Sales Tax: Definition, Types, Purpose & Examples

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  • 0:01 Definition of Sales Tax
  • 1:24 Types of Sales Tax
  • 3:15 Purpose
  • 4:08 Examples of Sales Tax
  • 5:28 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn what sales tax is and get information about many of the different types that you may pay. Discover where all that money goes and how it is used to offer services that you benefit from every day.

Definition of Sales Tax

Have you ever gone up to the cash register to purchase something and been surprised when the total cost was higher than what you expected? Maybe you thought your new DVD player was on sale for $99.99, but when you went to pay, it was actually $109. Or, on a slightly smaller scale, maybe you had $2 dollars in cash to buy a $1.89 cent cup of coffee, but found you were five cents short when they rang you up.

When you purchase an item at Wal-Mart or Target, the final price paid is usually higher than the price you saw on the sign hanging in the aisle, and this is because of added sales tax. Sales tax is an additional amount of money you pay based on a percentage of the selling price of goods and services that are purchased. For example, if you purchase a new television for $400 and live in an area where the sales tax is 7%, you would pay $28 in sales tax. Your total bill would be $428.

It is important to note that sales tax is not revenue that the seller gets to keep. The seller is simply collecting the tax as part of their agreement to do business in that city or state. Every month or quarter, the seller will have to prepare forms and pay in the money they collected for taxes to the state or local government. There are different types of sales taxes, so let's look at a few of the most common.

Types of Sales Tax

Retail Transaction
This is the most common tax people are familiar with. This is one of the most common ways your state and local government generate revenue and can often range from a few percentage points to more than ten percent of the cost of goods! Every time you go shopping, there is a good chance you are paying this tax. Buying toothpaste, paper towels, soda, and clothing will all have sales tax attached to the final price.

Vendor Privilege
These taxes are imposed on retailers for the privilege of doing business in a state. Think of this as a licensing tax to operate a business. It is different than a retail sales tax because it is charged to the seller rather than the consumer. Businesses usually have the option of paying this tax out of their own pocket or passing it along to customers in the form of higher prices.

Excise
This tax is usually charged on items that are not considered necessary for survival. Cigarettes and alcohol usually have an excise tax tied to them. These taxes are paid by the people who produce them or the wholesalers. These taxes ultimately raise the price we pay for these items. For example, a bottle of wine that normally costs $9 may have an excise tax of $3 on it. The end result is that you will pay $12 for that bottle of wine.

Use
This is charged to consumers when retail sales tax wasn't charged but probably should have been. You may be responsible for declaring and paying a use tax in your home state when you purchase products from an internet site, catalog, or television network that does not charge retail sales tax in the state in which you live.

Value-added, Gross Receipts¸ and Wholesale
These are all additional ways that government authorities can raise revenue based on sales and production of products and services.

Purpose

So why do we pay all these taxes? Everyone likes safe highways and good schools. We also like to have people pick up and take our garbage away every week. These things are made possible by the revenue collected from different forms of sales tax. Ultimately, sales tax can pay for whatever the local or state governments legislate it for. In general, the tax we pay on the items we buy goes towards public schools, state and local parks, highways and bridges, and social services for lower-income citizens.

Part of the local sales tax you pay may also help ensure that your city or county can hire police officers and firefighters. Those extra pennies you are paying for that cup of coffee are helping ensure that you have clean water and other public-provided utilities. Many of the local services you come to rely on are funded through the income provided through different sales taxes.

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