How Do California Sales Taxes Work?
Most people are quite familiar with the concept of sales taxes on a very basic level. After all, we all buy stuff and, when we do, there is a tax associated with those purchases. Fundamentally, from the consumer’s perspective this is what sales tax is: tax on the sale of a good (or sometimes service).
From the business perspective, conceptually sales taxes are a little different. In most cases, selling goods in California requires a permit from the state. The state issues that permit, which equates to permission, and in exchange for that the “seller” is required to collect tax.
Think about this like a contract. California is giving its permission to the business to sell goods and the business exchanges an obligation to collect sales tax on behalf of the state in exchange for that permission.
So, transactionally, sales tax is paid by the buyer as a part of the purchase price of an item, collected by the business (as permitted by the state) and then remitted to the state of California. The amount of sales tax due is measured by the gross receipts from total retail sales.
How Much Are Sales Taxes in California?
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.
California state sales and use tax is applied as a base percentage rate (currently 7.25 percent in California) plus any local and district tax. This is calculated from the 6 percent California state base tax rate.
The state then adds a mandatory 1.25 percent local tax that goes to the county and city. However, some districts within California have voted for an additional “district” tax which brings the total rate higher. These district taxes can range from 0.15-3.0 percent.
So, sales tax in California 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 to help pay for education, health care, public pensions, and other programs.
So, in San Diego for example, the sales tax rate is 8.25%. However, the City of Poway charges 7.75%. So, taking the base rate of 7.25%, San Diego adds another 1.0% for district taxes and Poway adds .50%.
Sales taxes can also be collected for special programs or specific areas 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.
The CDTFA provides a complete listing of all city and country district taxes and rates on its website.
Sales tax applies to in-state transactions. If you have a store in California that is selling merchandise to a California customer, that is a transaction where sales tax is applied.
Sales taxes are due on in-state transactions where a seller has nexus in California. Even without physical presence, a business lacking an exemption, such as a resale certificate, will be held to the same standard as a California seller.
Why Does the California Sales 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
Either way, just expect that sales tax rate changes are going to occur and keep on top of them. That is the best way for your business to be compliant and it’s one less area for an auditor to pick apart.
For a business owner, filing a California sales tax return is usually done on a quarterly basis, but can be done monthly or yearly in certain circumstances. A business will file sales taxes in accordance with the state sales tax rates and local sales tax rates in California. There are sales tax calculators that can help with the preparation and filing of returns.
What Is California Use Tax?
Now, what happens if someone in California purchases tangible personal property from outside the state? In this case, when the seller does not charge state sales tax, the buyer owes something called to the state of California “use tax.” Use tax is levied at the same rate as sales tax and applies when sales tax is not charged. The long and the short of it is that California always gets their money.
Use taxes are also levied on goods that make a stop in California in the course of being shipped from the vendor to the buyer, even if the goods did not originate there, were not purchased for use there, or if the buyer or eventual place of use is not in California.
What Types of Sales Are Subject to California Sales Tax?
Sales tax in the State of California is imposed on “tangible personal property,” which in English means items such as:
Some services require sales tax to be collected as well, but that can get tricky and we can get into that later in more detail. For example, 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.
What Is the CDTFA?
The California Department of Tax and Fee Administration (CDTFA) is the California public organization that administers the state sales and use tax laws and regulations. The CDTFA also conducts audits, collects unpaid California state sales and use taxes, and administers the state property tax. It also issues and administers sales licenses, permits and use accounts.
This agency regularly conducts audits to ensure that businesses are correctly collecting, recording, reporting and paying sales and use tax.
The revenues from sales and use taxes are used for roads, schools, parks and other vital public programs. As state budgets are always in need of more funds, it is in California’s interest to pursue the payment of these taxes aggressively.
Anyone who sells goods or services in California is required to:
- Obtain the correct sales permit from the CDTFA
- Collect sales and use tax at the appropriate rate at the point of sale
- File regular self-reported sales tax returns to the CDTFA on a monthly, quarterly or annual basis
- Pay any sales and use tax due at the close of each reporting period
There are presumptions of the tax code that the CDTFA follows in its operation and decision-making process.
The CDTFA presumes:
- All sales are taxable unless specifically exempted
- Exemptions must be supported by documentation
- The taxpayer is responsible for maintaining and providing documentation in case of examination or audit
Pivoting to the main topic of sales tax audits, this is part of what makes the audit process so daunting. In theory, reporting and paying sales tax is a simple process, but in practice, it can be anything but. There are a thousand small ways that businesses can miscalculate or underpay the sales tax due to the CDTFA. And, because selling goods is considered a privilege and not a right in California, the consequences of doing things incorrectly can be pretty severe.
In addition, the CDTFA is part of an information sharing program and shares its information with the Franchise Tax Board (FTB), the Employee Development Department (EDD), and the IRS. Therefore, audits, investigations, and adverse consequences from these agencies may be triggered by this shared information.
All it takes to put you on shaky ground with the CDTFA is a bookkeeping oversight or a moment of crisis where funds set aside for sales tax are spent to cover payroll or pressing invoices. Oftentimes, liabilities and mistakes, once started, continue to snowball and become much worse than the original error.