Sales tax obligations are getting more complicated for businesses of all industries. And it takes just a few mistakes to add up to a big liability and hefty fees. In this blog, we’ll talk to some of the common missteps businesses make when trying to manage sales tax on their own.
- Not evaluating economic nexus
Figuring out where you have nexus is key to determining your sales tax liability. Without sales tax nexus, you have no further sales tax obligations to a state, but it’s easy to slip up when trying to determine this.
Nexus is your company’s connection with a state or other tax jurisdiction (such as municipalities) that’s substantial enough for that jurisdiction to hold you accountable to their sales tax laws. Sales tax nexus can be created via a physical presence or an economic presence.
From an economic presence perspective, most states have a $100,000 in revenue and/or 200 transactions per-year threshold. But you need to understand the particulars for the states in which you have customers as it may be different depending on the state or jurisdiction. (There are maps available outlining the different thresholds per state but it is always best to verify with a sales tax professional.) It’s also easy to miss the constant developments in this field. As of this writing (April 2021), the last two states that don’t impose sales tax obligations on out-of-state sellers – Florida and Missouri – are working on such laws and Wisconsin just removed their transaction number threshold and are only relying on annual revenue into the state.
- Not knowing if your products and/or services are exempt
Once you have your nexus footprint under control, you must ensure that what you are selling is subject to sales tax. And, like most other aspects of sales tax, it’s not an easy task. Taxability of products and services, especially those impacting technology and software, can vary WIDELY across states and taxing jurisdictions.
For each state in which you have sales tax nexus, you must know how each state defines your product or service and if it is taxable. The general rule is that tangible personal property is taxable unless specifically stated otherwise; and services are generally not taxable unless specifically stated otherwise. This is a very general rules and has many variances from state to state.
For example, consider software. Is it software as a service (SaaS-based)? How is it delivered? Are there maintenance or support services included? Are those services optional? These questions all factor into determining whether sales tax applies. Software delivered via CD will have the most states that tax it, while electronically downloaded software will have fewer states, and SaaS will have the least number of states that tax it.
Digital products are often considered to be “intangible”, but this is not a uniform rule. These products can include digital books, music, internet TV and streaming media, webinars, subscriptions, and apps, among many other products. The U.S. has no uniform sales tax on digital items, though periodically there are attempts to firm up guidelines.
State departments of taxation and revenue are good sources of information for the latest digital taxation developments. The Federation of Tax Administrators also provides updates.
Other industries face intricacies as well, construction, marketing and leasing companies can all create missteps for your business if taxability is not evaluated correctly.
- Rushing into a VDA
When companies discover they are out of compliance, they often look for options to eliminate their sales tax risk. One of the more common options is to pursue a Voluntary Disclosure Agreement (VDA). Although a VDA might not always be the best option.
A VDA is a legal means for taxpayers to self-report back taxes owed for income, sales, property and other types of tax. In exchange for voluntarily reporting the tax due, states generally grant a waiver of penalty and limit the look-back period, potentially reducing the tax due.
But many companies leap at this option without homework. The first step in the VDA process is a cost/benefit analysis. You need to look at the three primary objectives in pursuing a VDA:
Eliminate liabilities prior to the look-back period. Assuming you haven’t collected the taxes, the state will waive its right to collect any sales tax exposure prior to the look-back period. For example, if you have $1 million in total tax liability and $800,000 of that is beyond the look-back period, you only have to remit the $200,000 within the look-back period, plus interest. This could be a big “win” for a company.
Establish the company as compliant for all prior periods for sales and use tax. Essentially, under due diligence by an acquiring entity or for financing purposes, the company can represent that it is compliant with all sales and use tax laws. The states can always audit the VDA periods, but so long as there were no material or intentional misstatements of fact, the state will not audit beyond the look-back period.
Penalty abatement. In most situations and in most states, if you don’t mitigate the exposure via the VDA process and were audited, the state would likely grant some level of penalty relief anyway. As a result, the guaranteed penalty abatement as part of a VDA is valuable.
VDAs often work best if your company has previous non-compliance and exposure dated back more than four years, you’ve collected sales tax but have yet to register and remit to the prospective state or if you want to sell your business or otherwise seek outside capital and have previously not complied.
Sales tax obligations are something to be taken seriously. It’s a complicated process where it’s easy to make mistakes if you don’t have the experience to back you up. Do your research and be sure. And when you can’t be sure on your own, it’s always best to reach out to an expert. Contact TaxConnex to learn how we can take sales tax off your plate.
This is an excerpt from a larger piece – Six Common Missteps of Sales Tax Compliance – to learn more – download the full eBook.