Sales tax risk: What to ask (part 1)

Whether you’re a consultant working with companies or you run your own company... whether you’re just looking to clean up your own operation or you’re doing homework for an M&A... sales tax risks and exposure should be an important topic. And getting to the bottom of that topic means knowing what questions to ask.

Our recent webinar “What to Ask Your Clients to Identify & Manage Their Sales & Use Tax Risk” addressed many of these questions – along with what to do once you find out the answers.

Good questions

The right inquiries depend greatly on the individual circumstances of companies and their sales tax situation (and past exposure), but some general questions are good places to start in determining whether a company needs to evaluate its sales tax compliance process.

• Did your e-commerce sales increase in 2024?
• Have you added remote employees recently?
• Are you comfortable with your sales tax nexus footprint?
• Have you completed a taxability review of your products on a state-by-state level?
• At the time of invoicing, are you bundling taxable and non-taxable products/services?
• Are there any active or pending sales tax audits?
• Does your business hire contractors or use third parties to provide services connected to your product (such as installation)?
• Have you expanded sales into Canada?
• Where and how are you selling your product?
• Are you looking to sell the company or acquire venture capital funding in the next 12-24 months?
• Did the company acquire new businesses in the past year?

You might want to ask these some or all these questions every six to 12 months.

The results of our 2024 survey on managing sales tax also backs up the questions’ validity. For instance, only about half respondent companies were even only somewhat satisfied with how they management sales tax obligations, with half of respondents citing lack of guidance and insufficient time to keep up with changes in sales tax. Almost half also said that sales tax examination might soon be needed because of an M&A.

Due diligence wrinkles

Twelve to 13 years ago, sales tax not so was much of a focal point in due diligence. Now it’s a heavy point; some degree of review is almost always done on sales and use tax. And nothing can complicate a deal quicker than sales tax exposure.

Buyers often usually send in a third-party sales tax specialist in sales tax to ask brief but revealing questions such as “What are your revenues and where do you have employees by state?” and “Where are you registered and where have you been filing and how much sales tax have you been reporting.” If this examiner can’t reconcile your answers, they’ll say you’ve got sales tax exposure – and the onus is on you to mitigate or explain the exposure.

We have, for example, seen situations where a company trying to sell itself underwent due diligence that found a wholly surprising $2 million in past sales tax exposure. Effects of such a discovery on a deal can vary (though are rarely good) and usually at a minimum a buyer will secure against risk via escrow and require the risk to be mitigated.

Asking the questions suggested earlier can help prepare against such a problem in due diligence. Answering most of these questions accurately depends on being able to define key terms in sales tax, starting with nexus and taxability. Beyond that, you’ll want to explore how to mitigate past exposure and establish methodologies to prevent such exposure in the future.

We examine these and other questions and answers in Part 2.

Let TaxConnex manage the burden of keeping up with all the changes and challenges that come with staying compliant in sales tax. Contact us to learn more.