US Sales Tax 101 — Foreign Startup Guide
Is my startup supposed to pay Sales Tax?
We frequently get asked by non-US founders about US sales tax issues in the context of Saas and marketplaces companies expanding to the US.
When starting a company in the US, most founders are aware that the company will be required to pay some form of income tax to the government. In most cases, the type of tax obligation determines the type of business entity the founder sets up, e.g., the different tax implications of setting up an LLC, C Corporation or the S Corporation. However, one tax that is usually left out of the equation is the state and/or local sales tax. This is a huge mistake since failure to pay sales tax is an offence and the penalties include paying the outstanding tax plus penalties and interest (which could be up to 6.4% of the outstanding tax) and, in some cases, late fees.
But first, what is sales tax?
The sale tax as the name implies is a tax on sales, i.e., sales of goods or services. Sellers, i.e., individuals or companies in the business of providing goods and/or taxable services are required to collect and remit the sales tax to the state or the city. Sales tax are usually governed by state and local laws and prior to the case of South Dakota v. Wayfair, Inc, 138 S. Ct. 2080 (2018) (“Wayfair”), only sellers with a physical presence, such as an office space, a storage facility or employees (‘tax nexus”), in such state were required to pay sales tax. This physical presence requirement excluded out-of-state (e.g. online) sellers who sold in states with no such physical presence in those states.
However, in the Wayfair decision, the US Supreme Court determined that in certain circumstances, states have the right to collect sales tax from out-of-state sellers — this is even when the seller has no physical presence in such state. As such, online businesses which were previously exempt from sales tax laws unless they had physical property or employees in a state. Therefore, any company that either (1) has a physical presence in a state; and (2) is an out-of-state seller but has sales in a state that meet certain conditions may be taxed in such state may be required to pay sales tax.
As of today, about 45 states in the US collect sales tax. However, for the purpose of this article, our focus is on both New York and California state sales tax laws and majorly as it relates to out-of-state sellers.
1. New York (NY)
In NY, the sales tax for taxable items is 4% on certain goods and services. However, to calculate the sales tax to pay for the sale of a taxable item, one would need to also factor in the local sales tax of the particular city, county or school district, and if applicable, the additional Metropolitan Commuter Transportation District (MCTD) tax rate, i.e., multiplying the amount of the taxable sale by the combined state and local sales (including MCTD) tax rate. The MCTD sales tax rate is ⅜% (0.375%) and is applicable to taxable sales within the MCTD. New York City and the counties of Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk, and Westchester are in this district.
For sales in New York City, the sales tax would be 4% (NY State), 4.5% (New York City) and 0.375% (MCTD), a total of 8.875% sales tax. A quick reference guide to what goods and services are considered taxable in NY can be found here. Of note for startups is the fact that computer software are, in certain cases, e.g. prewritten (i.e., canned) software, considered tangible personal property and its sale may be taxable.
Out-of-state sellers.
In addition to requiring sellers with a physical presence in NY to pay sales tax, NY law provides that sellers located outside of NY that sell tangible personal property delivered into NY, and have no physical presence in NY, are required to register as sales tax vendors and collect and remit sales tax on their NY sales if for the immediately preceding four sales tax quarters:
a. the seller earned more than $300,000 in gross receipts from sales of tangible personal property delivered into NY, and
b. the business made more than 100 sales of tangible personal property delivered in the state.
It is integral to understand that conditions (a) and (b) are cumulative and must both be met during the applicable period. Additionally, the tax due is the combined state and local rate in effect in the locality where the taxable product or service is delivered.
In order to determine whether to pay NY sales tax as an out-of-state business, it is recommended that each business first determines the total amount of gross receipts (i.e., without any deductions) from sales of tangible personal property made by the business that were delivered into NY State in the past four sales tax quarters. The NY sales tax quarters are as follows: March 1 through May 31, June 1 through August 31, September 1 through November 30, and December 1 through February 28 (February 29 in a leap year). Secondly, the business should determine the number of sales transactions made into NY during those same four sales tax quarters. If the business meets both requirements (more than $300,000 of gross receipts from sales of property into NY and more than 100 sales transactions in NY), the business must register for NY State sales tax. Where, however, the business meets or surpasses the $300,000 sales threshold, but did not make more than 100 transactions in that period, or vice versa, the business is not required to register for sales tax.
Sales Through Marketplace Providers
In NY, out-of-state seller who sell their products through online marketplaces (marketplace providers) such as Amazon have some leeway in collecting and remitting sales tax. For clarity, a “marketplace provider” is a company that facilitates the sales of tangible personal property by providing a sales forum, such as a catalog, store, website or other forum and collects the money paid by customers (or contracted with a third party to collect the payments) and then pays it to marketplace sellers.
Marketplace providers are required to register with NY for sales tax purposes and collect and remit sales tax if in the previous four sales tax quarters, the cumulative total of the marketplace provider’s gross receipts from sales made or facilitated of tangible personal property delivered into NY exceeded $300,000, and the provider made or facilitated more than 100 sales of tangible personal property delivered in NY.
As marketplace providers are required to collect and remit sales tax on all taxable sales of tangible personal property that they facilitate for marketplace sellers, an out-of-state seller that is required to register as a sales tax vendor need not collect sales taxes on sales made through registered marketplace providers such as Amazon. However, it is imperative that such out-of-state seller has either been issued a Form ST-150, Marketplace Provider Certificate of Collection. Or has entered into an agreement with the marketplace seller whereby the marketplace provider represents to the out-of-state seller that it is registered and will collect and remit sales taxes.
How to Register and Collect Sales Tax
The first step is to determine if the items to be sold are taxable. Then determine if the business is or would be required to pay sales tax, i.e., whether as a business with a physical presence or an out-of-state seller. After making this determination, register as a NY sales tax vendor by completing an online application and obtain a sales tax certificate of authority. The NY State Department of Taxation and Finance recommend that sellers register with the Tax Department at least 20 days before beginning business, if there’s an expectation to make taxable sales in NY. Finally, check if the business is eligible for any exemption.
After collection of the sales tax, each business is required to remit same to the government and file the necessary returns. If you cease doing business, you must surrender or destroy your Certificate of Authority and file a final sales tax return for the business within 20 days of terminating the business.
2. California (CA)
In CA, the state sales tax for taxable items is 6%. However, the total sales tax rate in any given location in CA is broken down into state, county, city, and special district rates. E.g., in San Mateo, there’s a minimum sales tax rate of 6.25%, i.e., the CA’s sales tax of 6% and San Mateo County’s additional sales tax rate of 0.25%, and any additional for the particular city. As such, the sales tax rates in the cities in San Mateo could vary. E.g., for Daly city, there’s an additional rate of 3.00% as special tax (with a total of 9.25%) while Burlingame has an additional Burlingame tax of 0.25 and special tax rate of 3.00% (with a total of 9.50%).
In CA, sale of services is generally not taxable, except in certain instances, such as if the service provided includes creating or manufacturing a product or is inseparable from the sale of a product. However, tangible products are taxable with certain exceptions such as certain groceries, prescription medicine and medical devices. The California CDTFA Publication 61 contains a list of items that are exempt from California sales tax. Note that, like NY, the sale of canned software is taxable in CA.
Additionally, example of physical presence in California include, but are not limited to maintaining inventory or office locations in CA; having representatives in CA for purposes of taking orders, making sales or deliveries, or installing or assembling tangible personal property; and Leasing equipment, including a computer server in CA.
Out-of-state sellers.
In CA, closely related to the sales tax is the use tax. However, while similar, the sales tax generally applies to the sale of merchandise in the state while the use tax applies to the use, storage, or other consumption of those same kinds of items in the state. Essentially sales tax would apply when a product is purchased in California, while use tax applies when a similar purchase is made without tax from a business located outside the state.
In addition to requiring sellers with a physical presence in CA to pay sales tax, CA law provides that retailers located outside of California (i.e., remote sellers) are to register with the CA Tax and Fee Department (CDTFA) and collect California use tax if, in the preceding or current calendar year, the total combined sales of tangible personal property for delivery in CA by the retailer and retailer’s affiliate exceed $500,000.
The above is applicable for any delivery of any product (or taxable service) into CA. Therefore, any remote seller would first determine the total amount of gross receipts (i.e., without any deductions) from sales of tangible personal property (and any taxable service) made by the business that were delivered into CA in the applicable calendar year. If this exceed $500,000 then the business is to multiply the determined total by the applicable tax rate i.e., the CA tax rate with the applicable county and city tax rate. This transaction threshold of $500,000 helps protect small business who do not reach the threshold, however, it is highly recommended for business to monitor their sales in order to protect themselves from any future penalty.
Additionally, the law provides that all sellers required to be registered with the CDFTA, whether located inside or outside of CA, are to collect and pay to the CDTFA the district use tax on all sales made for delivery in any district that imposes a district use tax, if in the preceding or current calendar year, the total combined sales of tangible personal property in this state or for delivery in this state by the retailer and all persons related to the retailer exceed $500,000.
Sales Through Marketplace Facilitators
In CA, the Marketplace Facilitator Act provides that the marketplace facilitator would be regarded as the retailer and must pay sales tax or collect and remit use tax on all sales of tangible personal property into CA, i.e., sales by itself and those sales made on behalf of its marketplace sellers, if the marketplace facilitator’s cumulative sales into CA meet the $500,000 economic nexus threshold.
In CA, “Marketplace facilitator” captures facilitators that list a seller’s items for sale on their platforms, and facilitators that set prices, take orders, or offer payment processing services or fulfillment or storage services. While this may lessen the burden of an out-of-state seller, it does not totally remove the seller’s tax obligations. The seller, in calculating its total sale in CA must include all its sales into CA, i.e., those sold directly and those facilitated by a marketplace facilitator. However, the marketplace seller would be required to pay use tax for its direct California sales and not sales made through the marketplace facilitator because statutorily the marketplace seller is no longer the retailer of such sales.
It is recommended that any out-of-state marketplace seller enter into an agreement with the marketplace facilitator whereby the marketplace facilitator represents to the out-of-state seller that it is registered and will collect and remit sales taxes.
How to Register and Collect Sales Tax
After determining if the items to be sold are taxable and if the business is or would be required to pay sales tax, i.e., whether as a business with a physical presence or an out-of-state seller, the next step would be to register for a permit online as a new business activity or location. Additionally, a business that is not required to register may voluntarily register for a permit to collect and pay use tax as a convenience to its CA customers. After collection of the sales or use tax, each seller is required to remit same to the government and file the necessary returns.
Conclusion
It is highly recommended that any seller of goods and services verify whether it is required by law to pay both state and local sales tax as failure to remit sales tax to the state authorities could expose such seller to huge penalties. Since sales tax requirements and rates vary state by state, we recommend getting an expert opinion to determine whether a seller has any sales tax obligations; if there’s any sales tax exemption applicable to the seller; and the correct rate for the sales tax to be remitted by the seller.
Finally, in order to calculate, collect and track monitor a business sales tax, there are numerous software that could help a business to automate the process. This is particularly important for out-of-state sellers as most states have different requirements for the sales tax and different sales tax rates, with rates varying anywhere from 3% to 9% throughout the country.
