So you think you don't owe sales tax?
Tax compliance offenses that can cost you big
If you think because you’re not a retailer you don’t have a sales and use tax obligation, think again. Often, companies not collecting and remitting sales tax actually have much more rigorous rules to follow for compliance. And when it comes to pleading your case to the state auditor, ignorance isn’t bliss.
Manufacturers, wholesalers, distributors, resellers, related entities, governments and not-for-profit and charitable organizations are some of the business types who do not expect to pay sales tax. The burden of proof is on the seller, however, should the state express concern about exempt sales, claiming “I didn’t think I owed sales tax,” likely won’t save you from an audit.
A smarter strategy is to be aware of where you might have sales tax compliance obligations and how it impacts your business. Here are four of the most common:
Sales tax exemption certificates
Even if you don’t sell direct to consumers, you may still be part of the transaction through a supply chain. As such, it is your job to reassure the state that you are exempt from collecting tax. Not-for-profit organizations and governments also need to prove exempt status. This proof is typically in the form of a sales tax exemption certificate, which can vary by type and requirements. 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.
Depending on your business, you may be responsible for both issuing and collecting certificates. The proper application of each exemption to each sale is critical. Without proper documentation, auditors could determine that you understated or improperly exempted taxable sales and that could cost you.
All states that charge sales tax also charge use tax. Use taxes are meant to minimize unfair competition between sales made in and out-of-state. But knowing when they are owed can be tricky. And because payment is often on a self-reporting basis, most businesses and consumers overlook this obligation.
So how does use tax work? If your business purchases goods from another company within the same state, sales tax is owed, which the seller collects and sends to the appropriate tax agency. If your company buys goods outside your state or online, you don’t pay sales tax, but you are required to pay consumer use tax for the storage, use, or consumption of tangible personal property (TPP). Companies are responsible for self-assessing when, and if, use tax is accrued, and to self-report on tax liabilities.
Should any errors be made in computing use tax, they must be reported to the appropriate jurisdiction on your balance sheet as an open liability. You must then remit the correct amount with your next tax return. The burden is on you to prove that the tax has been reported and paid.
Online sales of taxable goods
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. These include economic nexus, click-through nexus, and affiliate nexus. Unfortunately for businesses, no two state sales tax nexus laws are alike.
The way you deliver goods sold in online transactions can also have a huge impact on your tax obligation. Many online sellers (like Amazon) use drop shippers to deliver goods, creating complicated tax obligations. Using any third party, whether it be a drop shipper, supply chain, or online affiliate, can trigger nexus for your business.
State sales tax sourcing rules
Sourcing rules govern which state dictates the taxability of a particular sale. Intra-state sales—those made within a single state—follow the taxing rules for the seller’s location or “ship from” address. This is called origin sourcing. Conversely, sales between states (inter-state) typically base taxability on the customer’s location or “ship-to” address. This is referred to as destination sourcing.
In destination sourcing, nexus rules come into play. If you do business in multiple states or operate as part of a supply chain, this can get very complex very quickly, especially if you use drop shippers located in other states. Understanding how and when to charge sales tax to consumers and when to issue exemption certificates to distributors becomes complicated and creates added risk for your business.
Paying the price of non-compliance
Many businesses today still calculate and resolve tax compliance manually, despite this process being inefficient, time-consuming, cumbersome and prone to error. Failing to comply can put your business at high risk for audit, which can be an expensive costly lesson. The average cost of an audit ranges from $34,000 to $60,000 according to Aberdeen Group; Wakefield Research puts that cost closer to $100,000. Whatever the cost, the bottom line is you can’t afford to be complacent about compliance.
Some industries are more likely to draw auditors’ attention as the margin for error is much higher. These include:
To compensate and try to minimize audit risk, some companies over-assess tax liability. Others “prepare” by setting aside money in case they are penalized for non-compliance. Companies that under-assess taxes face the more serious risk of penalties and interest due on outstanding tax payments. You could even face fraud charges if it is proven that you willingly withheld tax but didn’t remit it to the state.
Automating tax compliance saves time and money
It’s likely that sales tax touches your business in some way, even if it’s just to prove you don’t owe it. Managing this compliance can get complicated quickly. You may not even be aware of how much time you are spending on this activity. In fact, the average company spends 175 hours a year complying with tax laws. And these laws change all the time. Plus, if your business is growing, your tax obligation could too.
There are steps you can take to make compliance easier. First, assess how your organization is currently meeting the challenges required to fully comply with sales and use tax obligations. Do the people overseeing compliance have the knowledge and resources they need to make informed decisions and comply with state requirements? Many businesses find that it makes sense to outsource compliance rather than continue to put their business at risk by trying to handle this complex matter in-house.
Here are a few steps you should take when considering tax compliance automation:
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