Where is compliance costing your business (and how much)?
Investing in tax compliance can often feel like updating the structure of a home: It’s not a lot of fun to do and while the end result provides security, there’s no stunning reveal with before-and-after pictures to show off at parties.
But like structural home renovations, putting off tax compliance can lead to expensive (or even catastrophic) consequences. After all, if a load-bearing wall isn’t properly braced, that beautiful chevron tile floor you just installed can literally fall out from under you.
Turning back to tax compliance, it can seem easy to build processes as issues arise. Over time, you manage calculation, returns, exemptions, and so on, in a way that makes sense for your business. Until you upgrade your accounting system or expand into new products or markets; then your process springs a few leaks and you realize you’ve been plugging hundreds of holes and you’re all out of thumbs.
It’s relatively easy to get a price estimate for a comprehensive compliance solution like Avalara. But how do you do a cost-benefit analysis if you aren’t entirely sure of what you’re currently spending on compliance? While they don’t bear an obvious price tag, inefficient processes can be a huge drain on your bottom line and often involve hidden costs.
To give you an idea of what compliance costs, let’s take a look at the processes along a typical tax compliance journey.
- Knowing where you have tax obligations
- Calculating tax rates based on current rules
- Collecting and managing tax documents
- Preparing and filing tax returns
- Determining use tax liability for your organization
Knowing where you have tax obligations
Most businesses have a basic understanding of tax liability in the state in which they operate. It’s simple enough: If you set up shop, you probably owe someone taxes.
But there are several types of sales tax nexus, an obligation to collect and remit tax. A few common ways of establishing nexus in other jurisdictions are:
- Meeting sales or transaction thresholds
- Storing merchandise
- Working with remote employees or affiliates
- Drop shipping from warehouses
To make matters more complicated, each jurisdiction has its own rules about what establishes nexus. The onus is on businesses to track the activities that trigger obligations and register to collect sales tax in a timely fashion.
Which means you need to invest in a sound strategy for:
- Tracking all remote sales
- Identifying where your inventory is stored or shipped from
- Accounting for out-of-state employees and partners
Once you have those details mapped, look up the particulars for each affected jurisdiction. Some handle sales tax at the state level, while others require you to break obligations down to the county or city level.
You also have to keep up with legislative changes. States can amend the sales thresholds, exemption clauses, and other nexus parameters at any point. For example, if a state lowers its economic nexus threshold from $500,000 to $250,000, your $372,000 in annual sales now obligates you to register to collect and remit sales tax.
What’s the cost?
Each month, you need someone to:
- Stay up to date on where you owe
- Monitor where you’re approaching nexus thresholds
- Track inventory and drop shipping locations
- Check for rule changes in each jurisdiction
According to an Avalara/Potentiate survey, businesses with 20–499 employees estimate spending an average of $1,740 per month on state sales tax obligations and filing requirements.
Calculating tax rates based on current rules
Once you’re confident you know the transactions to collect tax on, you have to apply the right rate. But how much do you collect? It depends on what you’re selling and where. A couple tricky examples are software and food. Some states apply sales tax on software, others don’t. Groceries are even more complicated. Depending on where they’re sold, groceries can be:
- Taxed at the standard rate
- Taxed at a reduced rate
- Tax exempt
- Taxed or exempt based on ingredients
- Taxed or exempt based on preparation
There are also special tax rates on all kinds of products and services based on location, like jet fuel in Georgia or farm equipment in Idaho.
Several states also have sales tax holidays, during which certain products are exempt. Each state chooses whether to have tax holidays, when they are, and which products apply.
Tax jurisdictions can also change rates at any point. As with nexus rules and requirements, it’s important to follow tax legislation in each place you collect sales tax so you can make sure you’re charging the right rates; you’re on the hook to remit increased taxes even if you weren’t aware the rate went up.
What’s the cost?
Again, the onus is on the business to apply and remit the right tax rate for each jurisdiction on every sale. For most businesses, this means tasking someone with:
- Classifying all products
- Verifying the tax rate for each item in a sale
- Uploading and managing rate tables in your system
- Collecting tax at the time of purchase
- Updating rates based on legislative changes
The Avalara/Potentiate survey found businesses with 20–499 employees estimate spending an average of $3,493 per month on tax rates and calculations.
Collecting and managing tax documents
When customers are tax exempt because they’re an untaxed entity or purchasing for resale, you need to collect the right documentation. Documents must be the correct form, valid at the time of sale, and available on demand if your business is audited.
If an auditor finds transactions in which you exempted tax but don’t have the right certificates on file, you’re responsible for paying the tax, as well as possible late fees or penalties.
Despite being worth their weight in gold (or possibly more), many businesses don’t properly manage exemption certificates. Hard copies get thrown into haphazard storage systems and digital versions hang out in the purgatory of an employee’s inbox.
Come audit time, a well-organized, easily accessed digital database can save you from a long, drawn-out investigation. And possibly an undue tax burden.
What’s the cost?
Regardless of whether you manage a physical or digital database, your business is responsible for:
- Collecting exemption certificates at the point of sale
- Verifying documents are correct and valid
- Properly storing documents for future use
- Tracking certificate expiration dates
- Aligning exemption data across all business systems
- Supplying requested documents to tax authorities
The Avalara/Potentiate survey found businesses with 20–499 employees estimate spending an average of $3,409 per month on exemption certificate management.
Preparing and filing tax returns
You’ve collected the state’s money and now it’s time to remit. But when do you file and how often? Well, that depends — which may as well be the tagline for sales tax compliance.
Each jurisdiction sets its own remittance schedule for businesses with nexus. The state assigns a frequency based on your sales: annually, semiannually, quarterly, or monthly. For the most part, the more you sell, the more frequently you need to file.
It’s important to consolidate data across your systems regularly so you aren’t left scrambling to align the numbers in time to meet filing deadlines. Even if you haven’t had any sales, most authorities require you to file a $0 return if you have nexus.
It’s also very important to make sure your returns are accurate. Improper filing is one of the easiest ways to draw attention from state auditors.
What’s the cost?
Once you establish an obligation to collect and remit taxes in a jurisdiction, you need to:
- Understand the frequency and deadline for each location
- Find out if you file at the state or local level
- Align transaction data across your systems
- Gather rationalization for tax decisions
- Download forms and prepare returns for each location
- File in the format each state requires
- Remit tax payments to each authority
The Avalara/Potentiate survey found businesses with 20–499 employees estimate spending an average of $4,894 per month on tax returns.
Determining use tax liability for your organization
Use tax is often overlooked by businesses but rarely by tax authorities. Going back to our house renovation metaphor, it’s like dry rot or black mold. It can silently infiltrate your business while you’re completely unaware — until an inspector shows up and reveals all the damage. Plus, the heavy cost of setting things right.
Use tax can be established in a number of ways, including well after a sale has occurred. For example:
- Getting goods in a state with a lower tax rate for use in your state
- Purchasing equipment from a central business location, then using it in others
- Buying stock for resale but using it on-site or for promotion
- Being undercharged tax by vendors
It can be incredibly tricky to self-assess use tax. It requires a lot of tracking, logging, verifying, and documenting. It also relies on constant coordination between inventory, accounting, purchasing, procurement, IT, and sales teams.
What’s the cost?
To stay on top of use tax liability, you need to make sure you:
- Verify the right tax rate is applied on all purchases
- Pay local tax on out-of-state purchases
- Account for repurposed inventory
- Track equipment deployed from a central purchasing department
- Incorporate employee purchases into tax data
- Align data across systems in each department
The Avalara/Potentiate survey found businesses with 20–499 employees estimate spending an average of $4,136 per month on consumer use tax management.
In total, from determining obligations through remitting taxes, businesses with 20-499 employees spent an average of more than $17,000 per month on tax compliance activities, according to the Avalara/Potentiate survey.
These estimates are averages, so you’re likely spending more or less, depending on the tax complexity of your business and the efficiency of your processes. But now that you have an idea of the time and money that goes into managing tax compliance, you have a good starting point for determining how to reduce your costs.
We recommend automation. Not only can a solution from Avalara save you time and money, it also reduces the risk of error, centralizes tax data, improves accuracy, and streamlines reporting in the event of an audit. Talk about a solid foundation.
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