Welcome to the 2016 edition of Avalara’s annual Sales Tax Survival Guide. Sales tax challenges are constantly evolving. This year’s completely revised and expanded guide provides tips to help your company survive 2016’s biggest sales and use tax compliance issues.
This guide is not to be used as a substitute for professional tax advice. Consider it a tool to help you understand and prioritize your sales and use tax challenges for 2016 and beyond.
The big crunch: States need sales tax revenue
When state budgets get tight, state governments crack down on taxes. In the 45 states with a statewide sales tax, businesses with a connection to the state are obligated to register and remit the correct amount of sales tax — and any mistakes can mean fines or penalties. Out-of-state firms and small sellers are not immune from state auditors seeking to fill budget gaps.
It’s not enough for a business to be aware of its sales tax obligations: knowing what solutions are available to solve your problems is just as important. That’s why, for each sales tax challenge in our 2016 guide, we’re presenting three survival tips to put you on the path to full compliance.
Sales Tax Survival Challenge #1: Surviving sales tax audits
No one wants to be subjected to a sales tax audit. But no business is immune from them. If you’ve never been audited before, the audit process can take you by surprise by taking longer and costing more than expected. The average audit, according to Wakefield Research, costs $114,000, and nearly half of businesses surveyed say they expect an auditor would find errors if they were subject to an audit today.
Survival Tip: Collect and remit the right amounts.
The single best defense any business has against an audit is getting rates and product taxability right. Even the most meticulous record-keeping won’t protect your business from fines and penalties if you’ve charged customers incorrect rates or have been remitting less to the state than you’ve been collecting.
Getting this complex step right can take a lot of effort — especially if you sell a wide variety of products. Check out a video on how sales taxes on food can be a minefield for sellers, and learn more about automating product taxability with Avalara.
Survival Tip: Keep documentation organized.
Which sales tax audit will disrupt your business more: one that takes an hour, or one that takes weeks (or even months)? If you’re filing documents manually and showing your auditor stacks of paper, it’s likely that you’ll be in for a long slog. Missing or expired exemption certificates are a particularly pesky problem, as many businesses don’t realize that they’re required to keep them on handreadily available for auditors to review.
Don’t just take our word for it: read this blog entry by a former sales tax auditor. The big takeaway? “If you make things easy on your auditor, there’s a good chance he or she will return the favor.” By automating the document storage and retrieval process, Avalara customers have seen auditors “run out of things to do” in their first day of an audit.
Survival Tip: Understand the audit process
If your business receives an audit notice, it’s important to know enough about the audit process to properly prepare.
Avalara’s guide to surviving a sales and use tax audit can help you make contingency plans in case you are audited in 2016. You’ll also learn how to decide whether you need to bring in outside help to make your audit run more smoothly
Challenge #2: Understanding and following changes in product taxability
If every sales tax jurisdiction used the same schedule for filing returns, businesses would have an easy time avoiding late filing fees and penalties. Unfortunately, every jurisdiction is different: some require annual filing, some quarterly, some monthly — and some have different requirements for different types or sizes of businesses, or different due dates for paper filers and electronic filers
Survival Tactic: Know your jurisdiction rules
Filing on time, every time, means knowing the due date rules for every jurisdiction where you have nexus. In states with local “home rule” jurisdictions, this may require knowing rules for local jurisdictions in addition to the rules of the state.
Check state department of revenue websites to confirm the exact details of this year’s due dates. Avalara’s guide to solving filing and remittance problems can help you understand the specific details that may impact when your returns are due.
Survival Tip: Learn about amnesty programs
If you’ve failed to remit the proper amount of sales tax, or have gotten behind on filing, you may qualify for amnesty. Many states offer temporary amnesty programs that provide a penalty-free late remittance period. Requirements to participate in amnesty programs and other “voluntary disclosure” programs can vary significantly, and other states may offer “voluntary disclosure” programs that act in a similar way from state to state.
Avalara’s Professional Services can help businesses evaluate whether it makes economic sense to use an amnesty or voluntary disclosure program in the event of late or missed sales tax payments.
Survival Tip: Streamline the returns process
Filing one sales tax return can be time-consuming. Filing dozens is a massive headache. Streamlining the returns process is good business sense, but different solutions make sense for different businesses.
Very small businesses and home offices may want easy, signature-ready forms — the kind TrustFile provides for businesses to complete. Companies with more complex needs can fully automate the returns process until it’s as easy as reviewing a multi-state ledger, approving the total, and clicking a button to file and remit all taxes at once.
Sales Tax Survival Challenge #3: Keeping up with laws and regulations
As states seek new revenue streams, they change the rules: rules about product taxability, who pays taxes, when sales and use taxes are filed, and tax rates. Thousands of tax rule changes every year make it tough to maintain compliance — even if someone at your company is watching carefully.
Survival Tip: Get acquainted with DOR websites
Each state’s department of revenue has its own website, where new rules (and, often, clarifications of existing rules) are published along with forms and filing deadlines. To keep up with rule and regulation changes in the states that matter to your business, you’ll want to familiarize yourself with the layout of these sites and the resources available on each.
Since each state’s department is independent from all other state departments of revenue, these websites look and feel drastically different. Spend some time exploring each one, and you’ll be better equipped to find any tax information you need to know.
Survival Tip: Follow the blogs
Want updates on changes, both big and small, to sales and use tax laws and regulations? Look no further than the Taxrates.com blog and Avalara’s blog. From half-percent rate changes to discussions of federal Internet sales tax reform proposals, you’ll find enough information in these blogs to become the go-to person at your company for sales tax news and information.
Survival Tip: Automate taxability and rate determination
Keeping up with new sales and use tax laws gets tougher as your business expands into new jurisdictions. If you’re feeling swamped by the sheer volume of tax law changes, look into automating your taxability and rate determinations with software like Avalara AvaTax.
Automation doesn’t have to be expensive — in fact, it can save money and time, allowing your company to focus more on revenue generation and less on avoiding audit risk. Avalara’s Rate Accuracy Guarantee means that you don’t need to worry about rate discrepancies costing your company money in the event of an audit.
Sales Tax Survival Challenge #4: Understanding use tax
So you’ve tackled sales tax — but what about its less-understood cousin, use tax? Two types of use tax (sellers’ use tax and consumer use tax) can pose compliance issues for businesses in the United States. To avoid running afoul of auditors, you’ll need to familiarize yourself with both.
Survival Tip: Get the rates right
Many businesses are surprised to learn that use tax rates and sales tax rates are not always equivalent. This discrepancy can lead to compliance issues and makes use tax a prime target for state auditors.
Even if you’re sure about the sales tax rates in the jurisdictions where you collect and remit sales tax, make sure that you also confirm the proper use tax rates. While the Supreme Court has ruled that use tax rates exceeding sales tax rates are a violation of the Constitution’s Interstate Commerce Clause, some jurisdictions still impose these higher rates and could hold a company liable for the difference in the event of an audit. Alternatively, if use tax rates are lower, you could be paying too much.
Survival Tip: Understand both use tax types
The names of the different use tax types can be confusing. Some sellers think that they are only liable for paying the sellers’ use tax and that only individual consumers are responsible for consumer use tax. The truth is that any time your business paid no sales tax (or a lower sales tax rate than your state charges) for products you used in the course of business, you will be liable for consumer use tax.
That means if you’re buying printer toner online, or making other purchases from out-of-state sellers who do not charge sales tax, you need to pay the proper use tax rate to avoid falling out of compliance. Check out this Will’s Whiteboard to learn more about getting consumer use tax right.
Survival Tip: Know your use tax exemptions
While most purchases used in a place of business will be subject to consumer use tax, many states make exemptions for certain types of purchases. One of the most common of these exemptions is manufacturing equipment; typically, use tax is not due on equipment used to manufacture other goods.
Some companies overpay use tax or keep large amounts of money in reserve for potential tax issues. This can be avoided by understanding and using the exemptions available. Tracking changes to these exemptions, however, can be difficult without automating sales and use tax compliance — especially when a business operates in a number of different tax jurisdictions.
Sales Tax Survival Challenge #5: Exemption certificate management
When a purchaser is exempt from paying sales tax, whether that purchaser is the federal government, a non-profit organization or a wholesaler, a sales tax exemption certificate must be received and filed. While many businesses maintain these files physically, manual filing leaves you open to audit risk and errors.
Survival Tip: Verify and validate
When you receive any new exemption certificate, it is important to make sure the certificate is valid and that all certificate numbers are correct. Incorrect numbers can put you at risk during an audit and cost you money at tax time.
Automatic verification ensures that any discrepancies are caught long before they become a tax hassle. Without it, it’s important to verify each certificate manually with each jurisdiction’s taxing authority (for example, California’s verification system for exemption certificates can be found here). Businesses that fail to verify certificates, either manually or automatically, are cutting a corner that could lead to more risk.
Survival Tip: Keep certificates up to date
Sales tax exemption certificates aren’t valid forever. When businesses file these certificates to sell to tax-exempt customers, they sometimes forget to note the expiration date of the certificate and obtain a new one. Having an expired certificate, in the eyes of the auditor, isn’t any better than not having one at all.
If you’re handling exemption certificates manually, it is critical to maintain a record of expiration dates and either contact your customers to obtain an updated certificate or ask them to provide one the first time they make a purchase after the expiration of their existing certificate. Otherwise, you could find yourself falling out of compliance, one customer at a time.
Survival Tip: Ditch the filing cabinets
One of the easiest ways to lose or misfile exemption certificates is storing them only as physical, hard copies. Filing cabinets are prone to misfiling and make for difficult, time-consuming searches. At audit time, paper records take longer for auditors to sort through, leading to longer, more expensive audits.
Scanning your exemption certificates is a good first step toward maintaining digital records. Using an automated solution like Avalara CertCapture makes that step far more powerful, allowing for automated verification and document management. Automation ensures lower risk at audit time and significantly reduces the time auditors take to match exemption certificate records.
Sales Tax Survival Challenge #6: Jurisdiction complexity
Finding the right state tax rates is the easy part of getting sales tax right. Then the tricky parts start: learning which states allow different rates in different jurisdictions , then figuring out which rates from which jurisdictions properly apply to each transaction.
Survival Tip: Understand drop shipping rules
Drop shipping relationships, in which a third party (like a manufacturer or a wholesaler) handles shipping rather than the seller or buyer, present one of the toughest challenges for businesses — even for those with sales tax savvy. Depending on which parties are in which states, drop shipping can trigger sales or use tax obligations.
Drop shipping triggers nexus obligations in some states, but not in others. In some states, the type and amount of tax you’re obligated to pay may depend on which parties in the transaction have nexus. For more information on understanding the implications of drop shipping, read our guide.
Survival Tip: Get past the ZIP code
Many businesses still get tax rates by looking up a table with ZIP codes and an associated rate. If ZIP codes and tax jurisdictions always lined up, this wouldn’t create the possibility of errors. Unfortunately, ZIP codes are a convenience for the federal postal service, while tax jurisdictions are created by state and local authorities. Translation: the boundaries have nothing to do with one another.
In states like Colorado, tax district borders are so tangled that next-door neighbors can have different sales tax rates. Check out Will’s Whiteboard to learn more about why geolocation — not ZIP codes — is necessary for accurate sales tax calculation.
Survival Tip: Know your Home Rule states
Some states make a single statewide taxing authority the source for all tax rules and regulations, as well as the sole determiner of nexus in the state. However, other states allow local jurisdictions to have some level of control over sales tax.
Different challenges arise depending on the state and the extent of its “home rule” doctrine for local tax districts. In some states, nexus must be established in a local jurisdiction in order for local sales taxes to be collected — while in others, simply having nexus anywhere in the state creates a nexus obligation for all taxing jurisdictions within the state. This Q&A provides more insight into the complexities of home rule.
Sales Tax Survival Challenge #7: Determining nexus
One of the easiest ways to end up with tax liability you didn’t know about is to ignore nexus. Defined as a substantial connection between your business and a state, nexus regulations determine whether you are required to file and remit taxes to a given jurisdiction. Understanding nexus is crucial to getting compliance right as your business expands.
Survival Tip: Learn more about what triggers nexus
Many businesses are surprised to learn that nexus connections can be made through relatively innocuous or seemingly casual business activities. Having a remote employee in another state, using warehouse space in another state through a program like Amazon’s FBA, or even attending trade shows in another state can all trigger nexus.
If you are not sure whether you’ve properly identified nexus obligations for your business, this brief questionnaire will walk you through some of the most common issues. On a state-by-state level, department of revenue websites usually include a page discussing what triggers sales tax nexus within the state.
Survival Tip: Understand click-through and affiliate nexus
One of the most rapidly changing areas of nexus involves so-called “click-through” or “affiliate” nexus. In order to collect sales tax revenue on previously untaxable sales (typically online sales) some states have declared that affiliate relationships create nexus.
This means that if someone in another state provides promotional codes or affiliate links that help your business make sales, you could be creating nexus in that state. This new wrinkle can lead to situations in which smaller businesses establish nexus in states without knowing it. It’s important not to be caught off-guard by these click-through laws — check out this guide for more information on the sales thresholds necessary to trigger affiliate or click-through nexus.
Survival Tip: Don’t get too comfortable
The definition of nexus has expanded a great deal in the last two decades, as Internet commerce has reduced sales tax revenue in many states. Internet sales tax bills have repeatedly been proposed in Congress — most notably the Marketplace Fairness Act, proposed in 2011 and then again in 2013 and 2015.
So far, all proposed Internet sales tax bills have failed to pass into law, but it’s important for today’s online sellers to realize that nexus as we know it is unlikely to last forever. Stay flexible and tuned in to current legislative proposals, so that you’re not caught by surprise if and when the situation changes.
Sales Tax Survival Challenge #8: Understanding service taxability
Sales and use tax used to apply exclusively to sales of tangible personal property (TPP). When the economy of the United States shifted from manufacturing-driven to service-driven, services began to be taxed as well. Today, most states that charge sales tax consider at least some services taxable.
Survival Tip: Know if your state is “presumed taxable”
Most of the 45 states that charge a statewide sales tax include some services. Each of the states that tax services can be considered either a “presumed exempt” or a “presumed taxable” state. Most states are “presumed exempt;” that is, a service is considered exempt from sales tax unless specifically made taxable by law.
In four states, however — Hawaii, New Mexico, South Dakota, and West Virginia — services are “presumed taxable.” In other words, in these states, a service is subject to sales tax unless a specific exemption has been made. If your business is engaged in selling services, it is imperative to know which states make a presumption of taxability.
Survival Tip: Separate service and non-service charges
In many states, service charges are considered taxable when they cannot be separated from the sale of tangible personal property. This means that if you sold a dishwasher with “free” included installation, versus selling the dishwasher for $50 less but with a $50 installation fee, a customer would pay the same base price for the dishwasher and service combined, but would have to pay more in sales taxes.
Depending on your sales tax jurisdiction and how it handles bundled purchases of services and TPP, you may want to create separate service charges. This difference can ensure that you’re saving your customers from paying taxes on services that would otherwise have been exempted.
Survival Tip: Watch for new laws
Because cash-strapped states are seeking new sources of revenue, service taxability is expanding in many jurisdictions. Even if your business is currently not subject to sales and use tax, or only a small portion of your sales are taxable, expansion to a new state or changing laws and regulations could make your taxability picture more complex.
Monitoring news sources and blogs, as well as state department of revenue websites, can help you to keep abreast of any new developments that could affect service taxability for your business.
Sales Tax Survival Challenge #9: Getting registered
Before you can file and remit taxes in any jurisdiction, your business needs to file registration forms. These forms vary by jurisdiction. While some states require just one registration form to collect tax in the entire state, many local jurisdictions in home rule states have their own individual registration requirements.
Survival Tip: Know what triggers registration requirements
Generally, if you are making any taxable sales in a state, the state will require you to file for a sales tax ID number. Many states (like New York) base registration requirements on what specific goods or services are being sold, and do not require businesses to register if none of their sales are likely to be taxable.
Survival Tip: Learn your NAICS code
In order to register to remit sales tax, you will need to know the NAICS code that describes your industry. This code will be required on most state registration forms. If you need to look up your industry’s code, the NAICS website has a handy lookup tool. For example, one commonly used NAICS code is for “Internet retail sales”: 454111. All Internet retailers, regardless of the specific goods they sell, will register using the same code.
Survival Tip: Outsource registration form filing
When your business is growing, you don’t want to take a chance on getting registration wrong. Instead of filing registration forms yourself, consider putting that time and effort back into your core business functions while outsourcing the tedious tasks associated with registration.
Outsourcing can also help if you’re interested in deregistering from a state. If you no longer have nexus, deregistration can ensure you are no longer on the hook for filing taxes in that state. Avalara Professional Services offers a full range of registration and deregistration services for businesses with outsourcing needs.
Sales Tax Survival Challenge #10: Sales tax holidays
You’ve mastered sales tax rates. You’re on top of taxability rules. And then the state throws in a monkey wrench in the form of a sales tax holiday. Meant to stimulate consumer spending, these temporary sales tax breaks can create big headaches for retailers, especially when tax holidays are announced only a short time before they take effect.
Survival Tip: Learn which products are eligible
Sales tax holidays generally don’t apply to all merchandise. Some are quite specific: in the case of Second Amendment sales tax holidays, only purchases of guns and ammunition are shielded from taxation — so if you’re not selling any products in those categories, you’re unlikely to face any changes. However, other tax holidays (like the back-to-school tax breaks common in August) can include a wider variety of products.
Sometimes, the products covered and not covered by the tax holiday law seem non-intuitive. For instance, Texas includes backpacks among tax-exempt items for its back-to-school sales tax holiday, while Iowa specifically excludes them (as well as some belts). Getting sales tax holiday product eligibility right can prevent costly mistakes when it’s time to file.
Survival Tip: Know exemption limits
The purpose of sales tax holidays is to make purchasing easier on the average consumer’s wallet. To that end, many states limit the cost of products that are exempt from sales tax during sales tax holidays — think Target, not Tiffany.
Some states have very high exemption limits (a wedding dress costing up to $2,500 can be eligible for sales tax holiday exemption in Massachusetts), while others limit exempt clothing purchases to individual items costing $100 or less. Exempting purchases that are too large for the limit could cost your business when it’s time to reconcile.
Survival Tip: Be aware of last-minute changes
Annual sales tax holidays present a challenge to retailers, but at least they’re usually scheduled well in advance. However, some states introduce another wrinkle by approving sales tax holidays only in some years, or only a few weeks in advance.
Massachusetts has, in recent years, been notorious for waiting to approve a sales tax holiday. Since 2004, an August holiday has been approved in every year except one, but retailers with nexus in Massachusetts have had just days or weeks to prepare each time. If your business has nexus in any state that approves sales tax holidays at the last minute, it’s even more important to regularly monitor department of revenue websites for updates. Cloud-based automation, which allows for up-to-the-minute updates, provides a great outsourced alternative to this kind of monitoring.
Automated solutions are cost efficient and comprehensive and can greatly diminish audit vulnerability.
No system is absolutely foolproof, but with a detailed process in place, an auditor is more likely to give your company a clean bill of health. The Streamlined Sales Tax states have partnered with private sector entities to become Certified Service Providers (or CSPs). Avalara is proud to be a Streamlined Sales and Use Tax CSP. A CSP allows businesses participating in SST to fully outsource their sales and use tax management processes. And by registering for SST, a business is eligible to use CSP services for free. The states also help pay for the software for some retailers. According to the SSUTA, “Any business that uses Streamlined-certified software is immune from audit liability for the sales they process through that software.” However, it’s important to note that this immunity extends only to businesses registered in SST states that are using a certified provider.
Developing a sales tax strategy protects your company against audit fines fees and penalties. Make 2016 the year you manage sales tax, not just survive it.
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