Sales tax is complicated. Many sales tax companies will tell you it’s simple with their solution, but when you take a look at all that goes in to compliance – you will understand that no technology can fully automate or manage sales tax without a good bit of project management from your side.
In this blog, we’ll take a look at the 6 steps to compliance and some of the complexities that go with them.
Sales and use tax nexus is a connection between a person or entity and a taxing jurisdiction. This is the basis for all your sales tax decisions. Without nexus, you have no further obligation to a state, but if nexus does exist, you’ll need to do some additional work. We have additional resources on the differences between physical and economic nexus if you’d like more information.
Once you’ve determined that you have nexus, you need to determine the taxability of your products or services in the states you have nexus. If you sell items considered to be tangible personal property, this should be fairly straightforward. Similarly, services are generally exempt unless stated otherwise.
But there are other product and service offerings that can be more complicated. For example, determining the taxability of software is challenging. There are multiple factors to consider including whether it is electronically delivered or is it software as a service? Are there mandatory maintenance or support fees? The same goes for telecommunications services. Telecom companies need to consider sales tax, communications taxes, and regulatory fees. For this task, it may be helpful to bring in a tax consultant or your CPA firm.
Quantify Your Exposure
To calculate the exposure, identify your revenue streams by product/service category by state. Knowing the taxability of the products/services from the previous section, and also knowing the current tax rate in the state (or average tax rate if local tax rates apply), you can determine the approximate amount of tax exposure. Later, you may want to perform a detailed calculation of exposure where you would use historical tax rates rather than current tax rates and actual local tax rates rather than a statewide average.
If these calculations indicate that you may have a material amount of exposure, there are steps you can take to reduce that exposure. If you believe that any of your customers are exempt from sales tax, try to get a copy of their exemption certificate. You could also reach out to determine if they’ve reported use tax on your sales. However, these tasks are not always simple. Depending how far back your exposure goes, these customers may no longer be in business, merged with another company, or simply just don’t want to cooperate.
To register in a state, you must go through the Department of Revenue in that state. You’ll be provided with a sales tax ID number and are then allowed to collect and remit sales tax in said state. However, do your homework before jumping in line to register. If you have a significant amount of prior period tax exposure, it may be beneficial to explore a Voluntary Disclosure Agreement (VDA). If you do have prior period tax exposure and you register with the state, you will be required to pay the state what you owe. A VDA is only helpful if you start the process before registering with the state.
In some states, you will also need to register with the Secretary of State (SOS) before they issue your sales tax license. The SOS has a separate set of compliance obligations and guidelines you’ll need to follow. This could be a larger undertaking than some businesses are truly prepared for, so be sure to take this into consideration when creating your compliance plan.
Establish a Tax Filing and Calculation Process
An important part of managing sales tax compliance ongoing is to have a process to calculate and report the proper taxes. In some situations, calculating the sales tax can be done within your existing accounting systems and online shopping carts. In other situations, separate sales tax calculation software can be leveraged.
In terms of reporting the proper taxes, there are certain steps you should be aware of. To start, you’ll need to gather your data reports. This may be housed in different systems across departments. Try creating a checklist to ensure you’re compiling all necessary data each month. You’ll also need to check for updates or nuances in your tax calendar. Tax calendars don’t necessarily remain static from month to month, so it’s important to check in regularly.
Many states request online returns, but most local jurisdictions often require a paper check. Be sure you can access all state websites and also allow enough time for checks to be cut. In addition to mailing paper checks, keep an eye out for any notices that may come through the mail. These notices often come with tight deadlines.
Implementing your plan
Before you get started, you need to make one of the most important decisions. Will you manage your compliance process in-house, or will you outsource the project to an experienced provider?
Keeping it in-house may seem like the simpler option, but you need to consider all the additional costs with adding more to your team member’s’ plates, or perhaps hiring a new employee. These costs include salary, benefits, software, postage, payment processing, and more. Outsourcing can save you time and money, as well as reduce over burdening your current staff and remove risk and liability.
Once you’ve determined the best strategy for your business, it’s time to get started. It’s unrealistic to try solving all prior indiscretions at once (if you have them), but you can start chipping away. Identify your largest risk areas first and start there. It may also be beneficial to seek professional guidance. A professional should be able to obtain a full understanding of your situation and provide examples of how they’ve helped businesses in similar situations.
Sales tax compliance is clearly a specialty and not getting any easier. If you’re looking to reduce costs, increase efficiencies and minimize the substantial risk of noncompliance, reach out to a sales tax expert. Consider working with TaxConnex™. Contact us to learn what it means when sales tax is all on us.