Sales Tax Voluntary Disclosure Agreements (VDAs): What Businesses Need to Know

Discovering that your business has unpaid or uncollected sales tax can be stressful, especially when the exposure goes back several years or spans multiple states.

Fortunately, businesses that are out of compliance may have options for addressing their historical sales tax exposure. One of those options is a Voluntary Disclosure Agreement (VDA).

A sales tax VDA allows an eligible business to voluntarily disclose previously unreported sales tax obligations to a state in exchange for certain benefits, which may include a limited lookback period and penalty relief. While a VDA can be an effective way to mitigate prior-period sales tax exposure, it isn't necessarily the right solution for every business.

Here's what you need to know about sales tax VDAs, including when to consider one, how the process works, and what businesses should evaluate before moving forward.

What Is a Sales Tax VDA?

A Voluntary Disclosure Agreement (VDA) is an agreement between a taxpayer and a state tax authority that allows an eligible business to voluntarily disclose and resolve previously unreported tax liabilities.

For sales tax purposes, a VDA can help businesses address historical obligations in states where they had sales tax nexus but did not register, collect, and/or remit the required tax.

In exchange for voluntarily coming forward, states generally offer some combination of:

• A limited lookback period
• Penalty waiver or reduction
• An opportunity to establish prospective compliance
• A defined process for resolving historical tax exposure

The specific terms of a VDA vary by state. A VDA is also generally most beneficial when a business comes forward before the state contacts the business about its sales tax obligations.

Why Would a Business Need a VDA?

Sales tax obligations can develop without a business realizing it has created an obligation to register and collect tax.

For example, a company may establish sales tax nexus through:

• Sales into a state that exceed its economic nexus threshold
• Employees or sales representatives working in a state
• Remote employees or service personnel
• Inventory or other physical presence
• Trade shows or other business activities
• Changes to its products, services, or business model

Once nexus has been established, the business may have an obligation to register, collect, file, and remit sales tax.

If those obligations weren't addressed when nexus was established, the business may have accumulated historical sales tax exposure.

A nexus review is often the first step in determining whether a VDA should even be considered. Businesses should also review the taxability of their products and services and estimate their potential historical exposure before deciding how to address the issue.

When Should a Business Consider a Sales Tax VDA?

A VDA may be worth considering when a business has significant historical sales tax exposure, particularly when the exposure extends beyond the state's potential VDA lookback period.

Common situations include:

• Your business has sales tax nexus but isn't registered
• You have several years of potential exposure
• You collected sales tax but didn't remit it
• Your company is preparing for a transaction (M&A, etc.)
• You want to establish a path toward compliance

What Are the Benefits of a Sales Tax VDA?

The potential benefits of a VDA depend on the state and the company's circumstances, but there are several reasons businesses pursue them.

1. A Limited Lookback Period

For many businesses, the limited lookback period can be one of the most significant benefits of a VDA.

If a business has been out of compliance for many years, an audit could potentially expose the company to historical tax liabilities extending much further back than the period covered by a VDA.

Under many VDA programs, the state agrees to limit the period for which the business must disclose and pay tax. TaxConnex generally sees lookback periods of approximately three to four years, although the actual period varies by state and situation.

For example, imagine a business has seven years of potential sales tax exposure, but a state agrees to a three-year VDA lookback. Rather than addressing the entire seven-year period, the business may only need to calculate and pay the liability within the agreed-upon lookback period, subject to the terms of the agreement.

That difference can be significant.

2. Potential Penalty Relief

Many states provide penalty relief as part of their VDA programs.

Instead of voluntarily disclosing historical liability and potentially facing the full penalties associated with noncompliance, an eligible business may be able to have penalties waived or reduced under the terms of its agreement. Interest, however, is generally still due.

It's important to remember that penalty relief is only one part of the potential benefit. The limited lookback period and ability to resolve historical exposure can be equally, or more, important when evaluating whether a VDA makes sense.

3. A Path to Ongoing Compliance

A VDA isn't just about resolving the past. It can also help a business establish a path toward compliance going forward.

Once historical exposure has been addressed, the company can register where required, begin collecting and remitting sales tax, and establish processes to remain compliant with ongoing filing obligations.

Is a VDA Always the Right Solution?

No.

A VDA can be an effective tool for mitigating historical sales tax exposure, but businesses should evaluate their options before pursuing one.

The first step should be a cost-benefit analysis.

That analysis should consider:

• Where the business has sales tax nexus
• When nexus was established
• Whether the company's products or services are taxable
• How much historical exposure exists
• How many years of exposure may exist
• Whether the business has already registered in the state
• Whether the state has already contacted the business
• Whether sales tax was previously collected
• The potential benefits available through a VDA
• Other available mitigation options

Depending on the circumstances, alternatives may include prospective registration, retroactive registration, customer refunds, tax amnesty programs, or other mitigation strategies.

The goal isn't simply to file a VDA. The goal is to determine the most appropriate way to address the company's sales tax exposure.

Who Is Eligible for a Sales Tax VDA?

VDA eligibility is determined by each state's rules, so businesses should not assume that meeting the requirements in one state means they will qualify in another.

Generally, businesses seeking a VDA must not have already been registered in the state and must not have already been contacted by the state regarding their sales tax liability or an audit. Some states have additional requirements or limitations.

This is one reason timing matters.

If a business discovers potential sales tax exposure, it shouldn't immediately register everywhere before determining whether a VDA or another mitigation strategy may be appropriate. In some states, registration or previously filed returns can affect VDA eligibility.

The Sales Tax VDA Process: Step by Step

While every state has its own procedures, the VDA process generally follows a series of steps.

1. Determine Where You Have Sales Tax Nexus
2. Review Product and Service Taxability
3. Estimate Your Historical Exposure
4. Evaluate Your Options
5. Submit the VDA Application to the state
6. Receive and Review the State's Terms
7. File the Required Returns and Pay the Liability
8. Register and Remain Compliant Going Forward

What Information Do You Need for a VDA?

Before beginning the process, businesses should be prepared to provide detailed information about their activities and historical sales.

Depending on the state, this may include company information, states where the company does business, dates of activity in each state, nexus information, sales by state, taxable and nontaxable sales, applicable tax rates, historical sales tax collected, historical sales tax remitted, estimated tax liability, explanation of why the company was not previously registered or compliant, and supporting financial or transaction records.

Having this information organized before beginning the process can make it easier to determine exposure and evaluate the potential outcome of a VDA.

What Happens If You Don't Address the Exposure?

Ignoring historical sales tax exposure doesn't make the liability disappear.

If a state discovers the issue through an audit or other compliance activity, the business could face tax, interest, and penalties. Depending on the circumstances and the state's rules, the business may also lose the opportunity to participate in a VDA.

That's why businesses that discover potential exposure should evaluate their options before a state initiates contact.

The earlier the issue is identified, the more opportunities the business may have to determine the appropriate path forward.

Sales Tax VDA vs. Sales Tax Amnesty

VDAs and sales tax amnesty programs are similar in that both can provide businesses with an opportunity to resolve historical tax liabilities under favorable terms. However, they aren't the same.

A VDA is generally an agreement between an individual taxpayer and a state and may be available on an ongoing basis, subject to that state's requirements.

An amnesty program, on the other hand, is typically a limited-time program established by a state with specific eligibility requirements and terms.

Because these programs vary, businesses should evaluate the current rules and requirements in each state before deciding which option to pursue.

The Bottom Line: Start With an Exposure Assessment

Finding out that your business may owe years of sales tax can feel overwhelming, but discovering the problem is an important first step.

Before registering, filing back returns, or contacting a state, businesses should first understand:

• Where do we have nexus?
• What do we sell, and is it taxable?
• How far back does our potential exposure go?
• How much could we owe?
• Have we already been contacted by the state?
• What mitigation options are available?

For some businesses, a VDA can significantly reduce the amount of historical exposure that needs to be addressed while providing a path toward compliance. For others, a different strategy may make more sense.

The key is understanding your exposure and evaluating your options before taking action.

Need Help Evaluating Your Sales Tax Exposure?

TaxConnex can help businesses determine where they have sales tax nexus, evaluate historical exposure, assess mitigation options, and navigate the VDA process.

Our sales tax experts can help you determine whether a VDA may be appropriate for your business and manage the process from initial evaluation through resolution.

Don't let historical sales tax exposure become a bigger problem. Start by understanding your options.