The US Sales Tax Guide for Start-Ups
With a Gross Domestic Product (GDP) of USD 23 trillion in 2021, the US is the biggest economy in the world. This was a rise of 5.7% in GDP when compared to 2020. Thus, it is no surprise that Indian startups that aim to become global companies, turn to the U.S. to find a strong customer base. Today, India has the third-largest start-up ecosystem in the world, after the US and China.
While the ecosystem is conducive for start-ups to do business in the U.S., taxes still remain complicated and cumbersome. Moreover, most start-ups do not have robust tax teams to handle their tax compliances and also find it difficult to engage a credible consultant to handle it on their behalf.
Avalara is here to help. Our professional tax compliance services help you determine your sales tax registration, collection, and remittance requirements.
This guide will help you understand what are the common hurdles that disrupt your business, stifle your cash flow, or even leave you legally exposed.
Insight into the Economic Nexus
That being said, most Indian start-ups do not realize that despite the location they establish their presence, it may trigger an economic nexus. Considering tax laws vary state by state, small corporations constantly grapple with understanding where they have a tax liability. This only adds to the layers of complications for startup founders and their administrative teams.
What Should A Start-Up Know?
Until 2018, companies paid their sales tax in accordance with the state and local tax laws and regulations in order to be compliant. However, the Supreme Court ruling (South Dakota v. Wayfair) gave rise to the concept of economic nexus.
The case set a new precedent that a company selling goods or services in another state may be deemed to have a presence in that state despite not having a physical store, offices, sales representative, or operations there. Therefore this attached additional sales tax burden on companies who now had to fulfill tax obligations in a state without having any physical presence.
This means that start-ups will now have to register in any state where economic presence is triggered. Further, sales tax will have to be collected if a set level of transactions or sales activity is met. In most states, the qualification clause would be sales more than USD 100,000 or 200 distinct in a 12-month window. One needs to be mindful of exceptions such as Texas and California both of which have a threshold of USD 500,000.
Take the example of Titan which began in 1984 and started its business by manufacturing quartz analog watches. Now it has diversified into various other products such as perfumes, jewelry, and eyewear. Its annual revenue during FY’21 was over 207 billion Indian rupees.
With large revenues and a wide presence it is important for Indian-based companies like Titan to be aware that the economic nexus statutes are different in each state with varying different definitions and thresholds. Solutions like Avalara automate the tax obligations based on the nexus and prevent errors while keeping track of tax deductions.
Why Is It Important For A Start-Up?
Interestingly, the complications of economic nexus are not limited to these provisions as sales tax nexus can get triggered despite making any sales in a state. Some instances where economic nexus could apply to businesses are:
- Transporting goods by out-of-state sellers across state lines
- Omnichannel ecommerce sellers and marketplace facilitator businesses (such as Amazon, eBay, or Etsy)
- Companies offering Software as a Service (SaaS)
Further, where there are sales tax obligations, there will also be corresponding liabilities in case an economic nexus is proven and sales tax remains uncollected.
Failure to collect sales tax from your customers would entail companies to pay up past dues along with an average of 30% of the said sales tax due in interest and penalties. Not only will this burn a hole in the pocket of small businesses but will also tag the startup as guilty of tax evasion. Hence, start-ups often file taxes in all states where they are registered to collect taxes irrespective of whether they have a sales tax liability during that period.
How Can Start-Ups Be Compliant?
Understanding your economic nexus and being compliant with the necessary laws is the first step in the multi-phased process.
Take the example of Mahindra group that has been present in US for more than 25 years.They have about 30 IT development centres and 790 tractor/vehicle dealerships across the US. Since economic nexus varies based on the location of the business, where their customers are situated, their sales volume, and their product line, they need to keep a constant check on these elements
Barring Oregon and Montana (where there is no sales tax), all US states have some form of economic nexus laws. View this state-by-state guide to economic nexus laws to find out if it is applicable to you!
A Start-up Roadmap to Sales Tax Compliance
Step-By-Step Process for Tax Compliant and Protected Start-up
1. Map Out Where You Have Sales Tax Nexus By State
The first step is to gather information regarding your business profile, industry operations, and revenue stream in order to determine your state-wise sales tax nexus. As highlighted earlier both economic nexus and physical presence can result in a startup having a sales tax.
Importantly, if you are a new start-up or you are planning to expand to other states or districts, you should always do your research to understand the nexus that is specific to your business or industry. Further, even existing businesses need to continuously reassess their nexus with both states as well as your (current and future) customers to avoid any potential tax compliance exposures.
2. Determine The Taxability Of Your Products
Not all products and services are taxable in every state. Even if the same product was taxable in two different states, the rates chargeable and exemptions available would differ. Hence start-ups need to review the established tax rules for tangible and intangible goods and services to understand the impact of their overall exposure.
Further, to better assess your taxability, you can make use of historical data such as legal rulings or regulatory trends specific to your products and services. This due diligence process will help in in-depth risk assessment and mitigation.
3. Create Custom Sales Tax Matrix For Your Startup
Considering the varying definitions and state-wise tax administration policies, you should create a custom sales tax matrix that will help you map out each law, regulation, and procedure of the state you are doing business in. Further, specifics such as common/typical transactions, exemption, rates, etc can also be charted out. Each sales tax plan created from this matrix will be tailored to your products and services to make sense of your specific situation and risk tolerance.
4. Create the perfect tax compliance plan for your startup
As discussed above, based on a sales tax matrix will help you put a robust plan in place to maximize your tax savings and keep you tax compliant.
Components of the plan include:
- Registering your startup with the states where you have an established nexus
- Commencing sales tax collections as per the stipulated dates mentioned in the state-specific regulations
- Filing sales tax returns periodically and remit payments timely and accurately
- Researching on historical sales tax issues to protect you from inadvertent tax evasion or non-compliance
Utilizing recommended resources, tools, and tax automation software to streamline your operations and eliminate any prospective tax compliance issues
5. Maintain the plan and adjust as needed
Sales tax laws are constantly evolving hence once your plan is in place, you need to constantly revisit it and make alterations in case of any changes in legislation or nexus profiles.
Checklist to Compliance
How can Avalara help?
At Avalara, we understand that start-ups are transforming the business landscape. While start-ups look to find simple solutions to complex problems, we endeavor to do the same.
And suppose you are an Indian-based business looking to expand abroad but are daunted by the various taxation obligations. In that case, solutions like Avalara allow you to optimize your tax savings easily with a minimal chance of errors.
Start-ups often tend limp through the tax compliance process. Considering the multiple transaction points like stores, websites, and third-party platforms, we help simplify the complexity of tax compliance so you can focus on business growth.
The recent socio-economic changes have brought about unprecedented changes in taxability. The hiring of employees from other states, opening a store or office in another state, or simply increasing revenues from a certain jurisdiction may give rise to an economic nexus that you may not be aware of.
Our solution helps calculate and collect sales tax on both physical and digital products through a systematic process. Here is how you can gain:
- Assimilate Nuances Of Registration And Collection
Gain insight into locations where economic nexus gets triggered and understand your sales tax obligations in a single window.
- Automate Sales Tax Collection
Despite the product you sell or the location you sell in, Avalara is there to help. We help you constantly monitor sales tax updates, be it rules or rates. Benefit from ready sales tax calculation and scheduled collections in an accurate and efficient manner.
- Simplifies Filing And Remittance
With Avalara by your side, you will be able to generate itemized reporting and tax summaries for each jurisdiction in a matter of a few clicks. We help you with swift and seamless sales tax filing and remittance.
Sales tax always seems like a cumbersome and complicated process. With Avalara’s sales tax automation software you will never miss a rule, data, or benefit anymore. Contact us today!