What Is Sales Tax?

Since sales taxes can vary by municipality, the tax implications can change depending on where you shop.

Sales taxes are imposed on many everyday goods and even some services. Keep reading to learn how they work and the different types.

Definition and Examples of Sales Tax

The tax administered by state and local governments on various products and services is called a sales tax. Examples of items and services that are subject to a sales tax include retail goods like food and clothing, and common services, such as dry cleaning and hairdressing. Sales tax can change depending on the state and county, resulting in customers spending more or less on the same item or service depending on where they complete the purchase.

Consider this example of sales tax. You’re shopping at The Clothing Boutique and want to estimate your total after taxes before you check out. After tallying the total price of the items in your cart, it comes out to $100. The sales tax in that county is 9.5%, so you would calculate 9.5% of $100 (100 x 0.095). The sales tax you will pay in this example is $9.50, bringing your total to $109.50.

How Sales Tax Works

Sales taxes are enacted when the product or service is actually sold, such as when the customer checks out at the register. On a receipt, the sales tax is itemized separately and then added to the sales price. Although the customer pays the sales tax, the business selling the goods or services must report the tax to the Internal Revenue Service (IRS).

Most services are taxed as well, but not as generally as most tangible goods. Some services are exempt from sales tax, such as consultations with doctors and lawyers. Hawaii and New Mexico, however, tax nearly all services.

There is no federal sales tax—state and local governments determine sales taxes. Five states don’t have a sales tax: Delaware, Montana, New Hampshire, Oregon, and Alaska. However, local municipalities in Alaska are able to impose local sales taxes within their jurisdictions.

As of 2021, California has the highest state-level sales tax rate at 7.25%. (Some counties within California have rates as high as 10.75%.) Indiana, Mississippi, Rhode Island, and Tennessee all have sales tax rates at or above 7%. Colorado has the lowest state-level sales tax rate at 2.90% (excluding states with no statewide sales tax rates), and is the only state with a general sales tax rate below 4%.

Types of Sales Taxes

Certain products and services may be subject to a certain type of sales tax.

General Sales Taxes

A general sales tax is the general tax applied to most retail sales (sales of goods for purposes not including resale) and services. State sales tax on retail purchases generated $340 billion in revenue in 2020.

Excise Taxes

Excise taxes are sales taxes applicable to specific goods or activities. Since excise taxes are commonly imposed on cigarettes, gasoline, gambling, and alcohol, many refer to these taxes as “sin” taxes. The government often uses excise taxes as a way to deter activities that could be considered harmful to the body or environment.

Federal excise taxes account for a small percentage of annual tax revenue. In 2019, they totaled $100 billion, which is 2.9% of all federal tax receipts.

Value-Added Taxes

A value-added tax (VAT) is a special type of tax levied at each production stage of a good or service. For example, in the production of a microwave, a VAT tax is applied when buying raw materials from a supplier, when assembling the product, and when sold to a retailer. 

The actual amount paid in VAT taxes depends on what value is created at each production stage—the tax is not based on the final product value. We include VAT taxes here because, as consumers, we pay a part of this tax at the time of purchase. VAT taxes typically apply to international commerce; the U.S. does not impose a VAT tax.

Notable Happenings

In 2018, the U.S. Supreme Court ruled that a state has the jurisdiction to impose a sales tax on online purchases if they satisfy certain criteria, such as meeting minimum gross sales and volume in transactions. In many cases, this could also mean having a physical nexus in another state, such as a warehouse with delivery trucks that deliver to the state.