Starting and running a business comes with its fair share of mysteries, and no matter how savvy you are, there are always learning hurdles to jump. Of the many confusing topics, NAICS codes are only one. In this article, we cover what NAICS codes are, why they are important for sales tax, and the different types of NAICS codes used in business and taxation.
What are NAICS codes?
NAICS codes stand for North American Industry Classification System codes. They are a standardized system used by the USA, Canada, and Mexico to classify business establishments by industry. The main purpose of this classification is for, “collecting, analyzing, and publishing statistical data related to the U.S. business economy” (United States Census Bureau).
A Study in Numbers
The NAICS classification system uses a six-digit code at the most detailed industry level. The breakdown is as follows:
- First Two Digits – designate the largest business sector
- Third Digit – designates the subsector
- Fourth Digit – designates the industry group
- Fifth Digit – designates the NAICS industry
- Sixth Digit – designates the national industry
As an example, let’s use the code 456110 for Pharmacies and Drug Retailers:
- 45 – retail trade
- 6 – health and personal care retailers
- 1 – health and personal care retailers
- 1 – pharmacies and drug retailers
- 0 – pharmacies and drug retailers
As you can see, in this NAICS code, the subsector, industry group, NAICS industry and national industry overlap. This is the case for many NAICS codes. However, some can be more detailed. Take code 449122 for Window Treatment Retailers:
- 44 – retail trade (this also overlaps with 45)
- 9 – furniture, home furnishings, electronics, and appliance retailers
- 1 – furniture and home furnishings retailers
- 2 – home furnishings retailers
- 2 – window treatments retailers
In the case of the Window Treatment Retailers code, each number concetrates on a detail of the latter until it narrows down to the national industry.
Of course, there are far more business sectors than just retail.
- 11 – stands for Agriculture, Forestry, Fishing and Hunting
- 23 – stands for Construction
- 42 – stand for Wholesale Trade
You can find an interactive search table of NAICS codes at the United States Census Bureau’s website.
How have NAICS codes changed over the years?
As more types of industries emerge, NAICS codes must constantly be reviewed and updated. Additionally, economic changes affect what NAICS codes are deemed valid or not.
Since the first adoption of NAICS codes in 1997, there have been five additional publications to the system. The two most recent publications were in 2017 and 2022.
There were 1,057 industries in 2017 NAICS United States, and in 2022 NAICS United States there are 1,012 industries. For 2022, revisions were made to address changes in the economy. These included the addition of new and emerging industries, content revisions for selected areas, title changes, and clarification of a few industry definitions.
The United States Census Bureau
Why are NAICS codes important for sales tax?
NAICS codes are a crucial component of sales tax compliance. Different states use different codes to determine sales tax requirements and exemptions for businesses. When a company registers for a sales tax permit, an NAICS code that correctly categorizes their industry and primary business activities must be identified.
The NAICS code maps a business to the appropriate tax rules, rates, product exemptions, reseller certificates, and more based on their operations. A restaurant may have different sales tax implications compared to a retail clothing store in the same state, but the only way for these implications to be properly applied is with the correct NAICS code.
Here are some other key reasons why NAICS codes matter for sales tax:
- NAICS codes define if any goods or services you sell are tax exempt. States grant sales tax exemptions to certain industries like food retailers, manufacturers, wholesalers, and service providers. The NAICS code indicates if your products or services are exempt.
- Different sales tax rates may apply based on your NAICS code. For example, a state may tax food sold at restaurants differently than uprepared grocery food.
- States require an NAICS code when applying for a sales tax permit, reseller certificate or exemption certificate.
- Incorrect NAICS codes can lead to penalties, interest charges, and other problems when filing sales tax returns. Applying the right code will help to prevent these issues.
How to choose the correct NAICS code
Many business owners find NAICS codes confusing at first, and for good reason! All those numbers and classifications are headache-inducing.
To find your NAICS code, the easiest method is to search on the main NAICS website on the United States Census Bureau. you can search by keyword or browse through their categorized NAICS code list. When searching, read through the code descriptions carefully to find the one that most closely matches your primary business activites. The codes can get very specific, and while it initially might look like a match, it may actually exclude your business activities upon closer inspection.
For example, code 236115 – New Single-Family Housing Construction excludes For-Sale Builders. Builders who construct housing for-sale will actually use code 236117.
It is also important to remember that a business can have multiple NAICS codes if they have secondary business activites. However, for sales tax purposes, the NAICS code used should be the one that most closely relates to that company’s principal business activity. In other words, the activity that generates the most income.
How NAICS codes are used in state sales tax registrations
To legally collect sales tax in a U.S. state, you must first register with that state’s department of revenue and obtain a sales tax permit. The application process to receive a permit varies by state, but each require similar business information including NAICS codes.
During the application process, each state will ask for a 6-digit NAICS code to identify the industry your business operates within. Providing the correct NAICS code is important because the code determines any industry-specific sales tax rules, regulations, or exemptions that may apply to your business.
One aspect of registrations that may confuse applicants is finding that the NAICS code they have for their business might not be an option in that state’s application. The reason is that some states are slow to update their NAICS codes. So a 2022 NAICS code might not show up on a state registration that still uses 2017 or even 2012 codes. In this case, you will need to search for the code that most closely matches with your business, even if it is an outdated code according to the Census Bureau.
How NAICS codes are used for sales tax filing
Some states also require an NAICS code to be entered in every sales tax return, along with a sales tax permit or account number. Having the NAICS code that is applicable to the specific state you are filing in makes filing returns a smoother process, and can help to avoid filing rejections or delays in processing.
NAICS codes are also used to deduct nontaxable sales. For example, some states have codes used for sales made through marketplace facilitators. When a portion of the gross sales are through a marketplace facilitator that is already responsible for collecting tax on its seller’s behalf, using the correct code will ensure that the seller doesn’t also need to pay sales tax on those sales.
Helpful Resources
The complexities of sales tax obligations can become very overwhelming, which is why utilizing available resources can make a huge difference. Here’s a short list of some resources for NAICS codes and sales tax.
State Revenue Department Websites
Most states have dedicated revenue department websites that provide information and resources related to sales tax collection, registrations, and filing requirements in that state. These states offer guidance and updates to sales tax, and often have FAQ pages. Checking the state revenue department sites that you have sales tax obligations in can help clarify specifics and answer questions.
Consult a Sales Tax Specialist
For businesses with complex sales tax needs, consulting a specalist and outsourcing your sales tax responsibilities can be both wise and a great relief. Knowledgeable sales tax specialists can advise you on registrations, multistate filing requirements, exemptions, managing audits, and ensuring overall compliance. Their expertise can save you time and potential penalties. If you are looking for a sales tax specialist for your business, contact us today!
The United States Census Bureau
For the most accurate information, it’s best to go to the source. The US Census Bureau’s official government website hosts the most expansive and updated information on NAICS codes, including an NAICS search, downloaded reference files for all of the current and past NAICS manuals, FAQs and history on the NAICS.
