Quick overview

Sales and use tax are among the most common state-level taxes small businesses face. Sales tax is a tax you collect from customers when you make a taxable retail sale. Use tax is what you (or your business) owe when sales tax was not collected on a purchase made out of state or from a vendor who didn’t charge the correct tax.

These taxes are set and enforced by state (and often local) authorities. There is no federal sales tax. The legal framework for modern multi-state collection was reshaped by the U.S. Supreme Court in South Dakota v. Wayfair, Inc. (2018), which allowed states to require out-of-state sellers to collect sales tax based on economic activity rather than physical presence. That means many online sellers now must register and collect tax in states where they meet economic thresholds (varies by state).

Authoritative sources: state Departments of Revenue (check your state’s site for rates and rules), U.S. Small Business Administration (SBA) guidance on state taxes, and the South Dakota v. Wayfair decision for nexus rules.

How sales tax works in practice

  • Sales tax is charged to the customer at the point of sale. The seller is responsible for collecting the tax and remitting it to the appropriate state/local tax authority.
  • Rates can include a state rate plus additional local (county, city, district) taxes. Effective total rates vary widely by jurisdiction.
  • Not every product or service is taxable. States maintain detailed lists of taxable versus exempt goods and services (e.g., most states tax tangible personal property; some tax certain digital goods or services).

Example: A coffee shop in Texas charges sales tax on the sale of beverages. The shop collects tax at the point of sale, holds it in trust, and remits it to Texas Comptroller based on the shop’s filing frequency.

How use tax applies to small businesses

  • Use tax complements sales tax. If your business buys taxable goods from an out-of-state seller that did not collect sales tax (for example, a vendor in another state or a foreign supplier), you generally owe use tax to your home state.
  • The use tax rate is typically the same as the sales tax rate that would have applied in your jurisdiction.
  • Businesses commonly owe use tax on equipment, supplies, or inventory purchased without tax.

Example: A California bakery buys a $3,000 industrial mixer from an out-of-state supplier that didn’t charge sales tax. The bakery must report and pay California use tax on that purchase.

Nexus: When you must register and collect

Nexus is the connection that triggers a state’s authority to require you to collect sales tax. Physical presence (store, warehouse, employees) created nexus historically; after Wayfair (2018), economic nexus—measured by sales amount or transaction count—also allows states to require remote sellers to collect tax.

  • Typical economic thresholds: $100,000 in sales or 200 transactions, but thresholds vary by state and change over time. Always confirm the exact threshold on the state’s Department of Revenue website.
  • Even without nexus for collection, your business may still owe use tax on purchases for in-state use.

Practical note from my practice: when onboarding an online seller, I map all sales channels and cross-check each state’s registration thresholds. Many small sellers are surprised to learn that a single large sale can create a registration requirement in a new state.

See our guide on State Sales Tax Registration: When and How to Register for step-by-step registration advice.

Common taxable vs. exempt items (general rules)

  • Commonly taxable: physical goods, prepared food, certain digital products, and some services (taxability depends on state).
  • Commonly exempt: wholesale sales resold by the buyer (resale certificate required), many professional services (varies), some groceries and prescription drugs (depends on state).

Always verify taxability with the state’s published lists and the seller’s certificate rules. Using a blanket assumption is risky and a leading cause of audit adjustments.

Filing, remittance, and reporting

  • Register for a sales tax permit in each state where you must collect tax.
  • File returns and remit collected taxes to the state on the schedule the state assigns (monthly, quarterly, or annually) — frequency is typically based on your sales volume.
  • Track exempt sales, resale certificates, and refunds accurately; states will require supporting documentation during audits.

Pro tip: Automate returns using accounting software that integrates with tax calculation engines. This reduces manual errors and helps prepare for state audits.

See our practical guide: Sales Tax Compliance for Online Sellers: A Quick Guide.

Use tax reporting and how to capture it

  • Many states allow or require businesses to report use tax on the same return used for sales tax.
  • For purchases where you did not pay sales tax, keep vendor invoices and calculate the use tax owed by applying the local rate where the item is used.
  • Consider an internal purchasing control: when staff buy supplies, require documentation for tax charged at purchase or a process to collect and remit use tax.

Example control: a centralized purchasing card (P-card) program that routes all non-taxed out-of-state purchases to an accounts payable reviewer who flags use-tax liabilities.

Common mistakes that trigger audits or penalties

  • Failing to register in states where you meet nexus thresholds.
  • Not collecting tax on taxable sales or incorrectly applying exemptions without proper resale certificates.
  • Poor recordkeeping: inability to produce invoices, exemption certificates, or filing history.
  • Confusing sales tax and income tax responsibilities—sales tax is collected from customers and held in trust until remitted.

Penalty risks include back taxes, interest, and state-imposed penalties. Several states aggressively audit online sellers using marketplace data and third-party reporting.

Practical compliance checklist (actionable steps)

  1. Identify all sales channels (online marketplaces, own website, brick-and-mortar).
  2. Map physical locations (stores, warehouses) and remote activity that may create nexus.
  3. Review sales volume and transaction counts against each state’s economic nexus thresholds.
  4. Register for sales tax permits in states where nexus exists.
  5. Configure point-of-sale or ecommerce tax settings to apply correct rates, including local add-ons.
  6. Collect and store resale/exemption certificates in a central repository.
  7. File returns and remit payments on assigned schedules; track due dates.
  8. Reconcile collected tax to posted returns monthly.
  9. If uncertain, engage a CPA or state-sales-tax specialist.

Special considerations for marketplaces and SaaS/digital goods

  • Many states have marketplace facilitator laws: the marketplace (e.g., Amazon, Etsy) may be responsible for collecting and remitting tax on seller transactions. Sellers still need to understand reporting and possible registration obligations.
  • Tax treatment of digital goods, subscriptions, and SaaS varies by state. A service or digital product taxable in one state may be exempt in another.

For more on how sales and use tax differ across transactions, see How State Sales and Use Tax Differ: A Primer.

Cost-control and cash-flow tips

  • Do not treat collected sales tax as revenue—segregate it on your balance sheet (liability account) until remitted.
  • Negotiate vendor terms that include tax treatment clarification. For large capital purchases, ask vendors to collect tax if registered in your state, or be prepared to remit use tax.
  • Use tax credits where states allow (e.g., if you paid tax to another state and can credit that against your home state liability).

Examples and real-world scenarios

  1. Online retailer exceeding $100,000 in sales in State X: registers, collects, and remits; files monthly returns.
  2. Small manufacturer buys parts from a foreign supplier who didn’t charge tax: records use tax, remits on the quarterly return.
  3. Contractor purchases materials out-of-state: if resale exemption applies when reselling materials to a contractor client, keep the resale certificate. If materials are used in your business, use tax may apply.

In my practice, proactive mapping of nexus and early registration cut a client’s audit exposure by more than half within two years — mostly by centralizing exemption documentation and automating collections.

Penalties, audits, and resolving disputes

States can assess back tax plus interest and penalties. Typical defenses include demonstrating reasonable reliance on vendor tax collection or good-faith efforts to comply. Prompt voluntary disclosures or payment plans can reduce penalties.

If you receive a notice, preserve records, respond by the deadline, and consider engaging a tax attorney or CPA experienced in state and local tax matters.

Professional disclaimer

This article is educational and does not substitute for professional tax advice. State laws change and specifics vary. Consult a qualified tax advisor or your state Department of Revenue for guidance tailored to your situation.

Authoritative resources

  • South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018) — U.S. Supreme Court decision on economic nexus.
  • U.S. Small Business Administration (SBA) — state and local taxes for small businesses: https://www.sba.gov/
  • State Departments of Revenue — search your state’s official site for rates, registration, and filing rules.
  • Tax Policy Center — analysis of sales and use tax rules and trends.

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