Understanding U.S. Sales Tax: A Guide for Foreign Sellers

For foreign businesses entering the U.S. market, the process of navigating sales tax can boggle the mind. Unlike many countries with a single national tax system, the United States operates a decentralized sales tax structure, where each of its 50 states establishes its own tax rules, rates, and exemptions. This means that foreign sellers must adjust to a variety of different requirements depending on where they do business. So here it is – the basics of U.S. sales tax to help foreign sellers adapt, and then a deeper dive into the various exemptions that can bring tax relief.

Here’s what you can discover:

  1. The Basics of U.S. Sales Tax
  • U.S. Sales Tax Overview
  1. Common Sales Tax Exemptions
  • Resale Exemption
    • How the Resale Exemption Works
    • The Role of Resale Certificates
  • Non-Profit Organizations
    • Tax Exemptions for Non-Profit Entities
    • Eligibility and Requirements
  • Government Entities
    • Sales Tax Exemption for Government Entities
    • Documentation Requirements
  • Product-Specific Exemptions
    • Exemptions for Food, Clothing, Medical Devices, and More
    • State Variability in Product-Specific Exemptions
  • Manufacturing Exemptions
    • Exemption for Machinery, Raw Materials, and Equipment in Manufacturing
    • State-Specific Rules for Manufacturing Exemptions
  1. Obtaining and Maintaining Exemption Certificates
  • Importance of Exemption Certificates
    • Role of Certificates in Sales Tax Compliance
  • Process for Obtaining Certificates
    • Steps to Secure Exemption Certificates
    • Variations by State
  • Best Practices for Certificate Management
    • Keeping Accurate Records
    • Ensuring Timely Renewals and Proper Documentation
  1. Comparing U.S. Sales Tax to VAT
  • Key Differences Between U.S. Sales Tax and VAT
    • Scope and Application
    • Documentation Requirements
    • State Variations vs. Nationwide VAT Rules

Not quite what you need? Let’s talk. Reach out to us at info@milesconsultinggroup.com.

1. The Basics of U.S. Sales Tax

As mentioned, sales tax in the United States operates under a decentralized system, where state and local governments administer and collect the tax, unlike the uniform Value-Added Tax (VAT) systems found in many other countries. This means there is no national sales tax; instead, the tax rates, rules, and enforcement mechanisms are determined at the state and local levels.

Key Features of the U.S. Sales Tax System

  1. Jurisdictional Variability:
    Sales tax rates and taxable categories of goods and services can vary widely not only between states but also among local jurisdictions within the same state. Some states, like Oregon and Delaware, impose no sales tax, while others, such as Tennessee and Louisiana, have combined state and local rates that exceed 10%. This patchwork structure demands careful attention to the specific tax rules in each relevant jurisdiction.
  2. Origin-Based vs. Destination-Based Taxation:
    Most states operate under a destination-based sales tax system, where the applicable rate is determined by the location of the buyer. However, a few states use origin-based taxation, taxing goods and services based on the seller’s location. This distinction is critical for determining the correct tax rate and compliance obligations, particularly for remote or online sales.
  3. Taxable Goods and Services:
    Each state defines its own criteria for taxable goods and services. While tangible personal property (e.g., electronics, clothing) is typically subject to sales tax, the taxability of services, digital goods, and software varies significantly. For instance, states like Texas tax data processing services, while others, like Colorado, may exempt them. In fact, to further emphasize the point, we have a lot of clients in the SaaS space.  California does not tax SaaS. Washington, New York and Massachusetts are 3 of about 21 states which DO tax SaaS. Texas, mentioned above, classifies SaaS as taxable data processing services (and gives a 20% reduction in the taxable base), while Colorado doesn’t tax SaaS at the state level, but cities within Colorado, like Boulder and Denver DO tax SaaS. Need a roadmap? Check out this article about SaaS.
  4. Local Government Impact:
    In addition to state sales taxes, many local governments impose additional taxes, which can create layered obligations. Sellers must not only account for the state-level tax but also ensure compliance with local rates, surcharges, and filing requirements.

Considerations for Foreign Sellers

For foreign businesses selling into the U.S., understanding the lack of uniformity in sales tax rules is crucial. Compliance challenges include:

  • Economic Nexus Thresholds: Following the Supreme Court’s 2018 South Dakota v. Wayfair decision, states can require remote sellers to collect sales tax if they exceed certain thresholds for sales volume or transaction count. These thresholds vary by state, adding complexity to compliance.

For more on the Wayfair decision and how it affects your tax liability by state, read this article we wrote.

  • Marketplace Facilitator Laws: Most states now require marketplaces like Amazon or eBay to collect and remit sales tax on behalf of third-party sellers. Foreign sellers must understand their responsibilities under these laws.

For more on what makes you a marketplace facilitator, read this article we wrote.

  • Documentation Requirements: Properly managing exemption and resale certificates, invoices, and tax filings is critical to avoiding penalties or audit risks.

2. Common Sales Tax Exemptions

Exemptions play a crucial role in helping businesses reduce their tax obligations and stay compliant with U.S. sales tax law. While exemptions vary by state, here are some of the most common categories that foreign sellers should be aware of:

Resale Exemption

One of the most important exemptions is the resale exemption, which applies to businesses that buy goods with the intent to resell them. In these cases, the seller does not have to collect sales tax on the transaction. To claim this exemption, the buyer must provide a resale certificate, a document that proves the purchase is for resale rather than for personal use. The process for obtaining and maintaining these certificates varies by state, and failure to comply can result in penalties.

Non-Profit Organizations

Certain non-profit organizations, such as charities and religious institutions, are eligible for sales tax exemptions in most states. These organizations must apply for tax-exempt status with the IRS and, once approved, they can present this status to vendors to avoid paying sales tax on their purchases. Note, however, that the form of the exemption certificate may differ between states as well. While many states do offer an exemption for sales to non-profit entities, some, like our home state of California, do not. Or, they may offer exemptions only to certain kinds of non-profit entities.  And of course, individual states may have additional requirements for proving eligibility.

Government Entities

Sales to government entities—whether federal, state, or local—are often exempt from sales tax. Sales to the US government are always exempt (although it may be tricky to determine exactly who is “the US government,” as certain agencies don’t qualify for a blanket exemption. Sales to other state and local entities are also often exempt, but not always! For foreign sellers, this means that sales made directly to government agencies or through government contracts are often not subject to tax. However, the seller must request and verify proper documentation, such as tax exemption certificates or purchase orders, to ensure compliance.

Product-Specific Exemptions

Many states offer product-specific exemptions, which can vary significantly depending on the state. Common examples include exemptions for food, clothing, medical devices, and certain types of manufacturing equipment. While some states exempt groceries or prescription drugs, others may not, creating a need for businesses to understand the specific rules in each state.

Manufacturing Exemptions

A particularly important area of exemption for foreign businesses engaged in manufacturing is the exemption for machinery, raw materials, and equipment used in production. This exemption allows manufacturers to reduce costs on necessary materials and equipment, but again, the rules vary by state. For example, some states allow exemptions for manufacturing tools and machinery, while others only provide exemptions for the raw materials directly involved in the production process.

3. Obtaining and Maintaining Exemption Certificates

Exemption certificates are crucial documents that foreign sellers must manage carefully to ensure compliance. These certificates serve as proof that a buyer is eligible for a specific exemption, such as resale or non-profit status. Below are some steps foreign businesses should take when dealing with exemption certificates.

Importance of Exemption Certificates

Exemption certificates are the foundation of tax compliance for businesses seeking to take advantage of available exemptions. Without these certificates, businesses may find themselves liable for sales tax, even if the transaction should have been exempt.

Process for Obtaining Certificates

To obtain exemption certificates, businesses must follow a state-specific process, which often includes submitting a completed form to the state tax authority. Different states may have varying renewal requirements, or some states may accept certificates from other jurisdictions, adding another layer of complexity for foreign sellers.

We can help you in the process. Contact Miles Consulting now.

Best Practices for Certificate Management

Proper management of exemption certificates is key to minimizing the risk of audits and ensuring compliance. Businesses should maintain accurate, up-to-date records of all exemption certificates, ensuring that certificates are renewed on time and that proper documentation is collected for every transaction where an exemption is claimed.

4. Comparing U.S. Sales Tax to VAT

For foreign sellers accustomed to VAT systems, understanding the structural and operational differences between VAT and U.S. sales tax is critical for ensuring compliance in the U.S. market. VAT (Value-Added Tax) is a multi-stage consumption tax levied at each point of the supply chain, from production to final sale, based on the value added at each step. In contrast, U.S. sales tax is a single-stage tax applied only to the final retail transaction. This difference significantly influences pricing strategies, compliance workflows, and record-keeping practices.

VAT operates under a nationwide framework with uniform rules, simplifying compliance across countries that use this system. U.S. sales tax, however, is a decentralized system where tax rates, exemptions, and filing requirements vary by state and, in some cases, by local jurisdictions. This fragmented regulatory environment necessitates a more tailored approach for foreign businesses operating in multiple states, requiring precise management of varying tax obligations.

Key Differences Between VAT and U.S. Sales Tax

  • Scope of Taxation:
    • VAT: Imposed at every stage of the supply chain, with businesses reclaiming VAT paid on inputs.
    • U.S. Sales Tax: Collected only at the final point of sale to the end consumer, with no input tax credit mechanism.
  • Documentation Requirements:
    • VAT: Involves detailed invoicing for every transaction within the supply chain to track tax credits and liabilities.
    • U.S. Sales Tax: Focuses on managing exemption certificates, tracking taxable versus non-taxable sales, and adhering to state-specific reporting obligations.
  • Regulatory Uniformity:
    • VAT: Governed by a consistent national framework, reducing administrative complexity.
    • U.S. Sales Tax: Managed at the state and local levels, resulting in diverse tax rates, exemption criteria, and compliance requirements.

Partnering with Experts: Miles Consulting Brings the Human Touch

If you’re suitably nervous now about your tax compliance as a foreign seller, we can help. Yes, navigating U.S. sales tax laws can be challenging, especially for foreign businesses unfamiliar with the complexities of state-specific regulations, but that’s where professional guidance makes all the difference. At Miles Consulting Group, we don’t just provide tax solutions. We collaborate with you to understand your unique needs and tailor strategies that fit your business – even if you’re all the way ‘across the pond.’ Helping foreign companies succeed in the U.S. market is what we do best. Let’s work together to simplify your sales tax processes and ensure compliance, so you can focus on growing your business here in the States. You’ll be in good company! We’ve worked with clients across the globe, including Canada, Mexico, countries in the EU and Asia, and Australia – just to name a few!

Whether you’re new to the U.S. market or expanding your operations, our expertise can help you streamline your sales tax processes and avoid costly mistakes. Book a consultation, drop us a line, or send us an email at info@milesconsultinggroup.com.