How sales and use tax affects your business
Sales and use tax affects all businesses in some universal ways
Sales tax is in the news more than ever today with national legislation being debated in Congress, and many states struggling to gain a hold on internet sales and the related tax liabilities. Sales tax policy is a fascinating subject and the internet revolution is pushing discussion of sales taxes to the public center. These developments indicate the high level of concern held by business leaders, politicians and bureaucrats in the sales tax field. The current focus on sales tax policy will hopefully produce a more rational sales tax compliance environment. Some day.
For now, we need to acknowledge that the sales and use tax compliance arena is fraught with challenges for businesses of all sizes and types. Sales and use taxes impact your business on a daily basis with legal liability requirements and they affect your business on a broader scale by their influence on strategic decision-making. The effects of sales and use tax management and compliance are not limited to traditional retailers either. All types of businesses must be aware of the instances of sales and use tax, and the challenges presented by calculation, collection and remittance of sales and use taxes and documenting tax-exempt sales.
Shifting tax rates and shifting jurisdiction boundaries
Sales and use tax rates are stable in some states, but tend to be volatile in others. In places where sales and use tax rates are more prone to change based on political whim, rates can change on a monthly basis. Even in more stable jurisdictions, rates vary from township to township, city to city, or county to county. Rates can vary based on the type of product or service you sell, who your customer is, even the manner by which your customer uses or consumes what you are selling.
Counties, cities, townships, fire districts, school districts, and even economic incentive zones are continually expanded, established and otherwise given effect in the United States. In some states, local sales and use tax jurisdictions are often little more than gerrymandered ink spots, bounded and strung together by individual lots or alleys. Traditional location methods such as the US Post Office’s Zip Code Service are simply not designed to support or delineate sales and use tax boundaries, yet many companies believe them to be adequate.
How changing tax rates and shifting jurisdiction boundaries affect your business: Identification of current rates and boundaries requires an on-going effort for any business. Even businesses that do not regularly sell outside their own physical location are subject to changes in the locations they do serve. For expanding businesses, new locations and new products or services present additional challenges as existing approaches and solutions must be modified or re-developed to meet the need of an expanded product or service line. Finally, don’t forget that rates and boundaries are the core elements of your sales tax compliance solution.
Put another way: Inaccurate rates and boundary information makes your company’s otherwise sound management and compliance efforts result in materially inaccurate calculation, collection and remittance. This means your business may be paying less or possibly more than required and have increased audit risk.
Aggressive state and local taxability rules
In general, the universe of taxable items increases in scope as time goes on. As our economy gradually evolves from a goods-centered exchange to a services-centered exchange, states and localities have reacted by expanding their definition of taxable items and services. In addition, businesses who regularly sell non-taxable and taxable items or services incur additional risk of adverse assessments where the two items or services are less distinct.
Revenue-strapped states and localities consistently expand their own interpretations of what are and are not taxable sales. States routinely change exemptions and basic taxability rules, but they also tweak their existing rules by issuing restrictive or otherwise aggressive rulings, opinion letters, bulletins and other informational publications. The expansion of taxability rules is not limited to newly taxable items or services, but is also due to inclusion of more transactions under the sales and use tax umbrella. As a result, transactions like leases, rentals, deliveries, or personal-type services are subject to sales and use taxation in more and more places.
How aggressive state and local taxability rules affect your business: A company must respond to aggressive taxability rules and definitions by dedicating the time necessary to remain current with states and localities’ interpretation and enforcement. Inaccurate understanding of the rules applicable to your business can leave you with little cover in the event of an audit.
Put another way: Making a mistake on taxability will result in materially mis-stating the amount of sales tax owed and puts your business at risk of a damaging negative audit finding. It’s bad business to go back to your customer and request additional sales tax due to your mistake.
Regular timely sales tax compliance burdens
States and localities expect, and need, these tax revenues. They expect taxes on time, in the accurate amount, accompanied by a properly filled-in tax return, and perhaps most importantly, they reserve the right to punish businesses that do not meet the aforementioned requirements. To that end, the states regularly pepper businesses with notices, requests for information, and less often, but perhaps more daunting, audits. Each of these tools inflicts a certain and distinct cost on your company. But even beyond the risk of adverse findings or assessments, honest evaluation of the economic and opportunity costs of regular sales tax compliance usually reveals a significant burden to businesses of all sizes.
How the regular timely sales tax compliance burdens affect your business: Filing the accurate amount of sales and use tax due, on time, and accompanied by an accurate return are the nuts and bolts of any business’ sales and use tax compliance solution. The time and resources required to accomplish the work “on the ground” to regularly comply with sales tax legal requirements are absorbed in your finance office’s overhead. The monthly or quarterly filing cycle crush may even require reallocating resources away from activities more closely associated with actual revenue collection and profits.
However, the effect of regular timely filing may also be measured by headaches. Rule changes, e-file requirements, changes in forms, changes in filing frequency, or even monthly rate and boundary changes all present challenges on a regular basis. An otherwise minor mathematical error or a mislabeled address field can result in months of corrective actions to undo what has been wrought. Even staff turnover, or leave time, can result in a cascade of inaccurate or late filings.
Put another way: Much of the hard work expended to calculate and collect sales tax is lost when the burden is not handled in a timely and accurate manner.
Managing sales tax exempt transactions
Retail businesses, related entities, exempt organizations and governments are just some of the types of customers who do not expect to pay sales tax. In fact, unofficial polling suggests many will gladly not ever pay sales tax unless you ask for it! Unfortunately for your company, the vital information required to support an exemption from sales tax must be maintained by you, the seller. That’s right, the administrative burden of exemption management is on the seller. Your customer’s status as a legitimate exempt purchaser must be assessed by you, and you must maintain the documents and transaction details upon which you made your decision. Bottom line: the burden of proof is on the seller when the state eventually makes a visit expressing concern about exempt sales.
How managing sales tax exempt transactions affects your business: For exempt sales, the core documentation required is some form of an Exemption Certificate. The Certificate entitles the customer to make purchases exempt from sales tax. The actual Certificate environment is less than precise however, as some certificates are limited to purchases of only certain items, others are limited to certain items used for the completion of a certain project; some certificates provide a fractional or percentage exemption, while others are date-sensitive. The proper application of each customer’s exemption certificate to each sale is critical to avoiding improperly exempted sales.
Put another way: It’s your job to manage the exemption certificates presented by your customers to minimize the risk of materially understating taxable sales. Lack of proper documentation of tax-exempt sales can cost you money.
Sales tax nexus and the right to demand collection
In the legal sense, nexus describes the connection between two or more participants, interests or concepts. Specifically in the world of sales tax, nexus refers to the connection a seller has with a state. Nexus is the legal connection that empowers a state to demand collection and remittance of a retail sales tax.
On June 21, 2018, the Supreme Court of the United States ruled in favor of the state in South Dakota v. Wayfair, Inc. The decision overruled a longstanding physical presence rule, allowing states to require remote sellers to collect and remit sales tax.
Since Wayfair, most (but not all) states have adopted new rules defining what establishes a sales and use tax obligation, known as nexus. Unfortunately for businesses, no two state sales tax nexus laws are alike.
How sales tax nexus affects your business: Nexus is the legal peg on which states hang their collection hat. Business activities such as physical locations, employees, order processing or storage intuitively trigger nexus; but other activities such as contracts with independent agents, making deliveries, business arrangements with affiliates, leases, or even a simple business registry can give a state the power to require collection. Strategic decisions about these and other activities impact nexus and thus impact the way your company will do business in the future.
Put another way: Once established, nexus with a given state or locality exposes your business to administrative sales tax collecting and return filing burdens, so make sure your expansion strategy is accompanied by a sales tax solution.
Automating sales tax management is the answer
Sales taxes, and the compliance challenges they present impact your business on a daily basis. The shifting sands of changing rates, boundaries and rules, regular timely filing requirements, exemption certificate management and even the way your company expands and grows are all significant issues affected by sales tax. These issues affect your business on a daily basis due to the pressure sales tax compliance exerts on administrative resources; and on a broader strategic scale due to the costs, obligations and pitfalls of becoming a revenue collector for states and localities.
Your business must perform accurate calculation, collection and remittance of sales taxes. In addition, you must properly document tax-exempt sales. Take time now to assess how your organization is meeting the challenges required to fully comply with sales and use tax obligations. Be aware of the many ways sales tax compliance affects your business. Investigate this now in order to make informed decisions to more effectively manage your business needs and reduce risk.
Automating sales tax rate calculation with AvaTax or managing returns filing with Returns for Small Business allows you to leverage technology to solve a complex, error prone aspect of running a successful business.