The question of who pays sales tax, the buyer or the seller, is one that often causes confusion. The short answer is that legally, the seller is responsible for collecting and remitting sales tax to state and local governments. However, the economic burden of the tax often falls on the buyer in the form of higher prices. Let’s take a deeper look at sales tax laws and who ultimately bears the cost.
What is Sales Tax?
Sales tax is a consumption tax imposed by state and local governments on the retail sale of goods and services. It is collected by the seller at the point of purchase and then paid to the appropriate tax authorities. Sales tax rates vary widely across the country.
As of January 1, 2022, combined state and local sales tax rates range from 0% in states like Oregon that have no sales tax, to over 9% in California. Sales tax applies to the final retail sale of tangible goods as well as certain services.
Sales Tax Collection Responsibilities
Under sales tax laws in the United States, the seller is responsible for collecting sales tax from the buyer and remitting it to the appropriate tax agency. This responsibility applies whether the seller is a large retail store, small mom-and-pop shop, or online ecommerce business.
Some key facts about sellers and sales tax collection:
- Sellers are required to register with tax agencies in states where they have a physical presence or exceed economic tax nexus thresholds.
- Sellers must calculate applicable sales tax rates for the products and services they sell. Rates vary not just by state but also by city, county, and other jurisdictions.
- Sellers are liable for collecting the correct amount of tax and filing returns on time. If they fail to collect tax as required, they can be audited and forced to pay those uncollected taxes out of pocket.
- Sellers must keep detailed records of taxable sales and remittances for a minimum period defined by state laws (usually around 4 years).
In short, the legal obligation for sales tax collection and payment lies with the seller in a retail transaction. But there are some exceptions…
Sales Tax Collection Exceptions
There are certain situations where the buyer is responsible for self-assessing and remitting sales tax directly to the government:
- Remote sellers – For online and mail order purchases where the seller does not have a physical presence in the buyer’s state. This still applies to marketplace facilitators like Amazon even though they handle collection for 3rd party sellers using their platform.
- Casual sales – When individuals sell used goods, like at a garage or yard sale. Sales tax usually doesn’t apply to these occasional non-retail sales.
- Purchases for resale – If the buyer intends to resell an item, they can provide a resale certificate to the seller to make the purchase exempt. The buyer is then responsible for collecting sales tax when they ultimately sell the product.
- Out-of-state purchases – For large purchases like vehicles, boats, and aircraft brought into a state from another state. The buyer must typically self-report and pay use tax.
So in certain scenarios, the buyer does directly pay the sales tax. But for most retail transactions, the seller handles collection.
Who Pays the Sales Tax?
While sellers have the legal obligation to collect and remit sales tax, the economic burden is typically passed on to buyers in the form of higher prices. Sellers factor the costs of sales tax into their pricing strategies and balance sheets. The increased costs are ultimately built into the retail prices that buyers pay.
Think of sales tax as just another cost of doing business for the seller – like rent, utilities, labor, shipping, etc. To maintain their profit margins, sellers will increase final prices to cover additional sales tax costs.
Theoretically, if sales taxes were eliminated, retail prices would decline and buyers would keep that portion of money in their pockets. But prices rarely go down, so the reality is that buyers bear the monetary burden in the form of higher everyday prices.
Sales Tax Incidence
The concept of measuring who really pays a tax economically is known as tax incidence. The effective economic burden of a tax does not always align with its statutory legal burden.
There are three potential types of tax incidence:
- Forward incidence – Where sellers are able to pass the economic burden of the tax forward to buyers in the form of higher prices. This is the most common scenario for broad-based sales taxes.
- Backward incidence – Where sellers must absorb some or all of the tax burden themselves in the form of lower profit margins. This can happen in competitive markets or for taxes levied early in production processes.
- Shared incidence – Where both buyers and sellers share the economic burden of the tax to varying degrees. The exact split depends on elasticities of supply and demand in a market.
Most evidence suggests sales tax is highly passed forward from businesses to consumers in the form of forward tax incidence. Estimates vary, but studies suggest buyers bear 70-100% of the cost of general sales taxes in the form of higher prices.
The Impact of Sales Tax on Buyers
Even though the legal burden rests with the seller, sales taxes do economically impact buyers in several ways:
- Higher purchase prices – As discussed above, higher sales taxes directly translate to higher retail prices for goods. With rates reaching 10% in some areas, sales tax significantly increases everyday purchases. This affects all buyers, even those with lower incomes.
- Changes purchasing behavior – Buyers may purchase fewer overall items or shift purchases to lower tax categories. For example, someone may eat at restaurants less and cook more food at home. Clothing and personal care items are often exempt from sales tax to avoid impacting lower income populations.
- Incentivizes online purchases – The lack of sales tax on many online purchases provided buyers with an incentive to shift away from brick and mortar retailers. However, remote seller laws have narrowed this gap in recent years.
- Reduces real wages – Although sales taxes are not directly levied on wages and salaries, higher consumer prices indirectly reduce real disposable incomes. This drives down standards of living, especially for lower income households.
So ultimately, the economic costs imposed by sales taxes fall predominantly on the buyers who pay higher final prices for goods and services in retail markets. Sellers may remit the tax, but consumers bear the monetary burden.
Sales Taxes vs. Income Taxes
Compared to income taxes and other forms of taxation, sales taxes are more regressive in nature. Regressive taxes take up a larger percentage of income for lower and middle class taxpayers compared to wealthier taxpayers. This contrasts with the progressive structure of income tax rates in the U.S.
The regressivity of sales taxes stems from two main factors:
- Uniform tax rates – Sales tax rates generally don’t vary based on the purchaser’s income level. Everyone pays the same rate regardless of ability to pay, unlike progressive income tax brackets.
- Spending patterns – Lower income households tend to spend a greater share of their earnings on taxed consumption goods compared to higher income households. This increases the effective tax rate on their income.
To mitigate the regressive impact of sales taxes, many state and local governments exempt necessities like groceries, medicines, and clothing. Some jurisdictions even provide sales tax rebates or credits for lower income households.
However, when evaluating the full basket of goods purchased by different income groups, sales taxes still tend to be more regressive than income taxes according to many economists. This has led some to argue that raising income taxes on higher earners would be preferable and more equitable than increasing broad-based sales tax rates. But sales taxes remain an important source of funding for state and local governments across the U.S.
International Comparison
The U.S. has one of the lowest rates of sales tax / value added tax (VAT) among developed countries. This comparison looks at standard VAT or sales tax rates in OECD countries:
| Country | Standard VAT/GST Rate |
|---|---|
| Hungary | 27% |
| Norway | 25% |
| Denmark | 25% |
| Sweden | 25% |
| Croatia | 25% |
| Finland | 24% |
| Poland | 23% |
| Greece | 23% |
| Italy | 22% |
| France | 20% |
| Czechia | 21% |
| Austria | 20% |
| Spain | 21% |
| Slovenia | 22% |
| Portugal | 23% |
| Belgium | 21% |
| Germany | 19% |
| Netherlands | 21% |
| Canada | 5% |
| Switzerland | 7.7% |
| Japan | 10% |
| Australia | 10% |
| United Kingdom | 20% |
| United States | Max 12% |
| Ireland | 23% |
| Turkey | 18% |
| South Korea | 10% |
The U.S. federal government does not levy any broad-based sales tax or VAT. The highest state-level sales tax rate is just over 9% while local rates add a few extra percentage points in some areas. Most European and other developed countries have standard VAT rates in the range of 20-25%, often with additional local taxes. This contributes a much larger portion of overall tax revenue compared to the U.S. reliance on income and corporate taxes. However, it also places a higher burden on consumption and household spending.
Sales Tax Laws by State
Sales tax policies, rules, and rates can vary widely across different states in the U.S. Here is a summary of some key sales tax variations:
- States with no sales tax – Alaska, Delaware, Montana, New Hampshire, Oregon
- Highest state rates – California (7.25%), Indiana (7%), Mississippi (7%), Rhode Island (7%), Tennessee (7%), New Jersey (6.625%)
- State revenue dependence – Some states like Texas and Florida rely on sales tax for over 50% of their tax revenues. Others like Vermont generate less than 10% from sales taxes.
- Taxation of groceries – Most states exempt groceries from sales taxes, but some including Mississippi, Alabama, and Kansas fully tax groceries.
- Clothing exemptions – About half of states offer sales tax exemptions on clothing purchases to reduce regressivity.
- Prescription exemptions – Nearly every state exempts prescription medicine from sales taxes for accessibility reasons.
- Remote seller laws – Laws expanded requiring online sellers to collect sales tax even without physical nexus in the state. This has leveled the playing field.
- Origin vs. destination – Whether sales tax is collected based on the origin or destination of the sale. This determines which state receives revenues.
The diversity of sales taxes across different states and cities makes compliance complex for large national sellers operating in multiple jurisdictions. Sales tax automation software has helped multi-location sellers manage this complexity.
Recent Sales Tax Trends and Developments
Some recent changes and trends impacting sales tax policies and collection across the U.S. include:
- Wayfair decision – The Supreme Court ruled in 2018 that states can require remote sellers to collect sales tax regardless of physical presence. This allowed states to tax online sales.
- Marketplace facilitator laws – Rules now require platforms like Amazon and eBay to collect sales tax on behalf of third-party sellers using their marketplaces.
- Software automation – Compliance has become easier with automated sales tax rate calculations and reporting built into POS systems and accounting software.
- Raising rates – Some states and cities have increased sales tax rates to raise revenues, especially in the wake of COVID budget shortfalls.
- Tax holidays – Periods exempting certain goods like back-to-school supplies from sales tax to provide family financial relief. However, evidence on effectiveness is mixed.
- Invoicing changes – Requiring separate sales tax line item on receipts and invoices to increase visibility to the buyer.
- Marijuana taxes – States legalizing recreational cannabis are levying special excise and sales taxes on its sale, often at double digit rates.
Overall, governments continue modernizing sales tax collections and expanding tax bases to capture more revenue as the economy evolves. This ensures buyers and sellers share tax burdens broadly across all forms of commerce.
Sales Tax Administration and Compliance
Properly collecting, reporting, and remitting sales taxes represents a significant administrative burden for companies. Key responsibilities include:
- Registering with tax authorities in every state they make taxable sales and remitting returns on varying schedules (monthly, quarterly, annually etc.)
- Integrating sales tax calculation and tracking into point-of-sale systems and accounting software
- Determining applicable tax rates accurately for every taxing jurisdiction their sales touch
- Issuing and filing resale exemption certificates when selling to resellers
- Providing itemized sales tax invoices to buyers
- Keeping detailed records of taxable sales and exemptions
- Allowing audits by state tax agencies to prove compliance
Specialized software programs and accountants can help businesses stay compliant with sales tax obligations across multiple jurisdictions. But it remains a time-consuming accounting burden, especially for small sellers. Non-compliance can lead to hefty interest, penalties, and back-tax assessments from auditors.
Guidance for Buyers and Sellers
For both buyers and sellers, it helps to understand certain guidelines when it comes to sales tax:
For Buyers
- Assume you are paying sales tax on any retail purchase, unless explicitly exempt
- Check receipts and invoices to ensure sellers charge appropriate sales tax rates
- Save documentation if you believe you were overcharged taxes
- Know any special product exemptions that apply in your state, like groceries, clothing, medicines, etc.
- If buying goods for resale, provide a valid resale certificate or exemption form to exempt the purchase
For Sellers
- Consult a tax professional to understand all registration and collection obligations in your state and locality
- Consider sales tax automation software to accurately calculate rates and simplify reporting
- Build the costs of sales tax into your final retail prices at the correct rate
- Train staff on properly charging tax rates at checkout and issuing exemption forms
- Save documentation on taxable sales and exemptions for each transaction
- File returns on time and remit all collected sales taxes to avoid penalties
- Allow occasional audits by state tax authorities to demonstrate compliance
Sales Tax Errors and How to Fix Them
Despite best efforts, sales tax mistakes and mischarges still frequently occur. Here are some common errors and how buyers and sellers can resolve them:
Overcharged Sales Tax
If a buyer is charged excess sales tax, they can request a refund from the seller. Provide the original receipt and explain the justification, like being charged an incorrect higher tax rate. If the seller agrees, they will issue a refund. Otherwise, the buyer may have to file directly with the tax agency.
Undercharged Sales Tax
If a seller realizes they under-collected sales tax, they are still liable to the state for the full amount. Attempt to contact past buyers to collect additional tax if substantial. Otherwise, the seller must absorb the loss from undercharging. Just make sure to correct the error moving forward.
Charged Tax in Non-Tax State
If a seller charges tax in a state with no sales tax like Oregon, show them state laws exempting all sales. Request immediate refund of the excess tax paid. File a complaint with the state tax agency if needed.
Wrong Tax Rate
If a seller charges the incorrect tax rate for a jurisdiction, point out the precise allowable tax based on published rates from the state. Request they refund overcharged tax and update their systems.
Exemption Not Applied
If a valid resale or other exemption isn’t applied, submit evidence like a resale certificate. Ask the seller for a refund of tax paid. Update the certificate on file if needed to prevent future errors.
In summary, work cooperatively with sellers to fix legitimate sales tax errors and overcharges. Save documentation and file formal complaints if they are uncooperative.
Sales Tax Exemptions – Nonprofits, Resellers, Agriculture, and More
Certain types of organizations and industries receive full or partial exemptions from sales tax in many states. Common sales tax exemptions include:
- Nonprofits – Most states exempt state sales tax on purchases made by charitable nonprofits like churches, schools, hospitals, social services, and cultural institutions. They avoid sales tax with a state exemption letter.
- Resellers – Sellers can provide a resale certificate when purchasing inventory intended for later retail sale. The subsequent sale is taxed instead of the wholesale purchase.
- Agriculture – Farm equipment, seeds, feed, and other agricultural supplies are exempt from sales tax in many states. Livestock sales and production inputs are not considered end-user retail sales.
- Manufacturing – Inputs that become part of finished manufactured products are exempt from sales tax, as are industrial machines used in manufacturing processes. This avoids taxing multiple steps in the supply chain.
- Government – Federal, state, and local government agencies do not pay sales tax on purchases in most states. This includes public schools, law enforcement, infrastructure departments, and other public sector bodies.
- Food – Grocery food intended for home consumption is exempt in most states. Prepared foods, alcohol, and restaurant meals are often still taxable. Several states fully tax groceries.
- Medical – Medicines, medical equipment, and other healthcare products are widely exempt from sales tax to avoid increasing costs for the sick.
- Services – Some industries like financial and professional services are exempt from sales tax in many states. However, repair and maintenance services are taxable as retail sales.
Ensure you understand and properly apply any sales tax exemptions relevant to your business or organization. Exemptions vary by state, so consult a local tax advisor to leverage available exemptions and avoid unnecessary taxes.
