What is Sales Tax? An Ultimate Guide

  If you have ever wondered what is sales tax, you’re not alone. Understanding what sales tax is and how it works should be your utmost priority, especially if you’re a newly established ecommerce business owner. You’re probably intimidated by the amount of information you have to learn at once. But once you get the hang of it, with the help of TaxHero, you have nothing to worry about.

To guide you through, we have broken down below what you need to know about the topic.

Key Takeaways

• Sales tax varies across states, counties, and cities. The state sales tax is not the same as the combined rate. The combined rate should encompass the tax rates of the state, county, city, and any applicable district taxes.
• You only need to collect sales tax when you meet two primary conditions: your business has a nexus in a state, and you’re selling a taxable product in the state where you have a nexus.
• The application of sales tax on goods and services also varies depending on each state’s rules. In some states, there are goods or services that are exempt from sales tax at the state level. However, local taxation may still apply. 
• You are responsible for collecting and remitting sales tax once your business establishes a nexus and you have registered your business in the state where you have a nexus.
• Online or remote sellers should still register and collect when they establish an economic nexus in any taxing state.

What is Sales Tax?

In a nutshell, it is a consumption tax collected whenever a purchase of products or goods and services is made. It is also generally added to the product price and remitted to the state government to be used to fund its programs and projects.

It is essential to understand that the Federal Government does not collect a federal or national sales tax. Instead, it is regulated at the state and local level, including cities, counties, and other special districts. That’s the reason why it varies from one state or territory to another.

State Sales Tax

As briefly mentioned above, sales tax is mandated at either the state or local level. The state sales tax is imposed by the state authorities. However, the state rate doesn’t represent the entire state’s tax rates.

For clarification, the state sales tax is separate from any local sales tax. That means a state’s total tax depends on the combined rates coming from both the state level and local tax rates, plus any additional special district taxes.

You must also know that some states have different kinds of taxes that function almost just the same as sales tax.

For example, Arizona has a Transaction Privilege Tax (TPT), and Hawaii has a General Excise Tax (GET). But despite the distinct tax names, people still generally recognize them as sales tax.

Local Sales Tax

Local sales tax typically refers to the state’s local jurisdictions, like the counties and cities. Sometimes, local tax includes special district taxes and other local option taxes. It’s important to know that state taxabilities are not always the same as local taxabilities. To ensure you stay compliant, checking local rules is also a critical step.

How Does U.S Sales Tax Work?

Sales tax is computed based on the percentage of the sales price, with the rate varying from one jurisdiction to another, and some local governments also collect their own.

To calculate your tax, you must list the price of your taxable product, including any taxable shipping charges. After that, take the state’s combined sales tax rate, depending on where you are selling. Then, convert the state’s combined sales tax rate into decimal format.

Once you convert the rate into decimal format, multiply your product’s price by the decimal format. The result is your estimated sales tax for that transaction.

• Here’s the simplified formula breakdown:
  Price of Goods + Shipping Fee x
  State Sales Tax Rates +
  Local Sales Tax Rates
  = Your Total Sales Tax

Example Scenario:

• You’re selling a taxable product worth $50 with a shipping fee of $10. This brings your total sale price to $60.
• The product was shipped to New York City, New York, where shipping is taxable.
  The combined state, county, city, and other local rates in New York City, New York, is 8.875%.
• Convert the state’s combined sales tax rate into decimal format.
  8.875% turned into decimal format is: 0.08875
• Now, multiply your sale price by the decimal format of the combined sales tax rate of the city, county, and state.
  60 x 0.08875 is = $5.325
  When rounded off, this amount becomes = $5.33
• Finally, add everything to your base sales price to accurately collect sales tax from your customers.
  [Product Price] $50 +
  [Shipping Fee] $10 +
  [Calculated Sales Tax] $5.33
  TOTAL = $65.33

To simplify the calculation, you can also use TaxHero’s FREE Sales Tax Calculator.

As shown in the example above, the combined sales tax rate refers to the combined state and local (i.e., County, City, District) sales tax rates.

You must also understand that the collection and remittance are the sole responsibility of the seller. Learn more about this in the following sections.

How Sales Tax Applies to Goods and Services

Not all transactions are subject to sales tax. So, how or when does sales tax apply to goods and services? The answer varies depending on the state’s specific rules.

What’s taxable in one state may be exempt in another. Additionally, what’s exempt at a state-level could still be taxable by the local government. With this complexity, navigating sales tax can be difficult.

So, how to easily identify the taxability of goods and services? Here’s what you can do: 

• Check the state’s specific rules – Most states tend to have a dedicated page indicating which goods and services are subject to sales tax or not. As long as you engage in business with a taxing state, reading the rules is a crucial compliance step.
• Verify the local taxability – Once confirming information at the state-level, you can take an extra precautionary step by verifying whether the county or city applies any local surcharge to the product you are selling. This practice can help avoid calculation errors.
• Read detailed guides – Just as you are reading this blog, you can also check out other posts that can guide you in terms of identifying whether a product is taxable or not. TaxHero offers state-by-state guides you can always refer to. 

NOTE: Sales tax rates and rules change intermittently. To stay compliant, always keep an eye on relevant news updates.

Which States Collect and Do Not Collect?

As of February 2026, a total of 45 states, including the District of Columbia, collect state-wide sales tax. On top of this, most local governments within the states also collect their own. However, the following states do not allow their local governments to collect:

• Connecticut
• District of Columbia
• Indiana
• Kentucky
• Maine
• Maryland
• Massachusetts
• Michigan
• New Jersey
• Rhode Island

For clarification, New Jersey still has an Urban Enterprise Zone, where a reduced local sales tax of 3.3125% is applied.

Meanwhile, the states that do not collect sales tax are called the “NOMAD” states, a name derived from the first letter of those states.

The members of the NOMAD states do not have a sales tax, and those states are:

• Alaska
• Delaware
• Montana
• New Hampshire
• Oregon

NOTE: Alaska allows its local jurisdictions to impose and collect local sales tax. Also, Oregon has a Corporate Activity Tax that functions similarly to a gross receipts tax, which can affect businesses in Oregon.

What are the Sales Tax Rates in each State?

Check out the table below to know what the rates are in each state:

STATE SALES TAX RATE Alabama 4% Alaska 0% * Local rate varies across jurisdictions Arizona 5.60% Arkansas 6.50% California 7.25% Colorado 2.90% Connecticut 6.35% Delaware 0% District of Columbia 6% Florida 6% Georgia 4% Hawaii 4% Idaho 6% Illinois 6.25% Indiana 7% Iowa 6% Kansas 6.50% Kentucky 6% Louisiana 5.00% Maine 5.50% Maryland 6% Massachusetts 6.25% Michigan 6% Minnesota 6.875% Mississippi 7% Missouri 4.225% Montana 0% Nebraska 5.50% Nevada 6.85% New Hampshire 0% New Jersey 6.625% New Mexico 4.875% New York 4% North Carolina 4.75% North Dakota 5% Ohio 5.75% Oklahoma 4.50% Oregon 0% Pennsylvania 6% Rhode Island 7% South Carolina 6% South Dakota 4.20% Tennessee 7% Texas 6.25% Utah 4.85% Vermont 6% Virginia 4.30% Washington 6.50% West Virginia 6% Wisconsin 5% Wyoming 4%

   

When to Collect Sales Tax?

Knowing what sales tax is and how it works is one thing, but knowing when to start collecting sales tax is another concern most new businesses tend to ask.

The short answer: You must start collecting sales tax once your business is registered in a state and it has established a sales tax nexus.

What is Sales Tax Nexus?

A sales tax nexus is a rule created to define your business presence in a state. You may view it as a bridge that connects your business to a state’s economic system. Once you fully cross that bridge, a sales tax nexus is formally established with that state.

When a sales tax nexus is created, your business is generally required to register in the state and begin collecting and remitting sales tax.

But how can you identify once a sales tax nexus exists for your business? Two types of sales tax nexus determine your business’s presence in a state: physical nexus and economic nexus.

Physical Nexus

A physical nexus is established by having a substantial physical presence or engaging in enough taxable sales activities within a state. Here are the common factors that create a physical nexus in most states.

• Physical Location: Having an office, a place for distribution, sales, or showcasing products, a warehouse or storage facility, or any other place where you conduct business.
• Inventory in the State: Storing products within the state, whether it’s done via a third-party fulfillment center or 3PL (such as Amazon FBA) or an online marketplace.
• Business Representatives: Having employees, independent contractors, agents, or other representatives operating within the state on your behalf.

Keep in mind that these are only 3 common factors for a physical nexus. Some states may have other conditions for establishing a physical nexus, such as an affiliate nexus or click-through nexus, as well as being present in trade shows, and more.

Economic Nexus

Economic nexus is established based on two common factors. 

• Total sales revenue
• The number of transactions you’ve had within the state. 

Each state has different thresholds, and these thresholds are also subject to change.

For example, in Alabama, the economic nexus threshold is only $250,000 in gross revenue in the previous calendar year’s sales. Once you meet that amount when making taxable sales in Alabama, you now have an economic nexus in the state.

Note that Alabama has already eliminated its 200-transaction threshold, and other states may also do the same.

To check each state’s economic nexus threshold, read: Ultimate Guide to Understanding Economic Nexus

Who Should Register for Sales Tax

As explained above, you should start collecting sales tax once you create a sales tax nexus. Now that you know the two types of nexus, which one can your business trigger? 

• State-based Businesses: Generally, in-state businesses can quickly establish a physical nexus in the state due to having physical presence, such as having physical stores or warehouses. This often leads local businesses to register almost immediately, unlike remote sellers selling in another state.
• Out-of-state Businesses or Remote Sellers: Remotely selling taxable goods in a state can still make you liable to sales tax obligations once you establish an economic nexus in a state. This means that even if you have no physical presence in the state, businesses must still register for sales tax as long as they create an economic nexus.

Did you know there’s an easy way to keep track of your nexus nationwide? You can try TaxHero’s nexus analysis through our free demo!

How to File Sales Tax Returns

Once you register your business in a state, you become responsible for collecting and remitting sales taxes accurately and on time. If it’s your first time filing a sales tax return, a general rule is that every state has different procedures, requirements, and due dates when filing sales tax returns.

In today’s digital age, where most things can be done online, we can generalize the steps for filing sales tax returns online into this standard process:

• Step 1: Prepare your ecommerce tax report (e.g., tax report from Shopify) – Make sure that your report is accurate and contains all the information you need to file your sales tax return correctly. 
• Step 2: Search for your state’s filing website – For example, Colorado instructs filers to use “Revenue Online” for a simplified filing process. Usually, the filing website is the same page when you register a business online. However, other states could have unique links that may direct you to.
• Step 3: Log in using your sales tax account – Generally, this account refers to your state sales tax account, which is typically created when you register your business online.
• Step 4: Locate the “File Return” option – Different state websites have different layouts, but since your goal is to file a return, most of them should have this option, or it may be worded differently.
• Step 5: Begin filing your sales tax return – Make sure you select the correct filing period and enter your data based on your tax report. Usually, there’s an option to save your return as a draft and continue later, in case you can’t complete the return immediately.

FILING TIP: A few states offer a discount for those who file their returns on time. This is commonly referred to as a “timely filing discount.” However, some states may use different terms, like Nevada’s “Collection Allowance.”

To claim the discount and help save, ensure you always file on time.

How to Stay Compliant with Sales Tax Regulations

With the complex nature of sales tax rules in the U.S., staying compliant feels like a difficult endeavor. To ensure your business abides by the varying laws, here are 7 critical things every business should know to stay compliant. 

1. Keep track of your nexus – It’s important to know where you stand in the “invisible bridge” that connects your business to a state’s economic system. Once you cross that bridge and establish a nexus, you’ll have to comply with tax regulations. Failure to comply results in penalties that can harm your business.
2. Check every state’s specific rules – Never assume that one state’s sales tax rule is the same as another’s. Even if some rules seem common among many states, it’s still best to navigate safely by verifying every individual state’s specific rules.
3. Always keep records – Your transactions are proof of your business activities. Once your business creates a nexus, a good practice to stay compliant is to maintain records. These records will help your business stay clear during audits and avoid penalties.
4. Register your business – Once a nexus is established, don’t delay your business’s registration. Otherwise, you risk being liable for non-compliance. If you need help registering your business, you can let TaxHero do it for you or read our state-by-state guides.
5. Identify your product’s taxability – The taxability of goods and services varies depending on the state’s specific rules and guidelines. You must know where your product is subject to taxation and where it is exempt.
6. Calculate with precision – Even a small difference in the report can cost you an audit. This is why tip #3 is crucial; your records can also help you calculate your total sales tax accurately. Always be mindful of local taxes, district taxes, and local option taxes that may apply to your transactions.
7. Remit sales tax on time – After registering your business, make sure you never miss your returns and their filing due dates. Dates vary across states, so always check the correct due dates for the states you are selling in.

NOTE: You can also consider outsourcing sales tax compliance by choosing the most fitting tax software for you. With TaxHero, we take care of all your compliance needs so you don’t have to.

What are Sales Tax Penalties?

Sales tax penalties are given to those who fail to comply with state and local laws. When they charge a penalty, it often comes with fees and interest, plus the risk of imprisonment. In some cases, authorities may also revoke business permits.

Depending on the offense and the state’s rules, the charges may vary. To learn more about penalties, read our guide.

Looking for help with your business’s needs? TaxHero got you!

We understand that it could be a lot for online businesses, especially the newly established ones, to handle their sales taxes. But worry not, for TaxHero’s team of experts and certified public accountants is here to take the stress of doing your taxes off your list so you can focus on building and expanding your business.

You may book a time with our CEO. TaxHero is eager to contribute to your success by helping streamline your tax compliance matters.

Frequently Asked Questions