How much time do you spend on sales tax compliance?
All good things come at a price. For many businesses, one of the biggest costs of success is sales tax compliance.
The more you sell, the more time you need to devote to managing sales tax. This is especially true for online sellers with customers nationwide. Getting sales tax right entails:
- Determining sales tax nexus
- Registering with the proper tax authorities
- Calculating the appropriate sales tax rate for all transactions
- Tracking changes to rates, regulations, and rules
- Validating exempt transactions
- Filing returns and remitting tax
Each step takes time to complete properly, and mistakes can lead to noncompliance and a spendy audit. Together, they amount to a significant burden.
Determine sales tax nexus
Sales tax nexus is the connection between a tax jurisdiction (e.g., a state) and a business that enables the jurisdiction to tax the business’s sales. A company with nexus in California must register with the California Department of Tax and Fee Administration, collect and remit sales tax, and file returns as required by law. A company without nexus can’t be required to do so.
Nexus is established by having a physical presence in a state, such as a brick-and-mortar store, warehouse, or employees. In 43 states plus the District of Columbia and parts of Alaska, it can also be established solely through sales activity (economic nexus), meaning businesses with no physical presence in a state can be required to register then collect and remit sales tax in that state.
Most state economic nexus laws provide an exception for small sellers, but that’s a bit of a double-edged sword. In California, the economic nexus threshold is $500,000 in sales in the preceding or current calendar year. But it’s $100,000 in sales or 200 transactions in Illinois, and $500,000 in sales and 100 transactions in New York. Every state’s economic nexus threshold is unique and subject to change.
Consequently, businesses must track their sales into all states with economic nexus laws so they can register and start collecting sales tax once an economic nexus threshold has been met. That takes time, though this free sales tax risk assessment tool can help.
Register with the proper tax authorities
Once you know you have nexus, it’s time to register with the state tax authority. While the process is more challenging and expensive in some states than others, it’s in every state’s interest to make it as simple as possible.
Companies required to register in more than one Streamlined Sales Tax (SST) member state may want to register through the SST. The 24 member states of the Streamlined Sales and Use Tax Agreement use a central, electronic registration system. Furthermore, SST states will subsidize certain sales and use tax compliance software, like Avalara, for businesses that qualify as a volunteer seller. Additional details can be found in What is Streamlined Sales Tax, and why should you care?
Calculate the appropriate rate for all transactions
All registered sellers then need to set up point-of-sale systems to charge the proper tax rate on taxable sales.
Sales tax rates vary by state, and in most states, by locality. For example, the sales tax rate is 6.35% in Connecticut and 6.25% in Massachusetts, two states with no local sales taxes. But sales tax rates range from 7.25% to 10.25% in California, and from 6.375% to 8.25% in Texas.
There can also be different rates for different products. A lot of clothing is exempt from state sales tax in New York, but subject to local tax in many parts of the state. Certain sweetened beverages are subject to a higher rate of tax than sales of unsweetened bottled water in San Francisco, Seattle, and the entire state of Vermont. Diapers and feminine hygiene products are exempt from sales tax in California, but only until January 1, 2022. And so on.
Track changes to rates, regulations, and rules
Once set up to properly tax every transaction in every jurisdiction, point-of-sale systems must also be monitored because sales tax rates, rules, and regulations are subject to change. In fact, rates for some products have to change in states that provide sales tax holidays — temporary (often annual) periods of sales tax exemptions for specific products.
State tax departments typically aren’t required to notify taxpayers of upcoming changes — the onus to stay in compliance always falls on the business. Thus, it’s essential to be vigilant. If you keep collecting sales tax when you shouldn’t, or don’t collect it when you should, you’ll likely run afoul of customers and tax officials.
Validate exempt transactions
Even businesses that deal primarily in exempt sales need to pay attention to sales tax. Many states count exempt sales in their economic nexus thresholds and require businesses that cross the threshold to register, validate exempt transactions, and file returns — even if no sales tax ever changes hands.
Exempt transactions must be validated with an exemption or resale certificate, and certificates must be kept up to date. They should also be well organized so they can be accessed quickly if an auditor wants to see them. And auditors do like to see them.
File returns and remit tax
The sales tax cycle ends with filing returns and remitting the collected tax. Companies are required to file returns in all states where they have nexus, usually even when there’s no sales tax to remit. When done manually, filing returns typically involves numerous spreadsheets, logging into various state websites, bottomless cups of coffee, long days, and frayed nerves — plus amending returns when mistakes are made.
Save time and money by automating sales tax compliance
Sales tax compliance can be handled manually, of course. It often is. You can also cut a lawn with scissors. The question is, how much time do you devote to the task? And how much do you suffer while doing it?
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
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