Offering a discount on products can be great for business, but confusing when it comes to sales tax. In our ten years of experience of helping online businesses with sales tax, we’ve learned all the rules – and idiosyncrasies! — when it comes to discounted goods.
Whether you’re reducing prices permanently, having a limited-time sale, or passing out promotional codes, these discounts can raise some questions at the point of sale. In our experience, the most common questions our customers have are:
- Are taxes levied on the original price or the discounted amount?
- How are taxes applied for different types of discounts?
- What are the responsibilities of sellers and customers?
- What role does technology play?
This article tackles these questions and more! Let’s get started.
Sales tax basics
Sales tax, a source of revenue for the government, is levied on sold goods and services at the state, county, and/or local levels. Businesses collect this tax and then remit it to the appropriate tax authority.
The complexity arises from varying rules and rates, which determine when you need to register for sales tax and then how much you should apply to your sales. Businesses only collect and remit sales tax where they are already registered.
When it comes to what products are actually taxable, certain goods and services are exempt to start with, such as food, prescription drugs, and medical services (in most places). On the other hand, sometimes surprising elements of the sales process are taxable: processing fees for payments with credit cards could be subject to sales tax charged to the merchant.
To learn more, check out everything you need to know about how sales tax works in the US.
Sales tax on discounted goods
Calculating sales tax for discounted items can be complex, due to the various types of discounts and the methods used for actually applying the tax to the transaction. Here we’ll cover 5 types of discounts:
- Cash discounts (percentage and fixed)
- Coupons
- Gift cards
- Buy one, get one free (BOGO)
- Rebates
Cash discounts (percentage and fixed)
Cash discounts can come in two forms: reduced by a percentage of the original price, or a fixed amount deducted from the total. In our experience Since discounts are typically provided by the retailer, they reduce both the sales price and the cash paid to the retailer. Whether sales tax applies to the pre-discount or post-discount price depends on the state, although most base the tax on the latter.
In Texas, for instance, sales tax is imposed on the actual selling price of the tangible property or the price after a cash discount has been deducted. For example, if a shopper wants to purchase a laptop priced at $800 with an eight percent sales tax, and the store offers a 10 percent discount, the sales tax will apply to the discounted price, which is $720, and not to the original price of $800. Therefore, the customer will pay $777.6—the sum of the discounted price of $720 and 8 percent of that discounted price, which is $57.60.
The same principle works where a fixed amount —for example, $10 off— is offered as a discount. In this case, the shopper will pay a total of $853.20, the sum of the discounted price of $790, and the sales tax of $63.2 applied to that discounted price.
Many other US states adopt the above approach when taxing sales with cash discounts, including New York and North Carolina.
Coupons
Sales tax is applied to coupons in two different ways, depending on who issued the discount. There are basically two types of coupons:
- Manufacturer coupon: discount designed by the company that made the product. If your business sells this manufacturer’s products, then you are just passing along a discount as a middleman.
- Store or retailer coupon: discount designed by you, the seller!
With a manufacturer's coupon, sales tax will apply to the item's full original price. The manufacturer will refund you for the redeemed coupon's value, the discount amount that you missed from your revenue. Therefore, your business will still be responsible for sales tax on the full amount of revenue from that sale.
With a store coupon that you’ve issued yourself, the tax will be imposed on the discounted amount because you are reducing the good's price without any reimbursem*nt from the manufacturer. The discount price is your revenue for the sale, and that’s what you should remit tax on.
Note: No matter which type of coupon you use, you should always note it on your sales receipts or invoices! This records your tax liability and affects your tax records. For example, in Pennsylvania, tax on a purchase made with a store or manufacturer coupon will be based on the discounted price on one condition: both the item and the coupon are on the invoice. If only the item is described and not the coupon, the tax will be applied to the full, original price.
Gift cards
Sales tax guidelines for gift cards are more consistent across the states than those that apply to coupons, but still with slight variations. Generally, you do not need to tax the sale of a gift card. But you do need to tax purchases that are made with a gift card. For example, in Illinois, gift cards are not taxed at the time of sale as these transactions are treated as just another form of currency exchange.
Once the card is used to purchase taxable goods, then it is taxed. In our experience, some confusion comes up when the total purchase is higher than the gift card amount. But from a tax standpoint, it doesn’t matter if only part of the sale is paid for with a gift card and the remainder with cash or credit. The total sale is taxed the same way.
Note: Some states might have gift cards that go by another name but function essentially in the same way. For example, New York has such a thing as a “stated face value voucher,” which is generally treated as a gift card.
Buy one, get one free (BOGO)
Calculating sales tax for buy-one-get-one-free offers varies by jurisdiction – and also depends on your advertising and accounting practices.
To provide this “two for the price of one” offer, businesses have two options. Some businesses will charge one item at the full price and list the other as free. Other businesses will charge half price for both items. Both methods seem like the same result for the buyer, but they’re actually taxed in different ways!
- Buy one at full price, second one free: Sales tax is charged once on the full-priced item being sold, and not applied in any way to the second “free” product.
- Buy two at half price: Sales tax is charged at the discounted prices on each item, so sales tax is calculated on two products.
However, when dealing with “free items,” most states invoke use tax, a tax on the use, storage, or consumption of items bought without paying sales tax.
The state or local government usually collects use tax on goods or services where they are used, i.e., not where they are bought. It’s meant to ensure that people buying from another state will still pay some tax revenue on their out-of-state purchases. So if you buy a television in Georgia but bring it home to Florida, then you pay a use tax to the Florida state tax agency. In most cases, the use tax rate is the same as the sales tax rate.
Rebates
A manufacturer rebate is money returned to the customer after they have paid for a product. While a rebate may seem like a discount, it's technically not! It’s actually a form of refund. A rebate can’t be used to lower gross receipts from a sale or a product's purchase price before taxation. This applies in all cases, whether the seller seeks to reduce the price or the buyer wants to use the rebate as a down payment.
Potential challenges with sales tax on discounted items
Sales tax calculations on discounted items can pose several challenges for businesses. One major issue is inconsistency across jurisdictions. As mentioned, tax laws and regulations vary widely. To determine whether sales tax should be calculated on the original (pre-discount) or discounted price, you should check with the local tax authority in the market where you’re selling.
Additionally, handling different types of discounts at the same time requires careful consideration and tracking. Sellers must choose the correct accounting and billing method to ensure accurate tax collection while providing discounts to customers.
Overall, the complexity of sales tax calculations on discounted items can lead to errors, audit risks, and customer confusion if not handled correctly. It underscores the importance of maintaining compliance and accuracy.
Retailers' Responsibilities and Consumer Implications
Retailers bear significant responsibilities regarding sales tax, directly impacting consumers. Their primary duty is correctly calculating and collecting the appropriate sales tax on taxable items according to local tax laws. Retailers must stay informed about changing tax rates, exemptions, and regulations.
Consumer implications of sales tax are twofold. First, sales tax affects the final price consumers pay for goods and services, increasing the overall cost. Sellers should communicate the tax amount clearly with transparent pricing at checkout.
Second, consumers rely on retailers to remit collected sales taxes to government authorities. Retailers must accurately track, report, and pay promptly. Failure to do so counts as non-compliance and could be met with financial penalties or legal consequences.
Clear communication and compliance are key to maintaining both a positive shopping experience and good legal standing for sellers and buyers alike.
Manage sales tax with tax compliance software
Tax compliance software like Quaderno can ensure that your sales tax is always applied to discounted items correctly. Because the software is easily integrated with your website, online shop, or other sales channels, any price changes or promotions you run on those platforms will be automatically accounted for when tax is applied at the point of sale.
In Quaderno, you can even create discount coupons for your customers to thank them for their loyalty or as part of a promotional campaign. We created this feature directly in our app because we know how important discounts can be to boosting business and keeping your customers happy – and our goal is to make your life easier.
In fact, Quaderno can do all of the following:
- Calculate the right amount of tax to charge each customer, right on your checkout page.
- Alert you when you are approaching a tax registration threshold.
- Notify you when any tax policies or tax rates change so that you’re always in the loop.
- Provide instant tax reports that will help you file tax returns in a few minutes.
- Automatically verify business numbers you receive from B2B customers.
- Collect and store the customer location evidence from every sale.
- Create tax receipts in multiple languages and currencies.
- Send tax receipts automatically.
Give us a try for free through our free trial.
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the tax authorities.
