What Is Sales Tax: A PenFed Youth Finance Guide

Picture it: you’ve saved money for months, and you’re finally ready to buy that cool game you’ve wanted. You carry it to the register knowing you have the $25 it costs ready in your pocket. Only when the cashier rings it up, she tells you your total is $26.55. 

The reason your game costs more than you expected is because of sales tax. In this article, you’ll learn what sales tax is, why you pay it, and how to calculate it.

What Are Taxes?

People and businesses pay money to the government in the form of taxes. In return, the government uses this money to provide services to citizens. The roads you drive on, the school you attend, and the police, firefighters, and hospitals that keep your town safe are paid for by taxes.

Types of Taxes

There are lots of different types of taxes individual people pay, and there are separate taxes for businesses, too. Below are some of the most common taxes you might pay.

• Income taxes are the taxes taken out of your paycheck and other sources of income. These taxes are progressive, meaning the more you earn, the higher your tax rate will be. When you hear people talk about “doing their taxes,” these are the taxes they’re talking about.
• Payroll taxes are divided into two categories — Social Security and Medicare. Social Security taxes provide income for people who have retired, and Medicare taxes help provide healthcare to people who are retired or disabled.
• Property taxes are taxes paid on your house or other land that you own. The amount you pay is based on the value of your property.
• Travel taxes are charged on products or services related to travel. That includes hotels, motels, rental cars, or flights.
• Capital gains taxes are taxes paid when you sell something valuable, such as stocks or land. The tax you’re charged is based on the amount of profit you earn from selling your valuable.
• “Sin” taxes are taxes that discourage people from buying or doing things that are considered bad for society, such as smoking, drinking alcohol, or gambling.

Why Do We Pay Taxes?

Taxes provide the local, state, and federal governments money so they can pay for essential services in our communities. Our taxes pay to build, maintain, and staff things like:

• Libraries
• Medical research
• Military expenses
• Roads
• Healthcare and health research
• Food inspectors
• Parks

Use What You Know

Can you think of three more things taxes pay for in your community?

How Do People Pay Taxes?

Different taxes are paid in different ways. Some taxes, like property and income taxes, are paid once or a few times per year. They can be paid online or by mailing a check to the government.

Payroll taxes are paid each time your job pays you. (Most people get paid once a month or every two weeks.) Your employer deducts these taxes from your paycheck and makes sure the government receives that money.

Some taxes are paid when an event takes place. For example, you would only pay capital gains tax when you sell something very valuable and gain a lot of “capital.” Similarly, you only pay sales tax when you buy something.

Did You Know?

Did you know that workplaces usually give their employees a pay stub with each paycheck? This stub shows how much the employee was paid, how much money was taken out for taxes, and which taxes they were charged for.

What Is Sales Tax?

Sales tax is a tax paid when something is bought or sold, or when someone pays for certain services. The buyer pays the purchase price — the actual price of the item or service — plus some extra for the tax. The seller or service provider keeps the purchase or service price and gives the government the extra money.

Fun Fact

The purchase price can also be called the “list price” or “buying price.”

Sales tax is a percentage of the purchase price. The percentage that is charged depends on the type of item or service you’re buying and where you buy it. Each state decides how much it charges for sales tax, but local governments in your city or county can also add a sales tax.

For example, let’s say the sales tax in your state is 4% and your local government adds a 2.2% sales tax. The total sales tax you would pay is 6.2%.

What Items Do I Pay Sales Tax on?

Most states don’t charge sales tax on essential purchases like food sold at grocery stores or prescription medications. You’ll pay sales tax on most other products, such as clothes, furniture, food at restaurants, cars, and even houses. You may also pay sales tax on various services such as property maintenance, landscaping, computer repairs, and accounting.

What Does Sales Tax Pay For?

State and local governments decide how to spend the sales tax they collect. Often that money goes to schools, public transportation, and other public facilities like parks or libraries. Sometimes sales tax pays for special projects such as repairing public swimming pools or cleaning up rivers.

Why Is Sales Tax Different in Different Places?

States and counties each set their own sales tax based on their needs. If a state is more expensive to run, then it will have to charge higher sales tax rates. Residents can also vote to approve higher rates or more taxes to pay for special projects they want.

California has the highest state-level sales tax at 7.25%. In part, that’s because California is geographically a big state with lots of expenses for highways, parks, and public transportation. It also has a large population, which means the state has to pay more for education, medical facilities, and other essential services for all of its residents.

Did You Know?

Did you know that five states have no sales tax? They are Alaska, Delaware, Montana, New Hampshire, and Oregon.

Why Does Sales Tax Matter?

In some countries, sales tax is included on the price tag of an item or the price listed online. However, in the U.S. most businesses list the purchase price of an item, and it’s rare to see the sales tax included. You need to know the sales tax where you live when you plan to make a purchase, or you may not have enough money.

Use What You Know

TaxFoundation.org provides an infographic each year showing the combined state and local taxes for every state. What’s the combined rate where you live?

How Is Sales Tax Calculated?

Sales tax is a percentage of a product’s purchase price. In other words, if a product costs $10, you pay $10 to the seller plus a percentage (or fraction) of $10 to the government. You can figure out how much that fraction of a price costs by using the sales tax formula:

If you buy a jacket for $32 and the sales tax is 5%, then you can calculate the sales tax you’ll pay using this formula. (Note: Don’t forget to convert your percent to a decimal.)

Sales Tax Amount = Purchase Price × Sales Tax Rate

= $32 × 0.5% = $1.60

Once you’ve calculated how much sales tax you’ll pay, you can also calculate the total cost of buying the jacket by adding the sales tax to the purchase price. In this example, you’d pay $32 + 41.60 = $33.60 for your new jacket.

Use What You Know

David is buying a new pair of shoes that cost $68. Sales tax in his state is 6.2%. How much sales tax will David pay? What is the total amount (purchase price plus sales tax) that David will pay?

What Is a Tip?

A tip, or gratuity, is money a customer gives a service worker such as a restaurant server, taxi driver, or hair stylist. Tips are extra money you pay on top of the purchase price of a product or service.

A tip isn’t a tax per se, but it’s somewhat like a tax in that it’s an additional amount you sometimes pay. So, we decided to include it here.

Tipping is done differently in different cultures, and some cultures don’t tip at all. In the U.S., we tip servers in restaurants because since 1966, servers have earned a lower minimum wage than other professions. Tips are intended to make up the difference in their wages.

There are some restaurants in the U.S. that pay their servers more or include the tip in the price of your meal, but this is uncommon unless you’re eating out with a large party. Many restaurants will include an automatic gratuity — basically a required tip — if your party contains over a certain number of people. This is because of the extra work required of your server.

Just like with sales tax, it’s important to consider the tip amount when paying for certain goods or services. You can calculate a tip the same way you calculate sales tax, using the same formula. Tip rates are somewhat standardized by industry, although not everyone pays the usual rate.

Tip Rates by Industry

It’s common to tip service workers in the U.S. Tip rates vary based on industry, with those for restaurant servers usually the highest. How much do you usually tip?

The Takeaway

No one wants to be caught off guard when buying things they need. Understanding sales tax and how to calculate it can help you make better choices about what you buy, how you buy it, and what it really costs.