictions impose additional sales taxes on top of state rates.

Special Sales Tax Districts

In certain areas, there may be special taxing districts with unique rates.

Handling Sales Tax Exemptions and Deductions

Understanding sales tax exemptions and deductions is another critical aspect of sales tax management, and applying these exemptions is crucial for an accurate calculation. Some sales may qualify for exemptions, such as sales to tax-exempt organizations or transactions involving certain types of goods, like food, essential groceries, or prescription medications.

Businesses must ensure they correctly identify and document exempt sales to avoid overcharging customers. Meanwhile, for deductions, certain business expenses can be deducted from your sales tax liability, reducing the amount you owe.

Dealing with Sales Tax Compliance

Navigating sales tax compliance can be challenging, but it’s essential to avoid legal troubles. Thus, the key aspects of compliance to consider may include:

1. State Sales Tax Laws: Familiarize yourself with the specific sales tax laws in your state.

2. Sales Tax Registration: Register for a sales tax permit with your state’s tax authority.

3. Sales Tax Filing and Reporting: Regularly file sales tax returns and report the sales tax you’ve collected.

4. Common Compliance Pitfalls: Avoid common mistakes like failing to update tax rates, miscalculations, and late filings.

Leveraging Sales Tax Management Software

For businesses looking to streamline their sales tax calculation processes and reduce the risk of errors, sales tax management software can be a valuable tool.

These software solutions can automatically calculate sales tax based on location, update tax rates as they change, and even handle complex scenarios like exemptions and discounts. An example is the Atomic Tax sales tax management software

Atomic Tax sales tax management software, for example, can integrate with point-of-sale systems or e-commerce platforms, making it easier for business owners to ensure accurate tax collection and reporting. It can also generate reports and assist with filing sales tax returns, saving time and reducing the likelihood of costly compliance errors.

How to Choose the Right Sales Tax Software

When choosing the right sales tax software for your business, consider factors such as

Your volume of sales
The states you operate in
Integration with your existing systems
Software’s ability to accurately calculate, process, report, file, and keep tax rates and rules up-to-date.

Wrapping Up: How to Calculate Sales Tax

Sales tax is a tax imposed by the government on the sale of goods and services. It is usually collected by the seller from the buyer and then remitted to the tax authority. Sales tax is one of the main sources of revenue for many states and local governments in the US.
To calculate sales tax, you need to know the sales tax rate, the taxable amount, and the method used by the state to determine the sales tax rate (origin-based or destination-based). You can use a simple formula to calculate the sales tax amount and the total amount due:
Sales Tax Amount = Sales Tax Rate x Taxable Amount
Total Amount Due = Taxable Amount + Sales Tax Amount
However, calculating sales tax for online sales can be more complicated than for physical sales, as you may have to deal with multiple tax jurisdictions, varying tax rates and rules, and changing tax laws and regulations. You also need to know whether you have nexus in a state, which is a connection or presence in a state that requires you to collect and remit sales tax to that state.
To handle sales tax for online transactions, you may need to use reliable sales tax software or service that can automate the process of calculating, collecting, reporting, and remitting sales tax for your online sales.
You may also need to keep track of your sales and transactions in each state where you do business and monitor the changes in the sales tax laws and regulations. You may also need to collect and maintain accurate and complete records of your sales and sales tax transactions and seek professional advice from a tax expert or an accountant if you have any questions or doubts about your sales tax obligations or calculations.

How to Calculate Sales Tax: Formula, Examples, Mistakes to Avoid and More