5 Sales and Use Tax Tips
Sales tax isn’t a high priority for many fast growing businesses these days; yet just beyond your field of vision lay compliance challenges that can start small and become serious and expensive.
These 5 tips provide a roadmap for sales tax compliance in 2015:
1. Watch for broader definitions of nexus.
Every time your company introduces a new product or service, sells into a new market location, or online into a state, remote seller nexus may apply. In 2015 these rules are a moving target. Due to state and federal court inaction, states have assumed a presumptive authority to broaden definitions of nexus, obligating more out-of-state sellers to collect sales tax.
Affiliate relationships are not only considered taxable when they occur among online sellers. Another affiliate relationship that creates a tax obligation is drop shipping. Drop shipping—shipping from the manufacturer or distributor straight to the customer—is another complex element of sales tax management. In some cases, the use of a drop shipper, or a contract with a distributor that functions as a drop shipper, is considered a taxable nexus-creating activity.
What states are doing:
Texas:In Texas, a Utah corporation that sells computer programs and digital content primarily through the Internet was found by the Texas Comptroller to have nexus with Texas and was assessed sales tax for the period January 1, 2002 through June 30, 2010.
2. Track your product taxability exposure.
The variability of product taxability rules among states is likely to continue in 2015, especially around emerging technologies. In many states, product taxability and the sales tax rate depend on the type of product, sometimes its ingredients, the date it was sold, how it will be used, and the location in which it was purchased. To make matters worse, the traditional definition of what makes something a product (i.e., tangible personal property) is changing. Nowhere is this more obvious than in the treatment of developing technologies. With the rise of digital downloads, including music and movies, some states are broadening taxable product definitions to include virtual products.
What states are doing:
Wyoming:Custom computer softwareThe sale of custom computer software is not subject to Wyoming sales tax, be it delivered electronically or “otherwise.” Charges for the creation of custom computer software (a service) are also exempt. The person who performs the service of creating custom software is considered by the state to be the consumer of anything purchased to perform the service.Prewritten computer softwarePrewritten computer software is considered tangible personal property in Wyoming and is therefore subject to sales tax. The delivery method (via CD-ROM, Internet download, etc) does not impact taxability. Examples of prewritten computer software include but are not limited to:
Microsoft OfficeQuickBooksTurbo Tax
In general, sales of modifications or enhancements of prewritten computer software are also taxable, although some exceptions are allowed. To be eligible for an exemption, charges for modifications or enhancements must be separately stated.
3. Pay attention to what services are taxable in what state.
States approach service taxability in various ways. Whether or not the service you provide is taxable depends on many factors including the customer’s location, the location of your service, and whether or not the service fits into the broad service categories used by a particular state. Services that are typically considered taxable range from personal services to fabrication, repair, and installation.
Whereas states like Delaware, Hawaii, and Washington typically tax services, other states such as Virginia, and New Hampshire tax very few. For example, if you provide service contracts to customers who purchase your computer software, that service would be considered taxable in states like Florida. Services provided under the “professional service category” can be confusing given that the modes of service delivery are increasingly moving online. So-called cloud services, such as IT support offered remotely, can be considered taxable in some states.
What states are doing:
Florida:TaxableThe service of cleaning nonresidential buildings, a category that includes public lodging establishments as defined by the North American Industry Classification System, is generally subject to sales tax. Examples of such services include but are not limited to:
Acoustical tile cleaning.Deodorant servicing of restrooms.Floor waxing.Janitorial services.Maid services.Office cleaning.Venetian blind cleaning.Window cleaning (both interior and exterior).
ExemptExempt cleaning services include:
Carpet cleaning.Pressure cleaning the exterior of a building.Residential and transient rental cleaning services (Warning! Charges for cleaning services that must be paid by the guest for the right to use the transient rental are subject to sales and local option transient rental taxes.)Sales to nonprofit organizations that hold a current Florida Consumer’s.Certificate of Exemption (Form DR-14).Sales of services for resale.
4. Keep accurate records of exempt transactions.
Sales tax exemption certificates enable a purchaser to make tax-free purchases that would otherwise be subject to sales tax. Resale certificates are provided to suppliers to substantiate that the items purchased are intended for resale only and therefore are exempt from sales tax. Sales can be exempt for many reasons including:
The nature of the use—how or where the goods will be used by the buyer (i.e., resale).The nature of the goods or services sold—some states do not tax services and labor, others do.The nature of the buyer—some states exempt nonprofits and government agencies from collecting sales tax. Others do not.
Collecting and filing these certificates can be a burdensome administrative chore, especially given the conflicting requirements of individual states. This is one of the most error-prone aspects of the sales tax management process that can leave a company open to considerable risk vulnerable to an audit due to expired or invalid certificates. In fact, disallowed exempt sales are a leading cause of audit fines, penalties, and interest.
What states are doing:
Tennessee: In Tennessee, many agriculture-related purchases are eligible for an exemption from sales tax. As a result, many agricultural businesses have agricultural sales or use tax exemption certificates. Yet these exemption certificates do not give businesses a blanket exemption from all sales and use tax. Recently, the Tennessee Department of Revenue sent a letter to holders of agricultural sales or use tax exemption certificates, reminding them of that.
5. Create a 2015 Action Plan.
Any sales tax compliance action plan for 2015 should include looking for more efficient, accurate, and cost-effective ways to manage the challenging sales tax environment. Companies striving to accurately collect, file, and report sales and use taxes face an uphill battle in 2015. Avoid practices that put you at risk for audit, such as using out-of-date rates and rules, failing to recognize new rules that create remote seller nexus, or using error-prone manual processes to manage unwieldy sales and use tax laws and rates.
Managing sales tax compliance through technology automates the calculation, reporting, and remitting of use tax. Minimized human intervention reduces the risk of over or underpayment. Most software solutions also feature dynamic, on-demand tools that deliver reports quickly and easily, improving accuracy and discouraging audits. Companies also enjoy rapid ROI from technology solutions due to improved compliance and redeploying staff time to revenue-generating activities.
The costs of manual compliance are often higher than automating anyway. In their report, “Effective Sales and Use Tax Management: Reducing Errors and Increasing Productivity,” the Aberdeen Group identified an alarming statistic—many financial officers underestimate the cost of sales and use tax compliance by 50 percent. These CFOs often assume sales tax compliance is handled due to the limited visibility of sales tax transactions and their lack of integration within manual billing and procurement processes. Given that the average penalty of a negative sales and use tax audit is $24,000 per occurrence, this assumption could bring ruin to many small- and medium-sized businesses.
Or follow the example of thousands of other businesses and use the expertise and affordable solutions Avalara provides.