How Sales Tax Is Calculated

For some businesses, collecting sales tax is a compulsory aspect of selling goods and rendering services. After sales tax is collected from customers, it is your responsibility to remit the tax to your state or local government. But before you commence collecting sales tax, you need to understand how to calculate sales tax so you don't remit lesser or higher than the amount you are supposed to pay.

Figuring sales tax rates can be difficult as a result of tricky sales tax laws in different locations. Once the rate at which you need to collect is determined, calculating sales tax becomes very simple.

In this article, we will learn what sales tax is, and how sales tax is calculated.

We will start by defining tax because we need to have the basic knowledge of tax before understanding sales tax.

In case you don't know, tax can be defined as a compulsory levy imposed on individuals, businesses and organizations by the government of a country. With tax, the government can build infrastructures and provide basic amenities for residents.

What is sales tax?

Sales tax can be defined as a tax imposed on customers when they buy goods and services. Sales tax is a pass-through tax, this means you collect it from customers and remit it directly to your state or local government. You do not contribute sales tax as a seller, they are contributed by customers when they purchase your products. There will be no sales tax to pay if you don't purchase a product.

So, this brings us to the most frequently asked question, how much is sales tax? Sales tax is calculated as a percentage of a customer’s total bill. The amount of sales tax to be remitted depends on what state, county, and city where your business has a physical presence.

Is there a need to collect sales tax?

Sales tax must be collected and remitted if your business has a physical presence in a state that imposes sales tax. If your business has nexus in several locations, you might need to collect and remit sales tax for other branches in different states, too.

You have nexus if you store goods, have employees, use a third-party provider to send orders to customers in different states, or attend a trade show in a state with sales tax law.

Sometimes, you might not need to collect sales tax on every transaction, or not to collect at all. Here are some instances where there won't be need to collect sales tax:

1. You do business in a state that does not impose sales tax.

2. There is a sales tax holiday.

3. The item is exempt from sales tax.

4. You sell products to resellers. If you sell products to customers who sell the same product to customers, there will be no need to collect sales tax. Instead, sales tax should be collected by your customer, who becomes the seller. The customers who is also a seller must have resale certificates to be exempt from paying sales taxes.

How to calculate sales tax

If your state, county, and city impose a sales tax on products, all the rates must be added together to arrive at the total rate.

For example, you want to ascertain the sales tax rate for Scottsdale, Arizona. Arizona has a state sales tax of 5.6%, Maricopa County has a county sales tax rate of 0.7%, and Scottsdale has a city sales tax rate of 1.65%.

Once you know the sales tax rate to be collected, then you will use the sales tax formula to determine how much to charge the customer. The amount you collect for sales tax depends on the sales tax percentage and how much money your customer spent on purchasing the products or services.

For example, a customer who purchased goods worth $10,000 will pay more sales tax than a customer who bought goods worth $1,000. The higher your total bill, the higher sales tax you pay and the lower your total bill, the lower your sales tax.

Use the formula below to determine how sales tax is calculated:

Sales Tax = Total sales × Sales Tax rates

To determine how much sales tax to charge on a particular sales, multiply the total bill of your customer by the sales tax rate.

We will use another example to illustrate:

Assuming your business is located in Cleveland, Ohio. You don’t have a secondary business location. You must collect sales tax at Cuyahoga County’s rate of 8.00% (state sales tax of 5.75% in addition to Cuyahoga County rate of 2.25%; Cleveland does not have a city sales tax so there will be nothing to add). Your customer’s total bill before adding sales tax is $399.

Sales Tax = $399 X 0.08

Sales Tax = $31.92

You will collect an extra $31.92 from the customer for sales tax. Then, ensure you remit the sales tax to the appropriate government in charge.