Avalara Tax Changes 2023

Tax changes for manufacturers

Avalara Tax Changes 2023

Tax changes for manufacturers

Manufacturing

Over the past few years, manufacturers have had to endure persistent supply chain interruptions and major staffing shortages. Even if the fourth industrial revolution helps ease lingering challenges, the manufacturing sector will still need to navigate complex and changing sales and use tax obligations. And, according to recent findings, those weigh heavily on many businesses.

SOURCE: Survey of businesses with <500 employees conducted by Avalara/Potentiate

SOURCE: Survey of businesses with <500 employees conducted by Avalara/Potentiate

SOURCE: Survey of businesses with <500 employees conducted by Avalara/Potentiate

SOURCE: Survey of businesses with <500 employees conducted by Avalara/Potentiate

Changing circumstances increase tax compliance complexity

Managing sales and use tax is never easy for manufacturers, and the turbulence of the last few years has made it worse. Breaks in the supply chain, geopolitical upheaval, and inflation can drive manufacturers to find new customers, source alternative suppliers, and develop new processes. Labor shortages may inspire manufacturers to adopt new technologies that enable (at least some) employees to work remotely. All these factors add to the manufacturing sector’s already considerable tax burden.

For example, a U.S. manufacturer of fertilizer saw sales explode after exports from Belarus, China, and Russia dramatically diminished. It had to quickly up production to meet the rise in demand. It also had to deliver to new markets. A boon for business, perhaps, but new customers and new suppliers can create new sales and use tax obligations. 

The speed at which manufacturers embrace new technologies and update operations to respond to changing circumstances isn’t always mirrored by the finance departments that handle tax compliance. On the other hand, tax officials increasingly rely on artificial intelligence and other new technologies to find noncompliant taxpayers and shore up revenue. Manufacturing businesses therefore need to be on top of changing tax obligations more than ever.

The ongoing challenge of economic nexus

Like businesses in other industries, manufacturers are often subject to state economic nexus laws, which base a sales and use tax obligation on business activity in a state (e.g., $100,000 in sales or 200 transactions in the previous calendar year) rather than physical presence. 

Economic nexus isn’t new: The Supreme Court of the United States overturned the physical presence rule with its decision in South Dakota v. Wayfair, Inc. in 2018. And in the almost five years since, sales tax complexity for the manufacturing industry has only grown. 

Some states base economic nexus solely on taxable tangible personal property, or taxable goods and services. Unfortunately for manufacturers, many states include exempt sales of products or services in their economic nexus thresholds. 

Manufacturers that establish economic nexus with a state must register with the tax department, collect sales tax on any taxable sales made in the state, remit use tax as required, validate exempt transactions with an exemption certificate, and file returns on time. 

On top of all that, manufacturers must monitor sales into all states with a sales tax because they all have economic nexus laws now too. Some states require businesses to register and comply with all applicable sales and use tax laws immediately after crossing an economic nexus threshold. 

Economic nexus can also impact a manufacturer’s purchases. “Manufacturers often purchase large quantities of goods and services from outside their state or country,” explains Scott Peterson, VP of Government Relations at Avalara. “Many remote suppliers may now have to charge sales tax because of economic nexus, so manufacturers that were accustomed to reporting use tax now have to monitor their purchase invoices to make sure all those new sales-tax-collecting companies are charging the right sales tax.”

SOURCE: Avalara

Ever-present physical presence nexus

Economic nexus didn’t eliminate physical presence nexus: All states with a sales tax still require businesses with a physical presence in the state to register for sales tax. In some states, picking up or dropping off supplies in a company vehicle can be enough to establish a physical presence. Attendance at a conference or trade show can also trigger nexus, as can storing inventory in a state. 

Clogged supply chains have inspired manufacturers across many industries, from construction to pharmaceuticals, to build new fulfillment centers, warehouses, and data centers. More storage space allows businesses to stock up on key supplies as they become available. More fulfillment centers can lead to faster order fulfillment and happier customers. There are advantages to expanding a physical footprint, but such growth can also trigger nexus in different tax jurisdictions.

While there are similarities, every state’s nexus laws are unique. This fact alone makes sales and use tax compliance challenging for all businesses working across state lines. Especially manufacturers.

Adding new technology adds new tax obligations

Higher costs may inspire manufacturers to put more into research and development (R & D) in the hopes of streamlining production. Most states, including Indiana and Washington, provide an exemption, partial exemption, or reduced rate for machinery and equipment, and even supplies purchased for use in R & D. Though generally beneficial to businesses, such exemptions can complicate compliance because qualifying R & D activities vary from state to state and can change over time. 

For example, starting July 1, 2022, Vermont’s sales and use tax exemption for manufacturing machinery and equipment includes equipment used as part of an integrated process. As of the same date, Florida provided an exemption for machinery and equipment necessary to produce electrical or steam energy that results from burning hydrogen. Florida’s new policy also specifies that hydrogen is exempt from sales and use tax when purchased for use as a combustible fuel in an industrial manufacturing, processing, compounding, or production process at a fixed location. 

Managing the documents that must accompany tax-exempt sales is another big pain point for manufacturers.

More exemption certificates, more compliance risk

Manufacturers often have to deal with hundreds or even thousands of exemption certificates. Case in point: R&B Wagner, a small manufacturer specializing in architectural handrails, has over 11,000 exemption certificates in its system.

According to Silvia Aguirre, VP of Certificate Management at Avalara, there are more than 1,000 different tax exemption forms in use in the United States. Determining the correct form for each exempt transaction is the first step. Ensuring each form is properly and accurately completed comes next. Then, of course, exemption certificates need to be stored (in an easily accessible way) and renewed as necessary. It’s a big job.

Knowing sales tax exemption certificate management is difficult, state tax officials tend to focus on it during audits.

Other factors likely to affect the manufacturing industry in 2023

Consumer use tax

Manufacturers often overlook consumer use tax for one reason or another, and they may be even more likely to do so today given the kinks in normal supply chains. To fill orders, manufacturers may need to dig into their own stores, exposing items purchased tax-free to use tax liability. They may need to pick up supplies from a new supplier rather than have them delivered from a long-term supplier. That type of flexibility is essential today, but can also expose businesses to consumer use tax liability. And as Silvia Aguirre points out, issuing exemption certificates for purchases that don’t qualify for an exemption can create higher audit use tax liability than sales tax liability.

More B2B marketplaces

With only 5–10% of business-to-business (B2B) transactions transpiring online, there’s tremendous opportunity for B2B marketplace growth. An estimated $100 trillion changes hands between businesses each year. 

According to research conducted by Gartner, “B2B organizations have shown strong interest in the marketplace model because it helps them to better engage partners and improve efficiency in the buying and selling process.”

Yet B2B marketplaces also face more complexity. In addition to dealing with economic nexus and marketplace facilitator laws like their business-to-consumer (B2C) counterparts, B2B marketplaces must validate exempt sales by collecting and maintaining exemption certificates for each and every third-party seller. They also must connect all their channels so they can properly validate, document, and report both taxable and exempt sales. It’s an enormously burdensome task.

Overpayment and/or underpayment of tax

Manufacturers need to improve sales processes to ensure a positive experience for customers. It’s not uncommon for manufacturing businesses to either undercollect or overcollect sales and use tax because it can be so difficult to determine which transactions are exempt and which are taxable (and at what rate). Businesses may not realize they’ve charged a customer the wrong rate until months down the line. Such errors can lead to steep assessments, penalties, and fines. 

Auditors tend to take a keen interest in manufacturers because they usually get a good return on their investment. It’s something to keep in mind. 

Stay tuned. We’ll share more insights in our upcoming comprehensive manufacturing industry report coming your way in 2023.


Avalara Tax Changes 2023

A tax compliance guide for businesses

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