Sales Tax State of the Union: Compliance Burdens Increasing

Nearly four years ago, the U.S. Supreme Court shook up the sales tax world with its South Dakota v. Wayfair decision, paving the way for states to pass economic nexus laws and significantly increasing the sales tax burden for businesses large and small. With this decision, physical presence is no longer required to establish nexus with a taxing jurisdiction. That means your organization could have a sales tax collection and remittance obligation simply by having a certain number of transactions or sales into a state.

The Wayfair decision was based on South Dakota’s model that utilized thresholds of $100,000 of sales into the state or 200 separate transactions in a year to establish economic nexus. While many states have enacted these same provisions, there are a vast number of states that deviate from the blueprint — creating complexity for businesses and bringing additional risk to online retailers that can easily cross a threshold without stepping foot in the state.

In addition to differing measurement periods and effective dates across the country, as states continue to change the requirements, evaluating economic nexus is only becoming more complicated.

How does your organization keep up with sales tax compliance?

Step 1: always start with nexus

Physical presence nexus, affiliate nexus, click-through nexus, and cookie nexus (seriously, Massachusetts) are well-established and all continue to exist. Post Wayfair, however, nexus can be established merely because the volume of sales into a jurisdiction exceeds a specified threshold, placing a burden on companies to closely monitor these filing requirements and be prepared to register, collect and remit tax.

Sales tax automation tools, such as automated software solutions, provide data to assist in determining if you reached a sales or transaction threshold. However, this data can be flawed because it does not dive into the nuances of whether your product is taxable or how a state defines what to include in the amounts. Sometimes the tools do not even have all the sales to determine if you meet the threshold.

Your organization’s risk tolerance and size typically determine if you should evaluate economic nexus on a continual basis, monthly basis, quarterly basis, or even annual basis. But remember, if you don’t collect sales tax at the time of sale, it’s difficult to collect sales tax from your customer after the fact. Many businesses take an ultra-conservative approach and collect tax everywhere just to be safe.

As a reminder, sales tax is a trust tax that is due from the end user; however, the sales tax can also be assessed against the seller if not appropriately collected at the time of sale.

Step 2: register for sales and use tax

Some states make the sales and use tax process simple, while others are more complicated. Most states ask for general business information, address information, owners’ and officers’ information (their Social Security numbers are required as they can be held personally liable for sales taxes). Other states add fields such as major vendors and banking information.

Before starting the registration process for multiple states, gather as much information as you can. Once you hit a roadblock registering online, typically you can’t continue until you enter the missing information — which can be frustrating if there is another missing item waiting on the next screen.

Step 3: collect the appropriate state and local sales tax

With more than 11,000 sales tax jurisdictions in the United States, just collecting the correct amount of sales tax can be a burden. Smaller organizations or businesses with few customers can be managed manually, but this is not typically sustainable and can result in errors.

As another option, upload rate tables to your enterprise resource planning software to determine what state and local sales tax rate to charge on invoices. Note that this does not help determine the taxability of your revenue streams in each state, as taxability can vary wildly — especially in the retail or technology space. Because of the complexities related to the taxability of products and services, it is often worthwhile for a Company to invest time or resources to build a taxability matrix to determine which products and services are taxed and at what rate.

The full-service option is to purchase a front-end tax engine to map your products and services to predefined categories. The software then determines what line items to tax and what rate to use based on the customer location. But mapping can be complicated and understanding the revenue streams and the state taxation of each revenue type is critical to this process.

Step 4: file the returns

Your next step may depend on how you chose to proceed in step 3. If you manually performed step 3 or used rate tables, likely you would manually file or outsource the filing to a professional services firm. If you invested in a tax engine, you could file the returns manually based on the provider’s reports, outsource the filing to the provider, or outsource to a third party.

What happens if you didn’t do steps 1 to 4?

Start at the beginning. Knowing where you have nexus and a filing obligation will help you determine how to proceed. An exposure analysis can help identify whether there are substantial liabilities for not collecting and remitting tax.

Most states provide a voluntary disclosure or amnesty program to waive penalties for businesses that voluntarily come forward and pay past due tax, which can include a limited lookback and a waiver of penalties. States generally have a three- or four-year statute of limitations, which means audit activity around economic nexus could increase substantially over the next year. Entry into these programs is often limited to companies that have not previously registered with the jurisdiction, therefore, it is important to evaluate the exposure up front to allow the company more options for cleaning up back liabilities.

A few states are being extremely aggressive to businesses applying for new sales tax permits, with states like South Dakota calling to confirm you did not have economic nexus prior to the date you applied for the permit. Other states may send a letter requesting sales data back to 2018 and require past due returns if you exceeded the economic nexus thresholds.

Knowing where you stand and how much potential liability you have will help determine how to proceed.

How do you pay for sales tax compliance?

Sales tax compliance can get expensive regardless of the method you choose.

The good news? Some states offer filing discounts to help cover compliance costs and some may cover the full cost of compliance if there is a lot of tax due each month.

Another avenue to help reduce the cost is to look elsewhere in the sales tax world for refunds. Review purchases and sales. In some states, it could uncover overpayments that can be refunded or used to apply to prior returns, although this varies by industry.

Most people think of the resale exemption or manufacturing exemptions in regard to sales tax refunds, but each industry has their own incentives (such as, research and development exemptions, interstate motor carrier exemptions, or packaging exemptions for retailers).

How we can help

State tax changes can be overwhelming. CLA’s state and local tax professionals stay on top of shifting state tax rules and help you understand your sales tax obligations.

From a Wayfair checkup to help you understand your sales tax exposure to researching the taxability of your revenue streams and outsourcing your sales tax compliance obligations, we offer services scaled to your needs — allowing you to refocus your time on value-added activity.