Sales and use tax compliance is not only difficult and time-consuming – it’s also expensive if you do it wrong. Here are some of the costliest potential errors in sales and use tax compliance.
1. Still not knowing nexus
Businesses that sell into various states must contend with the sales and use tax regulations and requirements of jurisdictions nationwide.
The 2018 U.S. Supreme Court case South Dakota v. Wayfair established economic nexus standards, stating that retailers located in other jurisdictions, even if they have no physical presence in the state, must collect and remit South Dakota sales tax if their sales meet certain minimum criteria. Enter economic “nexus,” a threshold of sales numbers (calculated by money, quantity or other factors) now embraced by almost all states and a growing number of smaller localities.
Economic nexus rules vary by state, which makes it difficult to manage. Your business needs to evaluate when it’s reached nexus thresholds to ensure compliance in collecting and remitting sales tax. Rolling the dice and hoping you don’t get caught out of compliance can be a costly mistake: Punishments can range from assessments, penalties and liens to use of collection agencies or referrals for criminal action.
Over the last several months, states and jurisdictions have seemed slow to ramp up penalties for non-compliance but are becoming more serious about enforcement – especially as the pandemic has caused tax revenues to shrivel (even though many filing deadlines have been postponed and some penalties waived). Penalties can start at 25 percent of tax liabilities; even non-filing of zero taxable sales can result in penalties. And there’s no statute of limitations for unfiled returns; unpaid tax liabilities can compound indefinitely.
Let’s say you are selling a product and/or service in a jurisdiction that you have nexus in, but you’re not taxing your customers. In the first year your company’s sales total $10 million and grows 20 percent annually over the next three years (totaling $36.4 million in sales). With an average sales tax rate of 8 percent, that’s more than $2.9 million of tax you should have collected. Add to that an additional penalty and interest assessment and your total exposure is more than $3.8 million.
2. Lacking a process
Putting the numbers on a return and sending to the various jurisdictions is often viewed as the easy part of sales tax compliance. But in addition to various state and local returns and the level of detail required on each return, there are other factors to consider when establishing a compliance process.
Ideally, all sales tax calculations are managed in one system and a single report can be produced each month that provides details with all the sales and use tax liabilities. But as your business grows, it will probably change accounting systems and launch new e-commerce platforms – resulting in different sales tax processes. Each of these different sources of sales tax information will need to be incorporated into the filing process.
Missing a filing can be very expensive. You should also have a tax calendar that reflects where your business is registered for sales tax purposes, the filing frequency of each return, the e-file credentials (states often require an online filing with an electronic payment) and other state-specific information. This calendar will need to be maintained and updated as filing frequencies change or you register in additional state or local jurisdictions.
Your process should also monitor jurisdictions’ deficiency notices – which can be the first sign of trouble with your filing and an expensive detail to ignore.
(If you do not have the resources, time or expertise, outsourcing your compliance may be right for you.)
3. Over-relying on technology
Even the smallest multi-state businesses and startups have access to sales tax automation options that lower costs of compliance. With the evolving rules and regulations across states and jurisdictions for sales tax in the U.S., it makes sense to automate where you can. But automation is a technology tool and not a set-it-and-forget-it catch-all for sales tax compliance.
Sales tax automation provides the most value at the point of sales tax calculation. The technology is able to understand the taxing rules and rates and apply these in real-time to determine applicable sales tax.
Sales tax automation has less (but still some) value in returns filing. The technology helps to map the sales tax data to the proper lines on the return and can generate EDI uploads to send to the jurisdictions. But it lacks the ability to know when a jurisdiction requires a filing frequency change and the ability to quickly follow-up on a notice from a jurisdiction.
The sales tax automation solution paired with an in-house team or an outsourced compliance partner can be a valuable option.
4. Mis-handling audits
An audit can be a business nightmare, consuming endless time and money as you attempt – and sometimes fail – to justify your compliance actions to tax jurisdictions.
Most states will send you a notification if there is a question about your sales tax account. Do not ignore this or hope the issue will go away. Clearly understand what the notice is for and contact the jurisdiction immediately if you’re unsure. Check for any a specific time period that you must reply by.
Documentation typically required by an auditor can include invoices, exemption certificates, summary reports, returns and more. Assess your records after being notified of an audit; make every attempt to identify your exposure prior to the audit. It’s also a good idea to assign one person from your company to manage the relationship with the auditor.
Negotiate the findings and work with the auditor to understand their thought process and decisions. There may be room for negotiation before the final assessment – potentially saving you money.
5. Not taking advantage of mitigation
If your business finds itself out of compliance and with historical tax exposure, consider entering into a voluntary disclosure agreement in certain states. VDAs provide companies the opportunity to come forward, in most situations anonymously, via a third-party. They report taxes owed in exchange for a waiver of penalty and a limited look-back period.
Other potential options for mitigation include refunding tax to your customers, prospective registration and compliance and possible tax amnesty from a given state.
Working with a sales tax expert can remove the risk of these errors costing your business time and money. Contact TaxConnex to learn what it means when sales tax is all on us.
Looking to estimate your sales tax exposure? Check out our sales tax risk calculator.