Sales Tax Definition

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Sales Tax Definition

What Is a Sales Tax?

A sales tax is a government-imposed consumption tax levied on the sale of goods and services. A standard sales tax is assessed at the moment of sale, collected by the shop, and paid to the government. A firm is responsible for sales taxes in a particular jurisdiction if it has a nexus there, which may be a physical presence, an employee, an associate, or some other kind of presence, depending on the regulations of that jurisdiction.

Understanding Sales Tax

Traditional or retail sales taxes are exclusively levied on the final consumer of a commodity or service. Because the bulk of items in contemporary economies transit through a number of production phases, which are sometimes handled by multiple businesses, a large quantity of evidence is required to verify who is ultimately accountable for sales tax. Assume a sheep farmer sells wool to a yarn manufacturing firm. To avoid paying sales tax, the yarn manufacturer must get a government resale certificate stating that it is not the final user. The yarn manufacturer then sells their goods to a garment manufacturer, who must get a resale certificate as well. Finally, the garment manufacturer sells fuzzy socks to a retail shop, which charges the buyer sales tax in addition to the price of the socks.

Distinct jurisdictions levy different sales taxes, which often overlap, such as when states, counties, and municipalities collect their own sales taxes. Use taxes, which apply to citizens who have bought things from outside their jurisdiction, are closely connected to sales taxes. These are normally set at the same rate as sales taxes, but they are difficult to enforce, so they are only applied on substantial purchases of physical products in reality. A Georgia person purchasing a vehicle in Florida, for example, would be forced to pay the local sales tax, just as if she had purchased it at home.

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Nexus

The way a government defines nexus determines whether a firm pays sales taxes to that government. A nexus is generally defined as a physical presence, but this “presence” is not limited to having an office or a warehouse; having an employee in a state, as well as having an affiliate, such as a partner website that directs traffic to your business’ page in exchange for a share of profits, can also constitute a nexus. This case exemplifies the difficulties that exist between ecommerce and sales taxes. New York, for example, has enacted “Amazon laws,” which require online businesses such as Amazon.com Inc. (AMZN) to pay sales taxes despite their lack of physical presence in the state.

Excise Taxes

In general, sales taxes are calculated as a percentage of the price of the products sold. For example, if a state has a 4% sales tax, a county has a 2% tax, and a city has a 1.5% tax, inhabitants of that city pay a total of 7.5%. However, some things, such as food, are often excluded, or are exempt below a particular level, such as apparel purchases of less than $200. At the same time, certain items are subject to additional taxes known as excise taxes. “Sin taxes” are a kind of excise tax, such as the $1.50 local excise tax charged by New York City per pack of 20 cigarettes on top of the $4.35 state excise tax.

Value-Added Tax

The United States is one of the few industrialized nations that still uses traditional sales taxes (note that, with limited exceptions, it is not the federal government that charges sales taxes, but the states).Value-added tax (VAT) systems have been implemented throughout the majority of the industrialized countries. These charge a percentage of the value contributed at each stage of a product’s manufacture. In the fuzzy sock example above, the yarn manufacturer would pay a proportion of the difference between what they charge for yarn and what they pay for wool; similarly, the garment manufacturer would pay a percentage of the difference between what they charge for socks and what they pay for yarn. To put it another way, this is a tax on the company’s gross margins, not simply the end consumer.

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The primary goal of implementing VAT is to remove tax on tax (i.e., double taxation) that cascades from the production to the consumption levels. For example, a laptop maker may buy raw materials for $10, which includes a 10% tax. This implies he pays $1 in tax on items worth $9. During the production process, he adds $5 to the initial ingredients, for a total worth of $10 + $5 = $15. The final product will be subject to a 10% tax of $1.50. In a VAT system, this new tax may be deducted from the prior tax he paid, lowering his effective tax rate to $1.50 – $1.00 = $0.50.

The wholesaler pays $15 for the notebook and sells it to the store for $17.50, a $2.50 profit. The 10% tax on the gross value of the product will be $1.75, which he may offset against the tax on the manufacturer’s original cost price, which is $15. As a result, the wholesaler’s effective tax rate will be $1.75 – $1.50 = $0.25. If the store has a $1.50 margin, his effective tax rate is (10% x $19) – $1.75 = $0.15. The total tax that will be levied from the producer to the store will be $1 + $0.50 + $0.25 + $0.15 = $1.90.

The absence of VAT in the United States indicates that tax is paid on the value of products and margins at every level of the manufacturing process. This would result in a larger overall amount of taxes paid, which would be passed on to the end consumer in the form of increased prices for products and services.

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