Basics of U.S. Sales Tax Regulations
When is Sales Tax Relevant?
While the concept of U.S. sales tax is similar to Israeli VAT regulations, the actual implementation and definitions are vastly different. For starters, unlike VAT which falls under one tax jurisdiction in Israel, sales tax in the U.S. is imposed on a state by state basis other than in the four states which do not impose sales tax at all (Delaware, New Hampshire, Montana and Oregon). Furthermore, each state may then have a unique interpretation of factors outlined below. As a general rule, sales tax collection would only be applicable if a sale meets all three criteria below:
1. Nexus – Companies having nexus (defined as a connection) in a state are required to collect and remit a state’s sales tax on sales to customers located in the same state. Nexus can be created in any of the following ways:
- Physical – Physical presence is established when a company has created a physical connection in the same state in which their customer is located. This is the most common (and logical!) form of creating nexus and such regulations are relevant in all states which impose sales tax. Examples of physical nexus can include any of the following in the state: employees, office, subcontractors, warehouse, inventory held by drop shipper, servers.
- Affiliate Based – Some states have expanded the definition of nexus to include activities of related parties. Affiliate based nexus is established when a related company of the Seller is located in the customer’s state and provides services on behalf of the Seller. An example of this would be when a US subsidiary interacts with a customer of the foreign Israeli parent company. In such case, nexus may be created for the Israeli company in the Subsidiary’s state.
- Economic – Economic nexus regulations reflect fairly new guidelines implemented by some states. This is intended to target e-commerce businesses which may have no physical presence in a state, yet are enjoying the benefits of selling to customers in the state. Economic nexus is established when a business reaches a certain threshold of sales or transactions in the state. The most common of these is when a company reaches 200 transactions or $100,000 of sales in the states which have implemented these regulations.
- Click-Through – A number of states have passed click through nexus regulations. This type of nexus is created when a Seller enters into an agreement under which another party refers potential purchasers to the Seller, including by an internet link or web site. This may be relevant for businesses which enter into agreements with bloggers or influencers who refer potential customers to a particular website.
2. End User – Sales tax is typically imposed on the retail sale of tangible personal property to a non tax-exempt entity i.e. only the final purchaser pays the tax and such tax is non-refundable. Therefore, in the case in which the company is working with distributors, then sales tax collection would not be required as the distributors are not the final end user. However, the Seller must ensure that they receive a valid Reseller Certificate from the distributor in order to absolve the company of the obligation to collect the sales tax. Similarly, if the company is selling to a tax exempt entity, it must receive an exemption form from the customer.
3. Taxable Transaction – Each state provides their own guidelines as to when a sale would be considered a taxable transaction subject to sales tax collection. In general, sales tax is imposed on the sale of tangible personal property and certain specifically enumerated services. A typical example would be that hardware is subject to sales tax while legal services are exempt. The challenge is when the product or service sold can fall under both categories, such as SaaS - software as a service. In such cases, tax regulations must be analyzed on a state by state basis to determine the treatment per state.
How is Sales Tax Collected?
Once the determination has been made that a particular sale is subject to tax, the Seller must determine the following:
1. Where is the product being shipped to?
2. What is the sales tax rate at the ship to address? Note that this may include both state and local taxes.
3. If there are multiple users of the product, such as licensed users of software, are they located in a number of states? If so, should the sale be allocated among the users and the sales tax rate adjusted accordingly?
The sales tax must then be added as separate line item on the invoice. If there are certain products or services which are taxable and some which are exempt, these should be separately stated and clearly indicated on the invoice.
When is Sales Tax Paid to the State?
In order to be able to remit the sales tax to the relevant states, the company must register with the state and establish a sales tax account. Depending on the volume of the sales, the frequency of filing may be determined as monthly, quarterly or annually. The corresponding due dates vary from state to state but are most commonly due on the 20th of the month following the reporting period i.e. for quarterly filings, the Q1 2018 report would be due on April 20, 2018.
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