The benefits of sales tax automation for retailers

Avalara Whitepaper

Retailers automate sales tax to keep up with consumer demand

The retail industry has undergone tremendous transformation, with the single biggest disruptor being online shopping, according to Price water house Coopers. In just four years, ecommerce spending in the U.S. alone has grown by 62% to $327 billion.

The ease and speed of ecommerce and mobile commerce mean consumers have more choices readily available. Competition is fierce and the pressure is on to keep customers happy and engaged. So it’s not surprisingly that 77% of retail CEOs are concerned about keeping up with the digital demands of their tech-savvy customers.1 This includes fast, accurate checkout — with no surprises

Retail leadership also face increasing pressures from stakeholders to show higher returns. With solution maturity and pricing no longer a barrier, they are pushing for automated systems to improve order accuracy, increase throughput and optimize the business. Sales tax automation is a key part of the equation.

By automating sales tax, retailers can be more responsive to customers and stakeholders, reduce risk associated with manual tax management, and be better prepared to enter new markets and sales channels that drive growth.

Retailers are accountable for applying the correct sales tax rules

The tax landscape has become increasing complex, making compliance more difficult for retailers. With numerous states desperate for more revenue, sales tax is broadening. Last year, there were more than 428,000 tax rules changes. Getting sales tax right in this inconstant environment requires extra vigilance. Applying incorrect rules, exempting taxable goods and services, or not using the proper forms and certificates can get you in trouble.

For example, national home furnishings retailer Furniture Row got hit with multiple audits for not collecting the right exemption certificates on tax-free sales. “There are so many laws out there that change daily, monthly, yearly,” says tax manager Heather Gravelle. “We needed to outsource sales tax to make sure we were compliant.”

Audits are now the least of retailers’ worries. Increasingly, both brick-and-mortar and online sellers have been finding themselves in court regarding sales tax mismanagement. Already this year, 12 states are moving to impose taxes on out-of-state Internet retailers — an aggressive response to Congress’ failure to pass a federal internet sales tax law. State lawmakers are banking on these litigious actions to pressure the federal government to act. Alabama expects a large Internet retailer will challenge its remote sales tax policy and South Dakota is suing four large ecommerce companies who refuse to comply with its remote seller laws.

Internet sales is just one of the issues coming under fire. Retailers are also facing scrutiny — and legal action — for failing to comply with state sales tax rules on certain transactions.

  • Papa John’s was penalized for charging sales tax on pizza delivery fees in states that prohibit taxing this service when an in-store pick up option is also offered.
  • Whole Foods and Hertz faced class actions for overcharging customers sales tax on coupon purchases.
  • Dunkin Donuts was found non-compliant in New York and New Jersey for charging sales tax on 70% of transactions involving tax-exempt items such as bottled water and packaged coffee.
  • Target stores in California were dinged for charging sales tax on hot coffee sold to go

These errors were likely not intentional, but states and consumers expect retailers to know the rules and apply local tax laws properly for every transaction, everywhere, every time. With 12,000 taxing jurisdictions and millions of tax rules in the U.S. alone, this is a daunting task no matter how big or small your business. This is where having a tax solution in place like Avalara AvaTax that can instantly and accurately apply rates and rules specific to that sale in that location becomes critical to compliance.

“Avalara has been a good tool for us to reduce our liability,” acknowledges Gravelle. “It supports what we need as far as staying compliant with all of those states, jurisdictions and cities.”

Nexus definitions are expanding, putting retailers at risk

As retailers grow, they are more likely to operate across state lines, which can trigger nexus, a “physical presence” in a state that creates an obligation to collect and remit sales tax. As such, they need to pay closer attention to where customers and partners are located and ensure point of sale, ecommerce systems and shopping carts are set up to calculate the correct tax in each state and jurisdiction in which they now have nexus.

A growing number of states have recently expanded the definition of nexus to include activities such as employing remote staff, attending tradeshows, warehousing inventory or using drop shippers or third-party fulfillment. Some states, like Alabama, South Dakota and Vermont, are pushing this boundary even further with “economic nexus” laws based on revenue or number of sales transactions. To date, 17 states are considering economic nexus legislation. The thresholds of economic nexus can be quite low. In South Dakota for example, $100,000 in annual sales or 200 separate transactions will give a company economic nexus in the state.

Having to comply with new nexus laws is quickly pushing many retailers beyond the threshold of managing sales tax manually and making automation a more attractive — and necessary — solution.

“We were collecting sales tax in three states where we had nexus,” explains Susan Smith, finance director for Natural Health Trends, a global ecommerce and direct seller of premium personal care, wellness and nutrition products. “Then we started to collect tax on behalf of our distributors and that put us in almost every state. That was not something we wanted to take on in-house.”

With sales tax automation software, Smith says the company doesn’t have to worry about keeping up with the tax or preparing and filing individual returns for all the different jurisdictions. “Avalara does that for us. And we know it’s correct.”

Online sales channels can lead to new sales tax concerns

Web stores are essential selling channels for retailers. More consumers are shopping online, and states are taking notice. At last count, uncollected sales tax from ecommerce retail sales topped $24 billion.2 With 17 states facing budget shortfalls in 2016 and 2017, that revenue would go a long way to filling the gap.

With the Marketplace Fairness Act (MFA) and similar federal legislation stalled yet again, states are taking matters into their own hands. Nearly half of all U.S. states now require sales tax collection on online and catalog retail sales. And another 13 states are considering similar laws. Alabama recently became the newest state to require out-of-state sellers to collect sales tax.

Online marketplaces like Amazon, eBay, and Etsy are great ways to expand customer bases and networks such as Fulfillment by Amazon (FBA) gets products into the hands of customers quickly. But more sales channels can also lead to more sales tax liability. Amazon now collects sales tax in 28 states, which represents 84% of the U.S.population.3 Drop shipping and affiliate marketing can trigger multi-state nexus.

“When we built out our affiliate program, states were already beginning to consider this sufficient presence to create sales tax collection responsibilities,” says Bob Romano, VP of Finance for Life is Good, a national apparel manufacturer and retailer. “As we grew, our affiliates created a presence for us in new states. Some states charge sales tax on freight, others don’t and each state has its own product taxability definitions and rules. We wanted to be ready and comply properly. But we couldn’t be a tax expert in every state,” explains Romano.

Sales tax automation software provides air cover for compliance as you onboard more channels so you can grow with confidence. Avalara’s tax engine applies the right tax rates, rules or exemption to every taxable transaction for more than 12,000 U.S. tax jurisdictions.

Managing product taxability challenges retailers

Most tangible products are subject to sales tax in the U.S. However, product taxability rules and rates vary widely from state to state and change frequently. If that wasn’t bad enough, certain goods and services fall into a nebulous category called “sometimes taxable” where use can make a difference in how an item is taxed. This can make sales tax compliance particularly difficult for affected retailers.

“Certain states view functional products differently than fashion products when it comes to tax,” explains Scott Cohn, VP of ecommerce for Chinese Laundry, a popular brand of women’s footwear. “I sell all different types of boots. Some, like rain boots, could be considered functional, while others are purely fashion. Trying to figure out how all of that breaks down is cumbersome.”

That’s one of the reasons Chinese Laundry outsources sales tax to Avalara. “They help us figure out how each state charges tax on those various subsets of the products we sell.”

Retailers commonly come up against the “sometimes taxable” issue during sales tax holidays, when certain items like clothing, shoes, sporting goods or school supplies are exempted, either fully or partially.

“You have to understand who is offering the holiday and at what level,” explains Cohn. “Is the state offering it and the county, but not the municipality or the other way around? Are there special taxing districts that have higher or lower or no exemptions? “Different states tax these categories in different ways. So while a company might think it is set with its tax compliance in one state or a set of states, selling in new states or introducing nexus may disrupt current practices.

It’s a major challenge facing retailers, admits Cohn. “The only way to manage this would be to have a massive in-house team. Or do it systemically with software.”

For retailers, the research, calculations, filing, and reporting required for sales and use tax compliance is not only time-consuming, it’s costly and prone to error. The average business spends upward of 300 hours per year manually managing sales tax at a cost of around $67,000; this is closer to $400,000 for larger companies.4 Yet, 8 in 10 businesses don’t have sufficient resources to deal with these tax activities in-house.5

To be more agile and efficient, retailers and ecommerce sellers are moving to automation over manual processes, in all areas of their business, including tax compliance. Leading brands are three times more likely than their trailing peers to automate sales tax, according to Aberdeen Research.

“We started out managing sales tax manually. But we weren’t equipped to keep up to date with changing sales tax rates and regulations in the various states and jurisdictions we were shipping to. It was too much to manage on our own,” explains Scott Vogel, CFO at David Yurman, a luxury jewelry brand. “Avalara AvaTax updates everything for us automatically. It’s saving us a tremendous amount of time and hassle.”

The payoff of sales tax automation are compelling. Research shows that Avalara AvaTax customers:

  • Reduced the time spent managing sales and use tax by 58%
  • Avoid overpaying sales tax 90% more often
  • Pass audits without penalty 50% more often

So it’s not surprising that once businesses decide to automate tax compliance, they never look back. More than 98% of the companies that implement Avalara’s software are still customers Avalara customers today. That’s more than 20,000 companies, including top consumer brands like Reebok, Smith & Noble, and 940 other leading retailers. In 2015, Avalara managed 213 million transactions valued at $16 billion in the retail sector alone.

If you aren’t automating sales tax with Avalara like these industry leaders, the question now is: what can we do to change that?.

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