Sales Tax Vs. Excise Tax Explained

Written by
Amber Hobert
Published on
April 23, 2022
Table of Contents

Your Personal Tax Guide

Sales and excise taxes are two separate taxes that many people pay attention to because they directly affect the price of goods and services. This article will aim to help you understand what these two taxes typically entail, how they affect you, and what goods and services are exempted from these taxes.

What is Sales Tax?

A sales tax can be defined as a consumption tax on goods and services. It is collected at the point of the transaction by the retailer and then remitted to the government. When it comes to business tax, businesses are expected to remit sales tax in a location where the company has nexus or jurisdiction. Nexus can be an employee, a physical location, an affiliate, or other presence specified by the law in that location.

Your organization may have a nexus in a neighboring state, which means you are affiliated or have a legal link that subjects your firm to tax laws in that state. You may be obligated to collect sales tax in that state and also file returns in the state, even in an origin-based setup. This kind of set is quite complicated, and as a business, you must get this right from the start.

How Does Sales Tax Work?

Sales tax is usually charged to the final consumer of goods or services. Most goods pass through different stages of production, and some of these stages can be so independent that different individuals or firms handle them. Thus, a tremendous amount of documentation is needed to identify who is liable for the sales tax.

For instance, if a cow farmer sells milk to a cheesemaker, for the cheesemaker not to be charged sales tax, then they must obtain a resale certificate showing that they are not the product's final user. The cheesemaker converts the milk to cheese which is then sold to the final consumer, who also charges sales tax.

Sales Tax and Use Tax

Different places charge different sales taxes. For instance, municipalities, counties, and states levy sales taxes that often overlap. Sales taxes have some similarities with use taxes. Use taxes are charges to residents who buy items from outside of their jurisdiction.

Use taxes typically have the same rate as sales taxes but are often challenging to enforce except for large transactions involving physical goods. For instance, a man in Alabama who buys a truck from New York will be required to pay local sales tax as if he bought it in Alabama.

Sales Tax Exemption

Some items are exempted from sales tax or taxed lower than other goods and services in every state. These items are mainly food and medicines. Some transactions may also be exempted from sales tax. This is not because of the goods or services but because of some attributes of the seller or buyer.

In every state that chooses to impose a sales tax, the baseline rule is that it applies to all tangible items you purchase. This means that if you make a retail purchase, you are expected to pay sales tax, except you can prove why the transaction should be exempted from sales tax.

Every state has its laws that govern items to be exempted from sales tax. Irrespective of the state, the exemptions are based on the following criteria:

Type of item

Every state understands that there are some items that individuals need to survive from day to day. Thus, most states offer exemption for commodities such as food, medicines, clothing, and prosthetic medical devices. Even states that do not provide exemptions for these items offer very low sales tax on them.

Type of buyer

States are not allowed to tax sales made to the federal government or any of its agencies, ministries, and parastatals. There are also similar exemptions in many states for sales to states and their agencies. Other common exemptions in this category include transactions involving religious and education organizations and non-profit organizations.

Item use

There is an exemption granted to items that support specific industries such as industry, manufacturing, and agriculture or encourage certain activities done for the good of the public, such as pollution control, expansion, or industrial development.

For instance, many states that are heavily focused on agriculture have exemptions that apply to the sale of products or equipment used to grow or process food. Again, some states do not impose a sales tax for the equipment and machinery used to produce agricultural products.

Sales Tax vs. Value-Added Tax

Sales tax is imposed at the final stage of the supply chain and collected by the retailer. The end-users pay for the sales tax when they purchase a good or service. When buying raw materials or goods resold to another user or business, such goods will be exempted from sales tax.

Businesses usually give a resale certificate to resellers so that they can qualify for sales tax exemption. Therefore, sales tax is not collected by any jurisdiction until the goods or services get to the final consumer.

On the other hand, value-added tax (VAT) is imposed at each stage of the supply chain. Everybody pays it, and all the players in the supply chain, from the suppliers, manufacturers, distributors, to resellers, are all expected to collect tax on every taxable sale. Businesses are bound to track and document all the transactions that they carried out and the tax that was paid so that they can remit them.

While sales tax is collected at the end of the supply chain and borne by the final consumer, VAT is imposed at every stage of the supply chain.

States with the Lowest and Highest Sales Tax

There are a total of five states with no sales tax. They are Delaware, Montana, New Hampshire, Alaska, and Oregon. States with sales tax below 5% are Colorado at 2.9%. Alabama, Georgia, Hawaii, New York, Missouri, and Wyoming, all at 4%. The rest are South Dakota and Oklahoma at 4.5%, and North Carolina at 4.75%.

On the other hand, California has the highest sales tax at 7.25%. This is followed by the quartet of Indiana, Mississippi, Rhode Island, and Tennessee at 7%. Minnesota is at 6.88%, Nevada at 6.85%, New Jersey at 6.625%, and the trio of Washington, Arkansas, and Kansas at 6.5%.

What is Excise Tax?

This is a tax imposed on some goods or services. It is commonly imposed on soda, alcoholic beverages, gasoline, cigarettes, betting, amusement activities, and insurance premiums. The government imposes excise taxes within its jurisdiction. A federal excise tax is levied on airline tickets, motor fuel, tobacco, and other goods and services.

How Excise Tax Works

Excise tax is imposed mainly on businesses and is transferred to the consumers in higher goods and services. Retailers pay excise tax to wholesalers and factor excise taxes in product pricing, which increases the retail prices of goods. However, some excise taxes are levied directly on the consumer. They are property taxes and taxes on retirement bonuses.

All levels of government, from federal to local government, have institutions that collect excise taxes. Although income tax has remained the primary revenue source for both federal and state governments, excise tax also makes up a tiny percentage of the total revenue.

Businesses accepting and charging excise tax must file form 720 federal excise tax returns every three months. Businesses collecting excise tax must remit their collection to the state and local government. Retailers may be given some deduction on their yearly tax remission related to excise tax.

Types of Excise Taxes

There are two distinct types of excise taxes: ad valorem and specific excise taxes. Let’s look at both of them in more detail.

Ad valorem excise tax

Ad valorem is a Latin phrase that loosely translates to according to value. This excise tax is imposed in percentages. The excise tax you pay will depend on the number of goods or services you purchase. For instance, if the IRS (Internal Revenue Service) imposes a 20% excise tax on the betting industry.

Therefore, someone who makes $1000 from betting must pay an excise tax of $200 to the IRS. If another person makes a profit of $200, the person will pay $40 to the IRS as an excise tax. Popular types of ad valorem taxes include heavy trucks (12%), firearms (10%), and airline tickets (7.5%). Property taxes can also be considered for excise tax.

Specific excise tax

Specific excise tax is imposed on a product on a per-unit basis. Examples of Federal specific excise taxes include gasoline ($0.183 per gallon), pipe tobacco ($2.83 per pound), cruise ship passengers ($3 per passenger), beer ($7 for the first 60,000 barrels), and cigarettes ($1.01 per pack of 20).

Often, sin taxes are imposed on goods such as beer and alcohol, which will be taxed at the federal level and by the states, making these products relatively expensive. For instance, New York imposes a specific excise tax as high as $4.35 per cigarette pack of 20. There is also a federal tax of $1.01. This means that the total specific excise tax on a pack of cigarettes of 20 is $5.36, which has a huge impact on the product’s price.

Excise tax on retirement benefits

Excise tax can also be imposed on retirement benefits. Many people usually view this tax as a penalty. For instance, a 6% excise tax is imposed upon accessing an IRA (Individual Retirement Account) contribution that is not corrected by the applicable deadline.

A 10% excise tax penalty is also applied to IRA contributions and other plans when an investor makes a withdrawal before clocking 59.5 years of age. Again, a 50% excise tax is imposed on investors who do not take the minimum specified distribution from some retirement accounts.

How is Excise Tax Charged?

Excise duty is charged once in the supply chain. It is imposed on import, manufacture, and sales of goods and when they are discharged for consumption. It is collected from the producer or importer of goods that are eligible for excise tax.

Since excise taxes are charged just once in the supply chain, businesses or companies who prove they have been charged more than once for excise duty will get a refund.

For instance, if a person imports sugarcane to make refined sugar, they will be charged an excise duty to import that product and another excise duty to produce refined sugar. Since both the importation of sugarcane and the production of refined sugar falls under one supply chain, the importer will be eligible for an excise tax refund.

How to Calculate Excise Tax

Let's take a hypothetical scenario to show how excise tax is computed. Assume that the excise tax rate in Georgia on cigarettes is 4 cents for every ten cigarettes.

A cigarette retailer purchases a pack of 1000 little cigarettes from a manufacturer. They will need to collect $40 in state excise tax on those cigarettes. Again, there is a federal excise tax on tobacco of $1.01 per 20-pack of cigarettes. Therefore, you need to collect $505 in federal excise tax. The total excise tax on 10000 pieces of cigarettes is $545.

Here is how it is calculated:

No of Cigarettes: 10,000

State excise tax rate: $0.04 per 10 cigars

Federal excise tax rate: $1.01 per 20 cigars

Therefore, we have 10000/10 = 1000

10000/20 = 500

State tax = 1000 X $0.04 = $40

Federal tax = 500 X $1.01 = $505

Total Excise Tax = $40 + $505 = $545

Doing this calculation for different transactions can be daunting and frustrating, but don’t worry; tax software is available to help you do this calculation. You simply input the number of goods whose excise tax you want to calculate.

Differences Between Sales and Excise Tax

Sales tax is imposed on everyday goods and services ranging from furniture, dry cleaning, movie tickets to books. Essentials such as groceries, rent, and utilities are often exempted from sales tax.

Sales tax falls under the control of the state and local government, who determine the rates. The tax rate may also change depending on the type of goods and services involved in the traction. Sales tax is collected as a percentage of the price of goods and services. There are four fundamental differences between sales and excise tax.

  • Sales tax is imposed on almost all goods or services you purchase (except the few mentioned above), while excise duty is imposed on some selected goods and services.
  • Sales tax is usually collected as a percentage of the selling price of goods or services, while excise duty or tax is collected at a per-unit rate.
  • State and local governments collect sales tax. The federal government is prohibited from collecting sales tax. However, the federal government imposes federal excises taxes.
  • While sales tax is always visible on your receipt, an excise tax is not because it has been applied before the sale price.

Seek SD Residency Through an Expert 

Sales Tax and Excise Tax are important in deciding where you choose to reside because a high sales and excise tax mean a higher cost of goods and, by implication, lower savings. However, a lower sales and excise tax does not automatically translate to a lower cost of living. You have to consider other factors, especially state income taxes, property taxes, and inheritance tax.

South Dakota, for instance, does not impose an income tax; sales tax is also low while your retirement income is exempted from taxes. If you are interested in settling in South Dakota, many firms engage in residency services. The residency service firms are there to help you obtain your South Dakota residency and help you settle down as soon as possible.

Moreover, should you be in the process of moving already, you should consider reaching out to a reputable mail forwarding service. These professionals will ensure that your mail or documentation makes its way to your new destination promptly and in one piece.

Sign up for Residency in South Dakota