If you're an entrepreneur planning to sell a new product or do business in a new area, there's a lot to take into consideration. Before rushing ahead, make sure you understand all the tax requirements in front of you.
In addition to state and federal income taxes, many businesses have other state and local tax obligations. Failing to carefully consider all the rules and think things through could impact your bottom line in surprising and unfortunate ways.
For example, let's look at sales tax.
Sales tax laws vary by state, and sometimes there are special rules and considerations for different cities within the same state. It's important to know in advance whether or not an item is taxable so that you a) know to collect the correct amount of sales tax from your various customers, and b) are prepared to report and pay those taxes on time to the proper tax authorities.
A Case in Point
In California, where I'm based, the sales of electronically downloadable items aren't taxable. However, if you include a physical product with the item — even if it's a free add-on — then the entire sale becomes taxable, not just the physical products combined with the sale.
Different cities and towns throughout California have different tax rates that are in addition to the standard 7.5% statewide sales tax. As a result, businesses need to update their accounting records to charge customers the correct amount of sales tax depending on where the products are sold or delivered.
Fortunately, the State of California lets businesses file one statewide sales tax return and make one combined payment for all taxable sales in California. Then, the state Board of Equalization allocates the local sales tax amounts to the various cities that need to collect it.
In other states, however, it's not so simple. For instance:
- Chicago has one of the country's highest sales tax rates and requires qualified businesses to file a separate sales tax return with the city office in addition to the State of Illinois sales tax return.
- Denver similarly requires qualified businesses selling taxable products to register with the Denver Treasury Division and file a Denver city and county sales tax return along with a separate sales tax return with the State of Colorado. Coffee isn't taxed in Colorado, but to-go cup lids and paper napkins are taxed. So if you sell coffee in a cup with a lid or offer your customers paper napkins, you'll need to pay sales tax to the state for those sales. Furthermore, you'll probably want to charge tax on the entire sale or bake the cost of the sales tax into each customer's total price.
Another Challenge: Business License Taxes
Another tricky tax area is business license taxes. Many businesses around the country are required to pay business license taxes to the cities and counties in which they operate, and those taxes can be difficult to calculate.
In Los Angeles, there are quite a few places where businesses must pay an annual tax to the City based on a certain percentage of total revenue that the business earned within the city tax boundaries. It feels like a combination of art and science to navigate the rules, figure out the correct tax rate and where exactly those boundaries are, and then accurately apply the tax rate to the company's total sales. And the city office is known to routinely audit businesses that are subject to these taxes, so you'd better get it right and have solid backup for your calculations. If you don't, you may face penalties and interest on any underreported amounts.
Other cities tax businesses in different ways. New York City, for example, taxes businesses based on a percentage of their total payroll costs for employees who work within the city limits.
It's helpful to work with a professional bookkeeping services company that is experienced in these areas, can ask you the right questions and can give you specific guidance on how to properly plan for selling products and conducting business in different places around the country. Penalties and interest charges can add up quickly for businesses that don't register and file these taxes on time or otherwise don't comply with local business tax regulations. Even if a business does not collect enough sales tax from their customer, for example, they're still required to report and pay the full correct amount of sales tax to the government — the difference comes out of the business owner's own pocket.
Working with the right experienced resources from the beginning can save you money while eliminating major headaches down the road.