Sales Tax Risk Assessment: What Businesses Should Review Before Year-End

Sales tax compliance can become increasingly complex as businesses expand into new states, introduce new products or services, and navigate changing tax laws. What may have worked for your business in the past may no longer be enough to keep you compliant.

In a recent episode of It Depends: A Sales Tax Podcast, Brian Greer and Jeff Meigs discuss how businesses can identify potential sales tax exposure, understand changing nexus and taxability requirements, and establish a compliance process that supports future growth.

With several important legislative changes on the horizon, now is a good time for businesses to evaluate their current sales tax processes and address potential risks before they become bigger problems.

Understanding Sales Tax Nexus

Before determining whether a product or service is taxable, businesses must first understand whether they have sales tax nexus in a particular jurisdiction.

Nexus is the connection between a business and a state that gives the state the authority to impose its sales tax requirements. Two common ways businesses establish nexus are through physical presence and economic activity.

Physical nexus can arise when a business has employees, property or other qualifying physical activities in a state. Hiring a remote employee, for example, can create nexus even if the company has relatively few sales in that state.

Economic nexus generally depends on a business exceeding a state's sales or revenue threshold. While $100,000 in sales is a common benchmark, thresholds and requirements vary by state. Some states have higher thresholds, and certain jurisdictions have historically used transaction-count requirements as well.

Businesses should regularly review their sales activity and physical footprint to identify where new obligations may arise. Waiting until the end of the year to evaluate nexus can leave a company unprepared for registration, tax collection and filing requirements.

Nexus and Taxability Are Not the Same

Establishing nexus does not automatically mean a business must collect sales tax on every transaction. Nexus determines whether a state can impose its tax laws, while taxability determines whether a particular product or service is subject to tax.

For businesses selling tangible goods, taxability may be relatively straightforward. However, services, software and digital products can introduce additional complexity.

Software-as-a-Service (SaaS), cloud storage, infrastructure-as-a-service and other cloud-based offerings are treated differently across jurisdictions. Telecommunications services can be particularly complicated because of the variety of applicable state and local taxes and regulatory fees.

Businesses must also consider where a transaction is sourced for tax purposes. Although many transactions involving tangible goods are sourced to the destination where the customer receives the product, sourcing rules for cloud-based services can be more complicated. For example, a SaaS subscription purchased by one company may be used by employees working across several states.

Understanding both nexus and taxability is essential to determining where a business has an obligation to collect and remit sales tax.

Sales Tax Changes Businesses Should Know About

State sales tax laws continue to evolve, making it important for businesses to monitor legislative changes that could affect their operations.

Here are some important updates to keep in mind moving forward:

Illinois and Kentucky transaction thresholds

Illinois eliminated its economic nexus transaction-count threshold effective January 1, 2026, while Kentucky repealed its transaction threshold effective July 1, 2026. These changes highlight why businesses should review current state requirements rather than relying on outdated nexus checklists.

California's expansion of software taxability

California is introducing sales tax requirements for certain software and digital products, including SaaS and downloaded software, effective January 1, 2027, as discussed in the episode. Businesses selling software into California should evaluate how the changes affect their products, customer transactions and invoicing processes.

Colorado's SaaS taxability changes

Colorado is scheduled to begin taxing SaaS at the state level effective January 1, 2027. The change will bring the state's treatment more in line with certain local jurisdictions that already tax SaaS.

These developments demonstrate how quickly sales tax obligations can change. Businesses selling software, digital products or services across multiple states should review their taxability determinations regularly and prepare for upcoming effective dates.

How to Address Potential Sales Tax Exposure

Discovering that your business may have failed to collect sales tax can be stressful, particularly if the issue has existed for several years. However, identifying a potential liability is an opportunity to take action and establish a plan for moving forward.

Here are two common approaches to addressing past sales tax exposure.

1. Prospective Compliance

Prospective compliance involves registering and beginning to collect and remit sales tax going forward.

For some businesses, this may be a practical option, particularly when historical exposure is limited or paying prior-period liabilities would create a significant financial burden.

However, this approach does not eliminate potential liability for previous periods. Its appropriateness depends on the circumstances, and businesses should understand the associated risks before proceeding.

2. Voluntary Disclosure Agreements

A Voluntary Disclosure Agreement (VDA) is a process that allows eligible businesses to voluntarily address past sales tax noncompliance with a state.

Depending on the jurisdiction and the circumstances, a VDA may offer benefits such as a limited lookback period and penalty relief. Businesses generally remain responsible for applicable taxes and interest, and requirements vary by state.

VDAs can be particularly valuable for companies with substantial historical exposure or those preparing for a merger, acquisition or other ownership transaction where unresolved tax liabilities could complicate due diligence.

Choosing between prospective compliance and a VDA requires evaluating the business's historical activity, potential liability, financial position and future plans. Working with a sales tax specialist can help businesses understand their options before making a decision.

Building a More Reliable Sales Tax Compliance Process

Once a business identifies its obligations and determines how to address potential exposure, it needs a sustainable process for managing compliance.

Several key areas deserve attention.

• Registration: Confirm that registrations are completed correctly for the appropriate jurisdictions and tax types. Some states have local registration requirements or separate tax categories that businesses must consider.
• Tax calculation and invoicing: Ensure the appropriate tax is calculated and applied to customer transactions. The right solution depends on the number of states involved, the nature of the products or services sold, and the complexity of the applicable tax rules.
• Exemption certificate management: Maintain valid exemption certificates and supporting documentation for transactions treated as exempt. Missing or inadequate documentation can create additional exposure during an audit.
• Filing and payment: Establish a reliable process for preparing returns, remitting payments and reconciling sales tax activity with the general ledger. Businesses should also maintain a calendar of filing deadlines and payment requirements.
• Account access and notices: Use centrally managed credentials where possible and establish a process for monitoring state tax portals. Important notices may include filing frequency changes, payment issues or assessment deadlines that require timely action.

A well-defined process helps reduce errors, improve visibility into potential liabilities and ensure that compliance responsibilities do not depend on a single employee.

When Should Your Business Review Its Sales Tax Obligations?

Sales tax reviews should not happen only when a business receives an audit notice. Several common business changes can signal the need for a closer look.

Consider reviewing your sales tax obligations when your company:

• Hires employees in new states or expands its remote workforce.
• Experiences significant sales growth in a particular jurisdiction.
• Launches a new product, service or bundled offering.
• Changes its billing, invoicing or enterprise resource planning (ERP) system.
• Experiences turnover in its finance or tax department.
• Receives a state tax notice or audit inquiry.
• Prepares for a merger, acquisition or sale of the business.

These changes can affect nexus, taxability, registration requirements or the accuracy of existing compliance processes. Reviewing them proactively can help businesses identify issues before they become more difficult and expensive to resolve.

Prepare Now for Future Sales Tax Requirements

Sales tax compliance is an ongoing responsibility that requires businesses to monitor their activities, understand changing state laws and maintain reliable processes. As new requirements take effect and businesses continue to grow, a process that once worked may need to be reassessed.

Taking time to evaluate nexus, confirm taxability, address historical exposure and strengthen compliance procedures can help businesses reduce risk and prepare for future changes.

For more information, listen to our podcast episode on this here.

TaxConnex helps businesses navigate sales tax requirements through advisory services, tax calculation solutions and outsourced sales tax compliance support. If your business needs help evaluating its sales tax obligations or developing a plan for compliance, our team can help you determine the next steps.