Sales Tax: Definition, How It Works, How To Calculate It

What is sales tax?

Sales tax applies when consumers purchase goods and services. It’s a type of consumption tax, meaning it taxes people as they spend money, rather than on their income.

A sales tax is also a type of indirect tax, which means it isn’t paid directly to the government, the way income tax is. Instead, businesses collect sales taxes from consumers and then remit that money to the appropriate government entity.

How does sales tax work?

Sales tax applies to the sale of goods and services and is a percentage of the total purchase amount. Retailers are responsible for calculating and collecting sales tax at the time a purchase is made. Then, on a schedule set by the state or local government, retailers remit the sales taxes they collect to the government.

The U.S. government doesn’t collect sales tax. Instead, it’s imposed by state and local governments. Forty-five states and the District of Columbia levy sales taxes. Five states have no sales tax.

A total of 38 states allow local governments to collect sales taxes (including Alaska, which doesn’t have a statewide sales tax), according to the Tax Foundation.

Even in states that levy a sales tax, that tax usually doesn’t apply to every product or service. Most states don’t charge sales taxes on groceries or prescription drugs. Some states include clothing and medical devices on the list of items that aren’t subject to sales taxes.

Consumers can also purchase items free of sales tax during so-called sales tax holidays. A handful of states have a set handful of days each year that are designated as sales tax holidays, often corresponding with the start of the school year, when families purchase school supplies and clothing for their children.

What is nexus? (Hint: Think online shopping)

Nexus is an important concept that determines when a business must collect sales taxes in a given state. Prior to 2018, nexus was largely tied to a company’s physical presence in a state.

Generally, companies only had to collect sales taxes in states where they had a store or place of business, which meant many online sales were often sales-tax-free. While this situation could benefit companies, states were eager to collect sales taxes.

In 2018, the Supreme Court decision in South Dakota vs. Wayfair changed the way sales tax is collected, by disconnecting the need for an actual building in the state from the ability to collect state sales taxes. These days, companies often must collect sales taxes on online purchases even if the business isn’t located in that state.

This change didn’t happen automatically. States had to pass a law similar to South Dakota’s to require that out-of-state companies collect sales taxes. Currently states vary in how they implement the idea of nexus: 25 states limit nexus to sales that meet a certain dollar threshold; other states limit it to a dollar threshold of sales and/or number of sales, according to 2024 data from the Tax Foundation. The result is a non-uniform system that some experts say needs reform.

How to calculate sales tax

To calculate sales tax, you first need to turn the sales tax percentage into a decimal. Then multiply that decimal by the price of the item or service you’re buying. That’s your sales tax.

Then, add the sales tax onto the price of your purchase.

Sales tax example

Sales taxes apply as a percentage of the purchase price. Suppose you plan to purchase a $1,000 computer in Wisconsin. The state charges a 5 percent sales tax. Also, Wisconsin counties charge an additional 0.5 percent or 0.9 percent tax, bringing the total sales tax to 5.5 percent or 5.9 percent. (The city of Milwaukee imposes a 2 percent city sales and use tax.)

Say you buy your computer in a county with a 5.5 percent total sales tax. You’ll be required to pay the $1,000 for the computer, as well as $55 in sales taxes ($1,000 x 0.055). The retailer will keep the $1,000 for itself, and then set aside the $55 sales tax to send $50 to the state government and $5 to the county government.

How sales tax varies by state

Sales taxes vary significantly from one state to the next. A total of 45 states and the District of Columbia charge a sales tax. The five states that don’t impose a sales tax are:

• Alaska

• Delaware

• Montana

• New Hampshire

• Oregon

California has the highest statewide sales tax of 7.25 percent, followed by Indiana, Mississippi, Rhode Island, and Tennessee each at 7 percent.

But in many states, local governments also charge sales tax, on top of the state sales tax. When you look at the average combined (state and local) sales tax rates, Louisiana, Tennessee, Arkansas, Washington and Alabama have the highest rates. Alaska is the only state without a statewide sales tax that still allows local governments to charge sales taxes.

States with highest average combined state and local sales tax rates

Sales tax vs. value-added tax

The value-added tax (VAT) is another type of tax on the purchase of goods and services. The key difference between the two is that while sales taxes are collected at the final sale of a good or service, VAT is collected at each stage of production.

For example, suppose a product goes through four different stages of production from start to finish. VAT would be charged four different times to account for the change in the value of the product. The VAT is determined by taking the cost of the product at the current production stage and subtracting the cost of materials and any taxes that have already been collected.

The U.S. is one of a few countries that doesn’t impose a VAT. Some 175 countries worldwide impose VAT as their primary consumption tax, according to 2024 data from the OECD (Organization for Economic Cooperation and Development), a global policy group of 38 member countries.

How to claim the sales tax deduction

The sales tax deduction allows you to lower your taxable income by up to $10,000 if you itemize your deductions. You can claim either the state and local sales tax deduction or the state and local income tax deduction. (For context, the overarching deduction is called the state and local tax, or SALT, deduction.)

You use Form 1040’s Schedule A to claim itemized deductions. You can save your receipts throughout the year, or use the IRS’ sales tax deduction calculator.