When Is the Right Time to Collect Sales Tax?
- May 1, 2015 | Ryan O'Donnell
If you’re a small business owner, you likely have a lot of questions regarding sales tax. Do I need to collect it? How do I set up my store or website to handle it? How do I decide when to start collecting it? The answers here are tricky and, in many cases, unique to your situation.
We hear from small business owners all the time asking when they should begin collecting sales tax. As you’ll see, there is no formulaic answer to this question. It’s up to you, the business owner, to evaluate your situation and make the decision that is right for you.
That being said, finding the opportune time can feel like you’re in a catch-22. Businesses owners don’t want to register too soon and don’t want to wait too long. Either scenario could cost you unnecessarily. While we always advise businesses to be conservative in their approach sales tax compliance, finding the sweet spot can be a challenge.
Shoppers in a Tea House (Image Credit - André Hofmeister)
Understanding the Risk Spectrum
Let’s assume you’re selling taxable goods and services in a state that collects sales tax. In such a situation, the letter of the law would say you have a legal obligation to collect and remit sales tax. However, the more subtle answer for some retailers is that while the obligation is there, the decision to act on it depends on your situation as a seller.
As fuzzy as that may sound, collecting sales tax should always be weighed against the overall risk a business owner is taking on by being out of compliance. We call this “materiality”. Sometimes with low volume sales, the cost to collect and remit the tax actually exceeds the amount of tax itself.
Let’s consider a hobbyist selling goods on Etsy. If they are only selling a handful of low cost items each year, the cost of collecting, filing, and remitting sales tax likely far outweighs any potential penalties or interest charges. Moreover, they’re unlikely to be a target of a sales tax audit. In short, the risk of being out of compliance with state and local taxing jurisdictions is very low. That doesn’t mean they aren’t required to deal with sales tax. It means the chances of anything bad happening if they don’t are negligible (but never zero).
On the other hand, let’s consider an Amazon seller importing goods from overseas, storing them in an Amazon warehouse, and making multiple sales every day. In this case, the amount of sales tax being collected (or not) may be very high relative to the time, effort, and cost required to maintain compliance. Moreover, as a result of storing goods in warehouses in other states, this seller has likely triggered nexus in multiple states. This increases the number of potential auditors monitoring their business. Again, their risk level has gone up.
The third possibility is the startup that has taken off like a rocket. Almost overnight they’ve gone from being a small business to a large business. In such a situation, it can be hard to keep up with all the necessary changes to maintain sales tax compliance. Moreover, it’s possible the amount of sales tax not collected and remitted is so great that the associated penalty and interest charges are enormous. In such a situation, a voluntary disclosure agreement (VDA) provides an option. With a VDA, the look back period is limited to 3 years and, in some situations, the penalty and interest fees are completely waived.
In The End, It’s Up to You
How does one wrap their head around deciding whether to begin collecting and remitting sales tax? The truth is, it boils down to your personal level of risk tolerance. While that may sound like a weak answer, there really is no other way to know. Consulting an accounting professional may help you better understand your overall sales tax risk situation, but in the end, it’s your call to make.
We encourage all business owners to be knowledgeable about their sales tax situation. Sign up for a free Avalara TrustFile account and get access to liability reports that break down the sales tax you collected by jurisdiction. This will help you better understand where you have compliance exposure.