If you sell more than one kind of thing, setting sales tax per item is the simplest way to make the tax on a mixed invoice come out right. One rate across the whole invoice works fine until a taxable item and an exempt item (or two items with different rates) end up on the same bill. Then the total tax is off in one direction or the other.
To write this, I went through what California's tax agency and two common sales tax references say about how rates work, and how tax codes are set up in Octabiz.
In short
Key takeaways
Tax rates follow the item and the place, so one rate for a whole invoice can't fit a mixed sale.
In California, if you collect too much tax you have to give it back or pay it to the state.
In Octabiz, you pick a tax code on each invoice and bill line, and the tax is worked out from the code.
Why one rate on the invoice breaks
The first problem is that the rate depends on what you sold. In Massachusetts, regular grocery items aren't taxed, but a pre-made sandwich bought in a grocery store is (CalculatorSoup).
Other states draw their own lines. Texas exempts prescription medicine and food seeds. Vermont has a 6% general sales tax with an extra 10% on alcoholic drinks consumed on the spot (Calculator.net). Sales tax rates range from 0% to 16% by state and type of good.
The second problem is that the rate also depends on where you sell. California applies a base rate of 7.25 percent statewide. Some cities and counties add district taxes on top. More than three-fourths of businesses in the state are located in, or do business in, an area with a district tax (CDTFA). New district rates take effect on the first day of a calendar quarter, so a rate you set once can go stale.
- 7.25 percent
- California statewide base rate, before district taxes (CDTFA)
- 0% to 16%
- Range of US sales tax rates by state and type of good (Calculator.net)
Put those together on one invoice and you can see the two ways it goes wrong. Charge the taxable rate on everything and you overcharge the customer on the exempt lines. Leave tax off everything and you collect less than you owe the state on the taxable ones.
Overcharging isn't a free mistake
In California, if you collect more than the tax due, you must either return the extra to the customer or pay it to the state, and you may not keep it (CDTFA).
The math on a single line is simple: price times rate. CalculatorSoup's example is a $70 item at 6.5%, which gives $4.55 in tax (70 × 0.065 = 4.55). When each line carries its own rate, the invoice adds up those line amounts. An exempt line adds nothing.
As we wrote in our guide for rug retailers, retail carries sales tax complexity that service businesses don't: multiple product categories, exemptions, and rates that vary by jurisdiction.
How to set up sales tax per item in Octabiz
There are four steps, taken from the setup in our AI Tax Assistant launch post:
Setting a tax code on every line
- 1
Add your rates and agencies
Go to Rates & Agencies and add each rate you charge and the agency it goes to. If you came from QuickBooks or Square, check the Rates from other apps tab for rates you brought in.
- 2
Create your tax codes
Under Codes, give each kind of sale its own code: Taxable, Exempt, Zero-Rated, Out of Scope or Reverse Charge.
- 3
Put a code on every line
Pick a tax code on each invoice and bill line, and Octabiz works out the tax from the code.
- 4
Let the AI Tax Assistant catch gaps
The AI Tax Assistant flags transactions that are missing a receipt, a vendor or a tax code, so a line without a code doesn't slip through.
Tip
If you run a shop with a mix of taxable and exempt products, set up the Exempt code before you create your next invoice, so you aren't tempted to leave the tax off a line by hand.
A check to run on last month's invoices
Here is a short list you can work through with last month's invoices open in front of you:
- Pick out every invoice that has more than one kind of item on it.
- For each line, ask whether that item is taxable where you sold it, and at which rate.
- Compare the tax on the invoice with what the lines would give if each had its own rate.
- If you collected too much from a customer in California, plan to return it or pay it to the state (CDTFA says you can't keep it).
- Look at which of your rates are district rates, and note the start of the next calendar quarter as the date to check them again.
- In Octabiz, confirm every line has a tax code, and clear any missing-code flags from the AI Tax Assistant.
Common questions
P.S. We're still gathering our own numbers on how often mixed invoices show up, so if a tax mix-up on an invoice has caught you out, I'd like to hear how it happened.
Set up tax codes on every line
Where this came from
The research, methods, and photos behind this article.