This St. Patrick’s Day, don’t look to four-leaf clovers, pots of gold or leprechauns to bail you out of trouble with sales tax. If your company has a sales tax obligations and doesn’t have a process yet in place, plan for the risks of non-compliance.
When your business establishes nexus in a state or jurisdiction, you become responsible for collecting and remitting sales tax. This can be through a physical or economic presence. Most companies understand where they have physical nexus, but economic nexus is a different story. Economic nexus was established in 2018 through the U.S. Supreme Court Case, South Dakota v. Wayfair, and is based off transaction and revenue thresholds within each state. Sounds simple enough, but it’s not that easy. Each state sets their own rules and even certain local jurisdictions are getting in on the fun!
Many industry experts believe that as state tax revenues continue to dry up from the economic shutdown and pandemic, sales tax audits are likely to increase. Two out of five respondents to a recent TaxConnex survey agree, saying that they expect sales tax audits to increase over the next two years. Two out of three respondents have already seen an increase in audits over that same time.
Among larger states, California and New York have intensified efforts to enforce present, future and past compliance with sales tax regulations. Even the only two states with a state-wide sales tax that have held out from enacting economic nexus – Florida and Missouri – may be edging toward making sellers collect and remit sales tax. And in Alaska, individual municipalities are banding together to impose their own sales tax in a state that doesn’t have one.
And why not? According to Tax Policy Center, money collected from sales tax can be the leading source for many jurisdictions, constituting 25% to 35% of a state’s revenue.
What’s the actual risk to your business? How much could non-compliance cost you? Let’s say you are selling a product and/or taxable service in a jurisdiction where you have nexus but are not taxing your customers. In the first year your company’s sales total $10M and grow 20% annually over the next three years (totaling $36.4M in sales). With an average sales tax rate of 8%, that’s more than $2.9M of tax you should have collected. Add additional penalties and interest assessment and your total exposure can top $3.8M! And it’s not just your company at risk, often senior executives are at risk too! Make sure you are aware of responsible party laws that could hold you personally responsible for the sales tax of your business.
How might a taxing jurisdiction find out about your business and your potential non-compliance?
Jurisdictions can discover your company’s nexus through an audit – but not just an audit of your business. One of your customers undergoing its own sales tax audit might produce one of your invoices, resulting in the auditor possibly contacting you. A state may find that you didn’t charge your customer sales tax. An audit of one of your suppliers could turn up one of your exemption certificates for something the auditor may think is taxable. Audits of similar companies in your industry may also lead state tax authorities to run comparison data on you and your competitors.
The best defense: Preparation, paperwork and a working knowledge of the sales tax rules and how they apply to your business. (See our tips for managing a sales tax audit.) And a proper sales tax compliance process to ensure your compliant in the first place.
Sales tax requirements are complex and ever-changing; enforcement and penalties are increasing; and dealing with audits requires special work and preparation.
In other words, don’t just depend on luck.
Most answers related to sales tax are not one-size-fits-all. Outsourcing sales and use tax management to an expert can save your business time, money and stress. Contact TaxConnex to learn how we can help.