Understanding Sales Tax, Its Exemptions And Criteria

Accountancy Resources

Understanding Sales Tax, Its Exemptions And Criteria

Tax Author: Admin


A sales tax is a consumption tax that is typically assessed at the point of purchase (e.g. your local grocery store) on specific goods and services. It is considered to be tax-inclusive if the tax is included in the price of the good or service, and to be tax-exclusive if added at the point of sale. It is usually set by the government as a percentage of the purchase price. However, most states and governing bodies will have a list of exemptions to a sales tax such is commonly the case with non-prepared food.

In theory, a sales tax should meet the following criteria:

  • It is fairly applied to the entire populace
  • It should facilitate a high compliance rate
  • It is difficult to circumvent
  • It is assessed only once on any single item or service
  • It is easy to calculate
  • It is simple to collect

In most cases, a retail sales tax will meet all of the criteria, including the stipulation that it is only assessed once on any single item or service.

It is only assessed one time because tax is only charged on the end-user at the point of purchase, unlike a Value-Added-Tax which is assessed at multiple points along the production/distribution chain.

A gross receipts tax is sometimes confused with a sales tax but fails to meet the necessary criteria. It is levied on intermediate businesses (such as an automobile manufacturer that uses vendor parts to help assemble a finished product bearing the company name) that purchase materials for production or operating expenses prior to delivering a service or product to the marketplace. Thus, a gross receipts tax actually resembles a Value-Added Tax and should not be confused with a true sales tax.

Some argue that a sales tax is not fairly applied to lower-income groups and is therefore regressive in nature. In general, persons with lower income will spend a greater proportion of their income on taxable sales than persons at the higher end of the income spectrum. However, when those in higher-income groups realize capital gains from investments and purchase consumer and even luxury goods, the theoretical regressive nature of the sales tax all but disappears. When total tax paid is divided by the actual tax base (the amount of money spent on taxable goods and services), the rate is flat. This means that persons with higher income pay more actual tax than persons with lower income because they consume more taxable goods. So while tax on spending as a percentage of gross income will be regressive (tax divided by income results in a higher percentage for lower incomes), sales taxes are in reality progressive on consumption due to the rebates and exemptions which tend to help lower the tax burden for low-income persons.

The Internet is a unique venue when it comes to sales tax. It is a common misconception that no one has to pay sales tax for online purchases. This is a prime marketing tool used by many website owners but it is only partially true. Some Internet purchases are in fact subject to sales tax if they meet the following conditions:

  • If the retailer has a physical store in the state where the buyer is making the purchase
  • If the retailer has a physical office in the state where the buyer making the purchase
  • If the retailer operates a warehouse in the state where buyer making the purchase

Some websites that should be collecting sales tax from residents of their home state do not. The bad news for consumers is that even if a site does not collect sales tax (but should, at least for residents of the state where the company is located), the consumer is technically responsible for remitting the unpaid sales tax for the online purchase when the site is physically based in their own state. A Supreme Court Ruling in 1992 (Quill Corporation vs. North Dakota) dictates that the only time sales tax is not due for an online purchase is if the business does not maintain any physical presence in the state of.