Taxes for small businesses: One state can have many tax rates

You’re a new small business owner and you know you have to do something about collecting and remitting state sales tax. So, you get yourself a map that shows what the sales tax rates are in each of the 45 states (plus the District of Columbia) that have a general sales tax, because you know you’re going to have online sales.

That means you’re all set, right?

Hardly.

Most states allow for local option sales taxes, and different states tax different categories of items at different rates. Simply knowing that there are different sales tax rates in different states is merely the start of your sales tax calculation journey.

Welcome to Arab, Alabama, which has in the past held the dubious distinction of having the highest combined sales tax rate in the United States.

As a state, Alabama has one of the lowest general sales tax rates in the nation, at 4%. Depending on what’s being purchased, that state rate is sometimes even lower. For example, Alabama collects a 2% sales tax on car sales and a 1.5% sales tax on farm equipment and manufacturing machines. Food sold in a vending machine is taxed at 3%.

However, Alabama allows local jurisdictions to collect their own sales tax, with rates as high as 7.5%. That’s one of the highest local option sales tax rates in the country, according to the Tax Foundation. In all, there are about 350 local taxing jurisdictions within Alabama. On average, they collect at a rate that’s slightly more than 5%, which is added on to every purchase, along with the state’s 4% general tax rate.

Which brings us back to Arab. Everyone there pays the state’s 4% sales tax (with the above-noted exceptions) on their purchases. And the city itself levies a 5% sales tax within its jurisdiction. However, Arab also straddles the line between Marshall and Cullman counties. Marshall doesn’t have a countywide sales tax — but Cullman does; it’s 4.5%.

Add up the 4% state tax, the 5% city tax, and the Cullman County tax of 4.5%, and residents living on that side of Arab are paying 13.5% sales tax on their purchases. On the other side of town, the combined rate is 9%. (By the way, there’s only one ZIP code for Arab, which is just another example of why you shouldn’t use those postal codes to calculate the amount of sales tax you need to collect.)’

Alabama’s far from the only state that allows for local option sales tax rates that are high relative to the state’s overall sales tax rate. These maximum local rates can double or triple the amount of tax that needs to be collected and remitted in each transaction, which means sales tax rates can vary widely from county-to-county, or between cities. Some other notable examples:

Colorado — state rate is 2.9%, but local taxes can add up to 8.3% to the total
Georgia — state rate is 4%, but local taxes can add up to 5% more
Louisiana — state rate is 4.45%, but local taxes can add up to 7% more
Missouri — state rate is 4.225%, but local taxes can add up to 5.875% more
New York — state rate is 4%, but local taxes can add up to 4.875% more
Oklahoma — state rate is 4.5%, but local taxes can add up to 7% more

Perhaps the extreme example of this is Alaska, which has no statewide sales tax, but does allow local option sales taxes. As a result, 49 jurisdictions have local option taxes.

That means, if you’re a remote seller fulfilling orders in Alaska, you’ll need to remember there’s no sales tax within the boundaries of Anchorage or Fairbanks, but a 5% tax on deliveries to Juneau and 4% in Ketchikan.

You should also take note that Nome has a sales tax rate of 7% from May to August, but only 5% for the rest of the year. It’s one of four local jurisdictions in Alaska that vary sales tax rates by season.

New Jersey has an overall state sales tax of 6.625%.

However, New Jersey also has Urban Enterprise Zones where the tax rate is only half of that — meaning 3.3125%. In addition, businesses within those zones can get full tax waivers on purchases of capital equipment, facility expansions, and upgrades.

The key word there is can. To qualify for the tax breaks, businesses must apply to the Enterprise Zone Authority. The authority can grant certificates exempting businesses from having to collect or remit those portions of the sales tax they’d normally pay. (Exemption certificate management is a complex process. You can learn more about it here.)

There are 32 Urban Enterprise Zones within New Jersey. The zones cover parts — but not necessarily all — of various cities, including some of the state’s largest, like Newark, Elizabeth, and Trenton. The program was established in 1983, to stimulate growth in distressed urban communities. It was renewed in 2018. 

If you’re selling to buyers in New Jersey, you’ll need to be aware of those zones, and the different rates and requirements that go with them.

As of this writing, 32 state legislatures have decided not to tax food for home consumption — that is, groceries. (And of course, five other states have no sales tax at all.)

This could change, however, as a number of states are considering reducing or eliminating taxes on groceries and even restaurant-prepared food.
 

But for now, there are 13 states with a mixed shopping cart of grocery tax laws.

Three states — Alabama, Mississippi, and South Dakota — fully tax groceries.

Four other states fully tax groceries but offer some sort of tax credit or rebate on their state income tax to partially offset the grocery tax:

Hawaii extends its 4% general excise tax (charged to sellers) to groceries. Families earning less than $50,000 a year can apply for a food tax credit on their state income taxes, which can be as much as $110 for joint filers who earned less than $50,000 the previous year.

Idaho offers a $100 per person state income tax credit that is designed to partially offset the cost of the state’s 6% sales tax on groceries.

Kansas, which extends its 6.5% sales tax to all food, offers a $125 per person income tax credit for people over age 55 or for families that have children under the age of 18, provided the filer has income under $30,615.

Oklahoma offers an income tax credit of $40 per person to offset grocery taxes, as long as the taxpayer is over 65, has dependent children, or is disabled — and has earnings under $50,000 a year.

There are six states that tax groceries at rates lower than the state’s general sales tax rate:

Arkansas has a 0.125% grocery sales tax rate, compared to a 6.5% statewide general sales tax. Prepared food is taxed at the general sales tax rate.

Illinois has a 1% grocery sales tax rate, compared to a 6.25% statewide general sales tax. Hot foods and others sold for on-premises consumption are subject to the general sales tax rate.

Missouri taxes food statewide at 1.225%, compared to a statewide 4.225% general sales tax rate, and extends this to garden seeds or plants that produce homegrown food. Prepared foods are taxed at the different rates based on whether they’re served hot or cold.  

Tennessee cut its sales tax rate on food to 4% (down from 5%) in 2017. However, prepared foods are taxed at the state’s general 7% sales tax rate, plus local taxes.

Utah taxes groceries at a reduced 3% but charges a full 4.7% statewide tax rate on prepared food items. In addition, restaurants and bars pay an additional 1% state restaurant tax. Utah actually raised the food tax in 2019, but quickly repealed it after public outcry.

Virginia taxes food for home consumption, and certain personal hygiene items, at 2.5%, which is lower than the general state sales tax rate of 5.3%. Unlike Missouri, seeds and plants for growing food at home don’t qualify for the lower tax rate.

All other states exempt food sales for home consumption, and in most cases, local jurisdictions in those states don’t tax food either. However, Arizona, Colorado, Georgia, Louisiana, North Carolina, and South Carolina allow local jurisdictions to tax food, even when the state doesn’t, according to the Center on Budget and Policy Priorities.   

Some states also have some arcane rules around which food items are taxed and which aren’t. If you’re a specialty food processor shipping your direct-from-the-farm produce or prepared specialty food overnight to any of these states, you’ll need to know which rules and which rates apply to your products.

According to the Tax Foundation, 38 states plus D.C. tax clothing sales like any other retail purchase.

However, seven states have a full or partial sales tax exemption for most clothing sales:

Minnesota, New Jersey, Pennsylvania, and Vermont generally exempt clothing purchases from sales tax. And three states exempt purchases of items up to a certain dollar value: Massachusetts (up to $175), New York (up to $110 per item), and Rhode Island (up to $250).

And as a seller, you’ll either need to manually track which states have what rules for taxing clothing sales — or get software that can do it for you.

None of the examples above account for sales tax holidays, which about 17 states have established to provide tax-free sales of specific products during specific periods. (The precise number fluctuates because some states adopt new holidays while others allow existing holidays to expire.)

Taken all together, there are more than 13,000 different sales tax jurisdictions across the United States. You can get a glimpse of the ones where your small business has potential tax obligations with our free Sales Tax Risk Assessment. You also can learn more about sales tax rates by reading Tax calculation 101, part of our Small business FAQ.

Cover photo by Canva