3 risky sales tax survival strategies

The lengths businesses are willing to go to take the sting out of sales tax compliance                                                                                                                                              

Let’s face it, sales tax can be a drag for businesses. First, you have to figure out where you have an obligation to collect and remit sales tax, or nexus. Then, you need to register, set up your sales system to charge the proper tax rate for each taxable transaction, and establish a process to validate exempt sales. You need to file returns and remit taxes on time, every reporting period. And you have to stay on top of changes to rates, rules, and regulations wherever you sell.

It can be overwhelming.

To make it less so, some businesses cut corners. They don’t want to do anything illegal or improper; they just want sales tax compliance to be simpler and less time-consuming. So, they’ve come up with various sales tax survival strategies — described below, along with their risks.

There are more than 12,000 different sales and use tax rates in the United States, and ecommerce sellers with a broad customer base may need to contend with hundreds or even thousands of them.

Instead of applying the proper sales tax rate to each sale, some businesses charge all customers in a given state the lowest common sales tax rate. For example, since Texas sales tax rates currently range from 6.375% to 8.25%, the retailer would charge all customers in Texas 6.375%.

To ensure the Texas Comptroller gets the tax revenue that’s due, the business pays the difference itself. This is called absorbing sales tax.

Risks: There are a few reasons making a practice of absorbing sales tax is inadvisable.

First, it’s illegal in some states (although it’s legal to absorb sales tax in other states).

Second, it cuts into profits.

Third, it can anger competitors. Undercharging sales tax gives businesses a competitive edge, so competitors won’t stand for it. They’ll alert the tax authorities, who’ll likely initiate an audit.

Fourth, customers may find it confusing. While they probably won’t complain if they’re being undercharged, they may wonder why all businesses don’t charge them the lower rate. They could contact the state tax authority to ask about it, and trigger an audit.

Most tangible personal property is subject to sales tax in the 45 states that have a general sales tax (plus Washington, D.C.). Yet each state has its own unique product taxability rules.

For example, candy is subject to the full rate of sales tax in some states but exempt in others, and in some states, it’s taxed at a reduced rate. Diapers and feminine hygiene products became exempt in D.C. on October 1, 2019, the same date D.C. increased the tax rate on soft drinks. Connecticut recently reduced the sales tax rate for numerous digital products, while Rhode Island started taxing them at the full rate.

As with sales tax rates, the relentless ebb and flow of product taxability changes can wear down retailers trying to manage sales tax manually. So, some businesses make it easier on themselves by applying the same rate to all their products.

Risks: As above, there are several good reasons not to do this.

First, it can anger or confuse customers. Lots of people know how much tax they should be charged. Incorrectly taxing sales can therefore lead to an inquiry with the state tax authority, which can lead to an audit. And states generally don’t like it when businesses knowingly charge tax on sales that should be exempt, or exempt sales that should be taxed, or make a habit of charging the wrong rate.

Second, just like the first survival strategy, this can anger competitors. If other businesses learn a competitor is undercharging sales tax, they’ll likely alert the tax authorities.

Third, it can lead to negative audit findings, penalties, and interest. It can also lead to other charges, especially if it’s done willfully. 

Registered retailers in all states are generally required to file a return for each reporting period, even if there’s no tax to report. These are often called “zero returns.”

Some businesses make a practice of not filing zero returns. They assume, perhaps, that state tax authorities have better things to do than hassle companies with no sales to report.

Unfortunately, tax officials don’t know why a registered business didn’t file a return when a return isn’t filed. It could be there were no sales and thus no tax to report. But it could be the retailer collected tax and used it to pay their own bills or bankroll a trip to Tahiti. They don’t know, and so they need to investigate.

Risks: Not filing zero returns as required is risky for a few reasons.

First, tax authorities will notice and investigate, eventually.

Second, it can lead to financial penalties. Numerous states impose flat fees for failure to timely file a return with no tax due: It’s $50 in both New York and Texas.

Third, it can kill a business. States can and will revoke a sales tax license for failure to file as required, especially if it was intentional.

The above sales tax survival strategies may, indeed, save precious minutes in the short run. In the long run, however, the risks outweigh any potential benefits.

Undercharging sales tax, applying the same rate to all transactions, or failing to file zero returns are like jumping up and down in front of your local tax authority while shouting, “Look at me!” They’re all brilliant ways to invite an audit, which even the most tax-compliant companies find taxing.

That said, the desire to simplify sales tax compliance is understandable. Managing sales tax has become especially onerous since the Supreme Court of the United States issued its decision in South Dakota v. Wayfair, Inc. (June 2018): States now have the authority to require out-of-state companies with no physical presence in the state to collect and remit sales tax, and most do. That means more businesses need to comply with sales tax laws in more states than ever before.

No wonder some companies have gone into survival mode and embraced the above corner-cutting tactics, risky though they are.

With the additional complexity incurred by the Wayfair decision, automating sales tax collection, remittance, and exemption certificate management is really the only way companies that sell into multiple states can stay in compliance (and off tax authorities’ radar).

Learn how sales tax software solutions can help your business today at avalara.com.