Sales Tax
Even if you don’t sell physical products, it’s still good to have an understanding of sales tax in case you ever decide to sell goods in the future. Also, some states charge sales tax on certain services.
The number one thing to remember about sales tax is that every state has different rules. This is what makes understanding it a pain in the neck and also causes misinformation when people share how sales tax works for them in a Facebook group or forum.
The first thing I recommend doing is figuring out whether or not your state has sales tax. The following five states don’t have a statewide sales tax:
- Alaska (Some localities may have their own sales tax.)
- Delaware
- Montana (Some recreational localities may have their own sales tax.)
- New Hampshire
- Oregon
Next, you need to know whether or not your state has a destination-based, origin-based, or hybrid sales tax.
A destination sales tax means that you will charge sales tax based on the final destination or shipping address of your product. For example, if you live in Alabama and sell a product to someone in Alabama, you will charge sales tax based on the address where the product is being shipped. Your sales tax rate will change often, depending on what the local tax rates are for each address. If you sell a product to someone outside of Alabama, no sales tax is charged unless you meet their economic nexus threshold. More on that shortly!
| Alabama | Kentucky | North Carolina |
| Arkansas | Louisiana | North Dakota |
| Colorado | Maine | Oklahoma |
| Connecticut | Maryland | Rhode Island |
| District of Columbia | Massachusetts | South Carolina |
| Florida | Michigan | South Dakota |
| Georgia | Minnesota | Vermont |
| Hawaii | Nebraska | Washington |
| Idaho | Nevada | West Virginia |
| Indiana | New Jersey | Wisconsin |
| Iowa | New Mexico | Wyoming |
| Kansas | New York |
An origin-based sales tax means that your in-state customers are taxed based on the location of the business. For example, if you live in Arizona and sell a product to someone living in Arizona, you will figure the sales tax based on your business address. The rate will never change unless your business address changes. If you sell a product to someone outside of Arizona, no sales tax is charged.
| Arizona | Ohio | Utah |
| Illinois | Pennsylvania | Virginia |
| Mississippi | Tennessee | |
| Missouri | Texas |
California is the only hybrid sales tax state which charges state, county, and city tax based on the origin of the sale and a district tax based on the destination (shipping address).
Once you’ve determined which type of sales tax your state has, you’ll need to submit an application to get your sales tax ID number. The applications are fairly straightforward, but sometimes the question “how much do you plan to sell this year?” trips people up. Just know that your answer to that question is only being used to determine how frequently you will be required to file and pay your sales tax. It’s absolutely fine to estimate since no one knows what the future holds.
At the same time you receive your sales tax ID number, you will also be told how often to file the sales tax returns. Make sure to add these due dates to your calendar, along with a reminder so you never miss one. The due dates will either be monthly, quarterly or annually. It depends on your state and how much you plan to sell.
You will need a sales tax ID number for any state in which you have “nexus”. This is just a fancy word for having a significant presence within a state. That will definitely include the state you are living and working out of on a daily basis, but it could also include states you travel to for craft shows, markets, and essentially anywhere you physically go to sell your products. If you have a large number of transactions or sell a high volume in another state, you may have a nexus there as well. Again, each state has different rules, so you’ll need to look into those.
In addition, remote sellers are now faced with the new “economic nexus” rule, which became law in June of 2018. This rule requires remote sellers (online and off-line) to collect and remit sales tax to a state once your sales volume exceeds a certain level (as defined by that particular state). Economic nexus is based entirely on sales revenue, transaction volume, or a combination of both, that you have within a state. This means that you may have a sales tax obligation in a state that you never actually step foot in! Our own nexus calculator is a helpful tool in determining where you may owe sales tax.
When you begin selling products (and in some states, services), you’ll want to make sure you are keeping good records. This can be done using a spreadsheet or within your bookkeeping program. When you set up your program, make sure the rates being charged follow the rules of your state.
Finally, when filing and paying your sales tax, you’ll need to have access to all of your records in order to determine the taxable income. The tax calculated on the sales tax form should match up within a few pennies to what you’ve collected for the period. If not, you’ll need to go back through your records to see what’s causing the difference.
Self-Employment vs. Income
Self-employment tax and income tax are often mistaken for the same thing. It’s probably because they’re both paid with your annual tax return, but you should remember that they are two separate taxes.
Self-employment tax consists of two parts. The first part is Social Security tax (12.4% in 2022), and the second part is Medicare tax (2.9% in 2022). You’ll see this calculated on the second page of your personal 1040 tax return. You’ll also see a deduction on the front page for 50% of the tax. While the deduction doesn’t reduce the tax dollar for dollar, it does reduce your overall taxable income, which affects income tax.
Income tax is charged based on what income tax bracket you fall into. In 2022, this ranges from 10% all the way up to 37%.
Both taxes are added together to determine the total tax due on your annual tax return. Remember that when you’re making estimated tax payments, these payments go towards the total tax due on your return, not just self-employment tax or income tax.
Quarterly Estimated Taxes
If you’ve ever worked as an employee of a business, you had taxes withheld on each paycheck. Your employer paid your portion of the tax due plus their portion on a regular basis throughout the year.
When you’re self-employed, it’s your responsibility to pay these taxes to the government throughout the year. Since you’re essentially the employer and employee, you get to pay both parts of the tax.
This is called “self-employment tax.” In addition to self-employment tax, you will also need to pay income tax.
The government wants your tax throughout the year; however, these payments aren’t required. If you miss one, or never make a payment, the worst thing that will happen is that you may be assessed underpayment penalties and interest. This will kick in on your annual federal income tax return if you owe more than $1,000. For your state return, most states operate similarly and have a $500 threshold before the underpayment penalties and interest start to kick in.
Some business owners don’t mind paying the large tax due at the end of the year, but most people prefer to spread the burden out over the four quarters.
Calculating exactly what you owe each quarter can be difficult to do on your own because everyone’s tax situation is different. You can estimate these payments a couple of ways and get pretty close. See the Estimated Tax Worksheet below to calculate your estimates.
Quarterly Estimate Tax Worksheet
There are several ways to estimate your quarterly Federal tax payments. Methods one and two are the easiest while the third takes a little more time to calculate but is more accurate.
Remember that you will be assessed interest and penalties if you didn’t pay 100% (or 110% if you made over $150,000) of your previous year’s tax and you owe $1,000 or more on your tax return. If you overpay, you will receive every dollar overpaid back as your tax refund when you file your annual taxes. If this stresses you out, and you don’t want to DIY this part, contact your accountant, and they should be able to create a tax projection for you to get a more precise estimation on the federal and state level.
Method 1: Safe Harbor
- Look at page 2 of your prior year 1040 form for the line that says “Total Tax” (the last line of the “Other Taxes” section of this page).
- If you or your spouse is an employee getting taxes withheld, subtract the total Federal tax amount they will withhold for the year. If you have a paystub, you can multiply the amount withheld on one paystub by the total paychecks you will receive for the year.
- Now divide the number you’re left with by four, and that is your Federal tax payment each quarter.
- If your total income for the year is over $150,000, you’ll need to multiply your prior year’s “Total Tax” by 110% and follow the same process as above.
( prior year total tax – planned federal tax withholding ) ÷ 4 = amount to pay each quarter
Method 2: Percentage of Net Income
- For each quarter’s income and expenses, subtract expenses from income to get your net income.
- Multiply your net income by 25-30%.
- Pay this amount as your quarterly estimated payment.
( income – expenses ) x __% = amount to pay each quarter
Method 3: Use Worksheet from IRS Pub. 505
- Follow the instructions on the worksheet 2-1 from the publication, pulling information from the current year and previous year’s tax return.
- This method is more time-consuming but will help calculate a more accurate amount to pay.
How to Pay Federal Estimated Tax
There are two options for making your payments:
- Send in a check or money order with the payment voucher Form 1040-ES.
- Pay electronically at IRS.gov/payments. Be sure the person shown first on your tax return is the person whose Social Security number you enter when making the payment.
Quarterly Estimated Taxes Due Dates
Make sure you put these dates (and reminders) on your calendar if you’re planning to pay quarterly estimated taxes:
- Quarter 1 Due Date: April 15
- Quarter 2 Due Date: June 15
- Quarter 3 Due Date: September 15
- Quarter 4 Due Date: January 15
Annual Tax Return
This is where you’ll either hand off your info to your accountant, or you will file your taxes yourself.
If you decide to hire a professional, make sure to hire someone with experience in your industry. They’ll know common deductions that are taken by others in your field and can make recommendations.
Here is a list of things you need to give to your tax preparer for your business taxes:
- If you’re using accounting software, print out an income statement (also called a profit and loss statement) and a balance sheet for the year. If you’re using a spreadsheet, make sure it has all of the income and expenses totaled up for the year, by category.
- Any 1099s you’ve received.
- A list of any assets (computers, camera bodies, printers, etc.) that you purchased or sold during the year. Include the following info:
- Date purchased/sold
- Short description of asset
- Amount paid/sold for
- The total amount of miles driven for business purposes and miles driven for non-business purposes. The easiest way to get the second part is to write down your odometer reading on January 1st and again on December 31st.
- If you worked from a home office space used regularly and exclusively for business purposes, you can collect home office-related expenses. See the home office deduction worksheet for more information on what you can include here.
Don’t have an accountant yet or thinking of switching? There are some things you need to take into consideration when making this important decision. First, talk to others in your industry. See who they recommend, and then reach out to that accountant to see if you’re a good fit. Keep in mind, your accountant doesn’t have to be local. Thanks to the Internet and CPA Mobility laws, accountants can serve clients all over the US.
When you find an accountant you’re thinking about hiring, see if they’re able to talk with you on the phone, on a video call, or meet in person if they’re local. After talking with them for a few minutes, you can usually get a feel for whether or not you’ll want to hire them.
Once your tax return is complete, you’ll know whether or not you’re receiving a refund or need to pay tax due. As a small business owner, the chances of receiving a refund is very low, unless you’ve overpaid your estimated taxes or you’re an employee of a company that’s withholding tax from your paycheck.
If you end up owing more than you have available in savings, take a deep breath and contact the IRS and/or your state about installment payments. They are generally at a lower interest rate than your credit card, and they will take into account your ability to pay when calculating monthly payments.
After the return is filed and you’re done, it’s time to celebrate! Once the celebration is over, take a few minutes to review your tax preparation process. Was it easy? Then no need to change your process. Was it a nightmare? If so, it might be wise to adjust your workflow and put some of my tips into effect so tax time isn’t keeping you up at night.
