Overview of Sales and Use Taxes
Sales taxes are imposed on individuals and businesses which sell goods (not services) within the State of California. The amount is calculated by the CDTFA as the total receipt of sales minus any non-taxable sales.
An item is taxable if it is tangible personal property, which includes retail goods of all kinds. Although in general services are excluded, they may be subject to sales tax if they result in the production of a retail good.
A use tax differs in that it applies where a good is purchased from an out-of-state retailer who is selling the good within California but does not have sales nexus within California such that they are required to collect sales tax. The applicable tax rate is the same for both sales and use taxes.
As a business owner, you are responsible for paying the sales tax to be remitted to the CDTFA and you carry the liability for any unpaid amounts. However, you may pass the cost of that sales tax onto the consumer as long as the buyer is made aware that they are paying sales tax as part of the transaction.
Business owners must have a permit in order to collect sales tax and should register for the permit as soon as possible.
Rates of Sales Tax
Sales tax is measured by determining the business’s gross receipts and subtracting any non-taxable sales. The CDTFA may conduct an audit of sales/use tax at their discretion.
The current tax rate in California is 7.5 percent statewide, and is due to decrease to 7.25 percent at the end of 2016. However, some districts within California have voted for an additional ‘district’ tax which brings the total rate higher.
In Santa Barbara County, for example, an additional 0.5 percent has been added, meaning that the total sales tax collected is 8 percent. The CDTFA provides a complete listing of all city and country district taxes and rates.
Exemptions and exclusions from sales and use taxes
There are a number of exemptions to the obligation to remit sales and use taxes. Some of these exemptions exist in an attempt to promote certain types of industry or consumer choices. An example is the current such exemption on fresh, but not prepared, foodstuffs.
Other exemptions exist to avoid burdening certain organizations with the obligation to collect sales tax, and so many nonprofit or veterans’ organizations are wholly exempt. Other exemptions are in place so that the same item does not give rise to two sales tax charges. Thus, items purchased for resale, or to various out-of-state entities (usually transport companies) or which are in transit to an overseas destination, are exempt.
Other examples of exempt sales include sales of certain food plants and seeds, sales to the U.S. Government and sales of prescription medicine. The list of exemptions is long and detailed, so if you are not sure if your business falls under those headings, you may wish to clarify with the DOE. A comprehensive list is available as Publication 61.
In general, businesses which provide a service that does not result in a tangible good are exempt from sales tax, as it only applies to goods. For example a freelance writer or a tradesperson is not required to remit sales tax, although a carpenter making custom furniture is so required.
Online sellers who do not have sufficient sales nexus within California also do not have to collect sales tax, although the test for “sales nexus” is so wide that it will be considered sufficient if one of your affiliates, agents, warehouse suppliers or other place of business is located within the state. Presence at trade shows or conventions for more than 15 days in a calendar year will also establish nexus.
If you are selling to a customer who has an exempt status, you must collect a California Sales Tax Exemption certificate and keep it on file. If you are audited, you will be expected to produce this as proof that you sold an exempt item.
If you are a reseller, you may also apply for a California Resale Certificate, which allows you to buy goods within California for resale without paying sales tax on those goods.
What Sales are Subject to Sales Tax?
Nearly all states in the U.S. charge sales tax on items sold, California is no different in that regard. Sales taxes go into the general fund to help pay for education, health care, public pensions, and other programs. Sales taxes can also be collected for special programs or specific areas of the state.
How Does Sales Tax Work?
California state sales and use tax is administered by the California Department of Tax and Fee Administration (CDTFA) and applied as a base percentage rate (currently 7.25 percent in California) plus any local and district tax. Sales tax can be up to 10 percent or more on certain purchases.
A district can be an entire county or part of a municipality. District taxes are approved by the local voters and are used for special services, such as libraries, or general services. Sales and use taxes go into the state’s general fund.
Use tax is typically collected by the retailer at the time of sale, but it is imposed on items for use in California but purchased outside of the state.
Sales and use taxes are charged at the same rate.
The seller is responsible for paying the correct amount of tax to the CDTFA and almost always collects it from the purchaser. If the seller does not remit the taxes, they are then subject to additional tax charges, applicable penalties, and interest charges.
What is Subject to State Tax?
Sales and use taxes are collected on the retail sale or use of tangible personal property within the State of California.
Sales tax is imposed on items such as:
Some services require sales tax to be collected as well, but it can get tricky. If the service is “inseparable from the sale of a physical product,” that service may be taxed as well. It includes services such as machine or equipment set-up, fabrication, or assembly.
Installation and repair, on the other hand, are not taxable (usually) but installation and set-up sound like the same type of services. Construction is another service where it can be debated whether sales tax applies.
If you think that is complicated, shipping and handling are worse. California has unusually complex rules surrounding shipping which can be tax-exempt, partially taxable, or fully taxable depending on the situation.
If you do not keep accurate records of your shipping costs, include delivery charges in the cost of the product, or deliver it using your own vehicle instead of a common carrier, the shipping charges may be fully taxable and you, as the seller, are stuck for it.
When it comes to drop shipping and tax nexus, more complications set in.
Tax Exempt Items
There is a long and detailed list of items that are not taxable, but generally, the following are tax exempt:
- Food for human consumption
- Manufacturing machinery
- Raw materials for manufacturing
- Utilities and fuel used in manufacturing
- Medical devices and services
Looking at these lists, you can see the delineation between taxable and tax-exempt can be anything from the fact that the item in question is a human necessity, like food, to non-profit organizations to tax breaks provided to encourage certain industries to operate in the state. It seems like for each exemption or exclusion there is an exception to the rule. Let us take a look.
Overview of Tax Exempt Items
For a detailed list of tax-exempt items, the CDTFA puts out a Sales and Use Tax publication that shows the exemptions and exclusions to the tax, some of which have expiration dates.
The CDTFA breaks the items into broad categories:
- Necessities of life
- General public benefit
- Industry benefit
- Exclusions by definition
- Other exemptions, exclusions and credits
As you may have guessed, the top necessity of life is food. However, the exemptions can appear complicated because the CDTFA looks at a variety of items that may not seem to be food but are related in a way that allows tax exemption.
For example, most food products for human consumption are easily recognized but where and how they are sold impacts the exemption. Food that falls under the following conditions is considered taxable:
- Sold in a heated condition
- Served as meals
- Consumed on or at a seller’s facilities
- Is ordinarily sold for consumption on or near the seller’s parking facility, or
- Is sold for consumption where there is an admission charge
However, there is an exception. Hot bakery items or hot beverages such as coffee sold for a separate price are still tax exempt.
The justification for the tax exemption on food products sold through a vending machine is just as convoluted. The vending machine operator is considered the consumer of any food products retailing for 15 cents or less and food products sold through bulk vending machines for 25 cents or less.
Wait, there is more: for sales of cold food products, hot coffee, hot tea and hot chocolate through a vending machine for more than 15 cents, 67 percent of the receipts are tax exempt. The rest is fully taxed.
Other necessities of life include health-related products, services, and meals as well as some utilities like gas, water and electricity.
General Public Benefit
General public benefit tax-exemptions are conferred on alternate energy technology, museums and public art exhibits, certain aspects of non-profit, religious or educational organizations, and miscellaneous categories such as POW bracelets and pollution control facilities.
Non-profit organizations may only be tax-exempt if the profits from the items they sell go to benefit a specific group, such as AIDS/HIV patients or disabled children. Some exemptions even include language requiring the items to be made by the non-profit group.
Industry benefits in California obviously include the entertainment industry but also include transportation, petroleum, leasing, and manufactured houses and buildings, plus a raft of special classes like numismatic coins, custom computer programs and hay production.
Other exclusions and exemptions can be found in the list that includes details about sales prices and gross receipts, admission charges, and other transactions not considered to be tangible personal property. There is even an exclusion for the term “person.”
It seems there is no such thing as a simple tax. Sales and use taxes carry a plethora of legal definitions, exclusions, exemptions and exceptions within a group of exemptions. It’s enough to make a seller’s head spin. However, it is unlikely a single seller will need to be cognizant of every category.
If you are not certain whether you should collect sales or use tax, look at the California Department of Tax and Fee Administration website or call a knowledgeable tax attorney to help you make certain you are doing the right thing.
How the California Sales Tax Rate is Determined
New sales and use tax rates for the State of California have gone into effect January 1, 2017. You may be wondering how the rates are set and why they seem to vary across the state.
Here is a brief review of the sales and use tax and then we will break down how California sets its sales tax rate and the various elements that impact the rate.
Sales and Use Tax Review
Currently, the base tax rate for the state sales tax is 7.5 percent. Local jurisdictions may add onto that. This tax is imposed on all California retailers and applies to all retail sales of merchandise within the state. All retailers must have a seller’s permit and pay sales tax to the California California Department of Tax and Fee Administration.
Retailers are allowed to collect the sales tax from customers but are not required to do so. Most retailers do. In all cases, they are liable for sales tax on anything they sell, whether the tax is collected from customers or not.
Use tax is levied on consumers of merchandise used, consumed or stored in the State of California. It does not matter where it was purchased. If you buy something from an online source that is not registered to collect California sales tax or else does not collect it, you are on the hook for paying the tax, which is the same rate as the sales tax.
Use tax is also imposed on leased merchandise such as cars, boats and planes. If you make a purchase in a foreign country and hand-carry it through U.S. customs into California, you must pay the use tax.
Sales and use taxes are mutually exclusive. You cannot be required to pay both sales tax and use tax for the same merchandise.
Components of the Statewide Sales and Use Tax
There are seven components to the sales and use tax rate; six are state and one is local. Just over half of the sales and use tax goes to the state’s General Fund. A portion of a percent is sent to the state for local safety, statewide education, and local revenue support for health and social services.
The local component receives just over 1 percent for county transportation and city or county operations.
Why Does the Tax Vary and Change?
While the state sets a base sales tax rate, district tax jurisdictions are allowed to add onto it. The jurisdiction may encompass an entire city, or one jurisdiction may be covered by two different tax districts.
If you are engaged in business within a tax district, you are liable for the state sales tax and any additional taxes levied by the tax district in which your business is located.
Tax rates are changed two ways:
- Voters approve a new tax
- An old tax district expires
Destination vs. Origin Tax Rates and Nexus
Some states require you to collect sales tax for the state where the purchase originated (origin tax rate) while others require you to collect sales tax for the state where the merchandise was purchased (destination tax rate).
Other states, including California, determine whether you have a nexus within the state requiring you to pay sales or use tax.
A nexus is a significant presence in the state. In California, this means every retailer engaged in business within the state for the purpose of commerce according to the clause of the U.S. Constitution has a nexus.
It also includes any retailer that federal law allows the state to impose a use tax collection duty.
You could have a nexus simply because you have a presence at a trade show or you have affiliate sales within the state. Selling through AmazonFBA may cause you to have a nexus; the amount of tax depends on the location of the California warehouse where your products are stored.
Filing deadlines are set for annual, quarterly, and monthly filers. There is also an option for quarterly filing with monthly prepayments.
Annual sales tax returns are due January 31 of the year following the taxable period. If you plan to file an annual return for 2016, your deadline is January 31, 2017.
Quarterly sales tax returns are due on the following dates in 2017:
- First quarter (Q1) is due May 1
- Second quarter (Q2) is due July 31
- Third quarter (Q3) is due October 31
- Fourth quarter (Q4) is due January 31
If you file monthly, your return is due on the last day of the month following the taxable month. For example, you would file sales taxes for February 2017 by March 31, 2017. The deadline for March 2017 taxes is due by May 1 since April 30 is on the weekend.
Quarterly filers with monthly prepayments due file their tax returns on the same quarterly dates as above but prepayments are due on the 26th of each month.
Keep In Mind for 2017 and Beyond
The definition of a retailer “engaged in business” in a tax district means that you:
- Ship or deliver the merchandise into the district using your own vehicle
- Maintain, occupy, or use any type of office, sales floor, warehouse, or other space within the district, even if it is a temporary space, you are doing business indirectly or through an agent
- Have a representative of any kind making sales or deliveries, installing or assembling personal property, or taking orders within the district
- Receive revenue from the rental or lease of tangible personal property located in the district
- Sell or lease vehicles or undocumented vessels, which will be registered within the district
As long as you are “engaged in business” within the district, you are responsible for reporting and paying district taxes as well as state taxes. The requirement also applies to multiple business locations.
You are liable for the sales tax amount in force in the district where you have a retail presence and conduct principal negotiations for sales within that district.
For use tax, there is a single exception to payment or collection: if you ship or deliver merchandise outside of a district to a purchaser’s principal residence address or business address unless the merchandise is a vehicle, vessel, or aircraft.
The caveat is that you must accept, in good faith, a properly executed declaration under the penalty of perjury to be relieved of this obligation.
Some things are not taxable:
- Services you perform unless you create or manufacture a product in the process
- Exceptions noted in the tax code such as prescription medicine and medical devices
Some customers do not have to pay tax:
- Non-profit organizations
- Resellers who can show you a valid resale certificate
As of October 2016, only five states in the U.S. do not impose a state sales tax. The rest have a state sales tax with California charging the most. As a retailer, it is your responsibility to file and pay the sales taxes on products you sell within the state although most retailers simply charge it to the customer.
If you file on time according to the schedule you select, you avoid paying penalties and interest on late filing and payment.