Sales and Use Tax Demystified
Forty-five states and the District of Columbia impose a sales tax on retail sales and some services, as well as use taxes on sales and services. Today, most states obtain the bulk of their revenue from sales taxes, not income taxes. In an effort to guard this revenue, states pursue audits, which may result in an assessment that include penalties and interest. Some states (such as Florida, Texas, and California) also tax services, not just tangible items.
Businesses are required to collect sales taxes when the customer is in the same state or when the business has "nexus" in the customer's state. A sales tax is a levy placed by states on goods or services purchased from a business that has a physical presence in the same state as the consumer. A use tax is a compensating tax imposed by states to collect taxes on sales which do not take place in their state. The tax is meant to insure that all purchases are taxed, whether bought locally or from out of state sellers. The use tax is the customer's responsibility to pay but is increasingly being collected by vendors on their behalf.
Taxpayers located in one state are not required to collect sales or use taxes on behalf of a different state unless they are "doing business" in the other state. A business must have "substantial physical presence" (such as a sales force, distribution center, or warehouse) in a state to be considered "doing business", and therefore required by the state to collect sales tax. Nexus is the legal term, which means connection to the state through a physical presence. The regular presence of a single sales person is enough to create tax nexus, therefore requiring the collection of sales tax. The concept of sales taxes seems simple but in reality can be very complex. Depending on the state, different items may be taxed at different rates. In some states for example, food is not taxed and clothing may have a lower tax than other items. Rates can often vary by city and/or county, so businesses must keep records of sales in each city, county, as well as each state in which they do business. Examples of the complexity of tax compliance for businesses are: - In Pennsylvania, state and U.S. flags are not subject to tax, but if they are sold with a flagpole, the entire purchase becomes taxable.
- In Rhode Island, fruit juice less than 100% pure is taxable while cranberry juice cocktail, a mixture of juice and water, is exempt.
- In Illinois, cooking wine is taxable as an alcoholic beverage, though it only contains a small amount of alcohol.
- In Texas, plain nuts are an exempt food, but once a candy coating is added, they become taxable.
The list goes on and on, only adding to the cost and resource burden of a business.
Audit Exposure
Faced with budget cuts and deficiencies, states are becoming more aggressive about going after every penny possible. "Businesses that are particularly vulnerable to sales and use tax audits are: grocery and convenience stores; restaurants; bars; liquor stores; manufacturers; printers; advertising agencies; sellers of vehicles, vessels and aircraft; leasing companies; people in high-tech industries, including sellers of computers, software, cell phones, and so on; and construction contractors." (Dan Davis, CPA, Arthur Consulting Group's website)
Penalties and Interest
Most states charge penalties and interest for late payments, underpayments, or failing to file sales and use taxes. States can also revoke the business' license and/or issue a tax warrant for the business owner's arrest. Further, if a state believes a business has had nexus in the state for a long period of time it probably will assess taxes, interest and penalties as far back as its statute of limitations allows.
What to do?
The best course of action is to keep current on filing sales tax returns and payments (quarterly or monthly, depending on the state's requirements), and keep accurate and detailed sales records. A business must also keep current on the 700 to 900 total sales tax rate changes made by states and municipalities each year. These changes include rate increases/decreases as well as new sales and use taxes added to jurisdictions.
Record keeping is extremely important in the event of an audit. Records to be kept - usually as long as the state's statute of limitations - include sales invoices, paid bills, contracts, purchase orders, register tapes, bank statements, canceled checks, and similar original documents. Other required records include documents supporting tax-exempt sales, such as resale and other exemption certificates, customer purchase orders, and freight bills indicating shipments to addresses outside of the state. Depreciation schedules and other fixed asset records should also be kept.
AvaTax Connect automatically calculates sales-and-use tax and generates reports for any jurisdiction in the U.S. and Canada. AvaTax Connect is an inexpensive, easy, and automated solution that will save time and money, ensure compliance in all tax jurisdictions, and eliminate audit risks for virtually any business. Any company, of any size, can realize the cost-saving benefit of AvaTax Connect and insulate themselves from audit fines and penalties associated with incorrect sales reporting.
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