Taxability complexities

Sales tax isn’t simple. Here’s a step-by-step overview of various complications of sales tax compliance – and how to handle them.

Nexus

Historically this connection between a company and a tax jurisdiction has been primarily physical, meaning that a company had an office, employees, trade show exhibits, inventory, contractors and so on in a state. Then came 2018’s South Dakota vs. Wayfair, the Supreme Court decision that made “economic nexus” constitutional.

Economic nexus kicks in at thresholds of a volume of sales (say $100,000) or a certain number of transactions, or both, into a state over, typically, 12 months or in a calendar year. Thresholds vary widely among states, and some are easing off thresholds.

But economic nexus did not and does not override the physical nexus requirement. Additional complexities:

• The five NOMAD states – New Hampshire, Oregon, Montana, Alaska and Delaware – do not have a statewide sales tax.
• “Home rule” localities’ tax jurisdictions in such states as Alabama and Colorado have their own nexus requirements, as do those in Illinois (Chicago) and Louisiana (parishes). And though it doesn’t have statewide sales tax – yet – Alaska has several communities joining to charge sales tax.

If you don’t have nexus in a tax jurisdiction, you don’t have to worry about taxability of your products or services.

Taxability

Generally, states require sales tax on tangible personal property or on services enumerated in statutes. Tangible personal property (TPP) is usually products perceivable by the senses.

Additional complexities:

• Services are frequently excluded from sales tax – but by no means all the time anymore and not in all states. This complexity crops up with technology products/services, where companies claim that they provide “professional services.” That’s a term states often consider too broad; best to keep “professional services” as a defined activity of architecture, engineering, medical, legal and accounting. Services outside of those, such as technology consultative or configuration services, has potential taxability.
• Telecom, by the way, is in our opinion one of the most taxed and regulated products/services across all states.

Situsing

Situs is where a transaction’s taxability is determined and what sales tax rate applies. Most states follow destination-based sourcing rules, where remote sellers must apply the sales tax rules and rates based on where they are shipping a product.

Some states are origin-based. If you’re based in one of these states or ship from within one of these states to a destination within the same origin-based state (Texas, for instance), you collect and remit sales tax according to the rules and rates applicable at the seller’s location.

Additional complexities:

• Some shipping terms such as Free on Board, which defines when in a shipped transaction a buyer or seller becomes liable for the goods transported, can complicate situs determination. In some cases, situs for sales tax purposes is actually the loading dock of the sender.
• Benefit of use can also determine situs. Especially in sales of software-as-a-service (SaaS), this could include far-flung and numerous users and not necessarily the home or branch office of a seller company.
• Drop shipments are when a seller uses a distributor for order fulfillment to a buyer. In such a transaction, a distributor must charge sales tax to the seller, who could then possibly validate their resale exemption with an exemption certificate. Understanding obligations in drop shipments involves knowing the nexus footprint of the business making the sale to the end-user, as well as the nexus footprint of the drop shipper/distributor. We recommend the Institute of Professionals in Taxation (IPT) website, which has a robust drop shipment survey of states’ requirements.

Exemptions and exclusions

Sales tax exclusions apply to items not covered by legislation, aka those things not enumerated as taxable in the statutes.

It’s uncommon to have an exemption without a formal request and a formal document. Exemption certificates are generally either entity-based (resellers, not-for-profits, federal and some state government agencies) or product-based. To prove sales tax exemption, the customer must provide a certificate.

Certificates are usually state-specific. They should describe the product sold, what it’s for and the purchaser’s sales tax registration number. The certificate should be signed and dated.

Additional complexities:

• Exercise reasonable due diligence in accepting any exemption certificate. Don’t accept a W-9 or a customer’s state sales tax registration, for instance.
• Some industries, such as manufacturing and agriculture, have many sales tax exemptions, including for equipment and some supplies.
• Manage the customers’ certificates you have on file. Index and store them securely, and recognize that some certificates have expiration dates.
• In New Mexico, the federal government exemption doesn’t always apply.
  
  

Compliance

Compliance means you need the ability to calculate, charge and collect the sales tax for transactions with your customers. It also means you must be registered and can get the tax returns filed and manage correspondence from states.

You may decide compliance is not worth the cost to your business. That’s a business decision – but you still have exposure to penalties and interest, with no statute of limitations. Evaluate your customer base and your nexus footprints for an informed decision.

For more, see our webinar, “Navigating the Complexities of Sales Tax Applicability.”

TaxConnex experts specialize in the intricate world of sales tax for companies in various industries. Contact us today to learn how we can help you streamline your sales tax process and ensure compliance.