Sales tax is traditionally a major source of revenue for states. For years, the increase in online sales had caused sales tax revenue to dwindle.
The Challenges of Sales Tax: Staying in Compliance Under Wayfair
Almost every business that sells a product is required to collect and remit sales taxes to a variety of jurisdictions.
Your clients deal with sales taxes, but how well? Walmart, Lowe’s, and Target handle sales taxes in thousands of retail stores across the country every day. Amazon and eBay collect and remit sales taxes online thousands of times per second. Even small retailers, convenience stores, and entertainment venues in places like Denton, Texas, Reston, Virginia, and Billings, Montana handle sales taxes. Depending on the states they do business in, almost every business that sells a product—and sometimes even those that provide a service or lease a product—is required to collect and remit sales taxes to a variety of jurisdictions.
It’s no secret that states continue to face challenging budget situations, are pinching pennies anywhere they can, and looking for new sources of revenue. One result is that they are increasingly aggressive on sales tax compliance enforcement. How would your business or your clients fare if faced with a sales tax audit?
For very small entities with one physical location, or nexus, doing business in only one city or state, compliance is generally not too daunting, but rather a monthly or quarterly chore that the business owner can handle with only minor assistance. However, as a business grows through the addition of more stores (physical locations) or through an increasing online sales base, the task of keeping up with reporting and remitting sales taxes to all of the jurisdictions becomes increasingly time-consuming and very perilous, since the risk of errors or non-compliance increases.
The WayFair Sales Tax Ruling
In June 2018, the U.S. Supreme Court ruled in the case of South Dakota vs. Wayfair that the physical presence of a business in a state (buildings, workers, warehouses, etc.) is no longer the determining factor as to whether a business has to collect sales taxes on customers in that state. Instead, states can now set their own guidelines as to which retailers must collect sales taxes if they do business with residents (within guidelines). Most states have adopted South Dakota’s model, which requires retailers with at least $100,000 in sales or 200 customer transactions in that state to collect and remit sales taxes.
Not So Simple
Sales taxes seem like a fairly simple concept. As noted previously, the retailer adds a percentage onto the cost of a transaction, paid for by the customer, and then periodically reports those transactions and sends that money to a government taxing agency. However, defining the what, when, where, who, and how much can be challenging.
What: Some items are taxed when they are sold at retail, some are not. What is taxable in California may not be taxable in Virginia, and vice versa. Some items, such as prepared food, may be taxable if consumed on the premises of the retailer, while the same item is not taxable if consumed elsewhere. Also, as noted previously, some states tax services in addition to retail goods.
When: The time of year can affect the taxability of some items. This is most frequently encountered for “back-to-school” sales tax holidays on certain items, but varies greatly by state and localities.
Where: Under Wayfair, the location of the customer is now generally the determining factor as to taxability, tax rate, and compliance. The “where” can be broad (within a state), or exceedingly specific (within a very defined geographic location that includes one side of a street, but not the other). Taxation zones can often have the appearance of heavily gerrymandered districts.
Who: Some purchasers are exempt from sales taxes, with limitations or other factors. Religious and nonprofit organizations are often exempt, as are wholesalers and industrial users of some products. Exemption certificates usually must accompany reporting of transactions for which no sales taxes were collected.
How Much: While most sales tax rates are set as a percentage of the transaction, the total tax paid is sometimes capped for specific items.
There is also the highly-volatile nature of sales tax rates. With thousands of cities across the country setting their own rates, there are often changes on a daily, weekly, or monthly basis. Rates can increase periodically or even decrease due to expiration, while the taxability of some items can be changed on the community level. All of that is compounded by the ongoing redefinition of nexus and changes in what items are subject to sales tax in some states, but not in others.
Since it is the business’ responsibility to keep up with these changes and correctly assess, collect, report, and remit sales taxes for each of these jurisdictions, it is imperative that they use the most effective tools to stay in compliance. The smallest retailers can likely keep track of the changes themselves, but those with high sales volumes across a state, region, or the nation need to utilize an automated system that keeps their sales tax rates and reporting in compliance.
Where is the Business and Where are the Customers?
Brick and Mortar
Although sales taxes may seem less complex than income tax compliance, the sheer volume of reporting requirements can swamp a business owner if they aren’t using the right tools. A single brick and mortar retailer or service provider is likely to face taxation from the state and city, and possibly the county and other special taxing districts. If that retailer offers delivery or mobile service, it can also affect the locations they have to collect sales taxes in. And that likely includes different tax rates. Each state has different rules on the taxability of delivered services and products, which can affect rates.
As a very small retailer or service business grows to a few stores in a metro area, the sales taxes can include rates and rules for many different municipalities. Still, brick and mortar retailers are not likely to face the most significant sales tax compliance headaches until they are in dozens of locations or more.
Ecommerce and Large Entities
Businesses that sell to customers across the country face the biggest challenges. Where this used to be a concern only for the largest retailers, who could afford large tax compliance teams, the internet and ecommerce have dramatically changed things. Opening up the world and the nation to sales opportunities for small businesses has been a great economic boon, of course, but it is increasingly becoming a minefield of taxability issues.
At the latest count, the Tax Foundation says there are more than 8,000 taxing jurisdictions across the United States—from states to cities and counties. At the broadest level, there are states (all but five have a state-level sales tax). The ones with no state sales tax are: Alaska, Delaware, Montana, New Hampshire, and Oregon. However, most retail sales in these states would still be subject to a sales tax at the local or county level. Likewise, in the states that do have a statewide sales tax, there are sales taxes enacted at the local and county level, and occasionally for special transit, school, development, or other purposes.
The concept of nexus was a major factor in sales tax regulation for 30 years. Nexus refers to the legal definition of the location of the vendor or seller of an item or service. The old standby definition came from the U.S. Supreme Court case of Quill v. North Dakota. Quill, a mail order catalog sales company, told North Dakota e it did not need to collect or remit sales taxes to them because it was not subject to their laws, even if the company’s mail-based customers lived there. However, the location of the transaction (the sale) was considered to have been in the state in which the customer resides.
In this case, the issue of nexus questioned whether the retailer had a physical location in that state, or other assets such as offices, warehouses, remote employees, distribution facilities, or sales agents? They did not. The Supreme Court ultimately ruled in favor of Quill and the court has not revisited sales tax nexus since then, but that case was in 1994, before the advent of the internet and ecommerce.
The Internet and Ecommerce Nexus
In the past ten years, the concept of nexus has changed significantly. Many states, in their push to collect more revenues from online transactions, have redefined nexus for their own state taxation purposes. Thus, the Wayfair ruling was necessary to create a, more or less, standardized system of sales taxation.
Online Sales Tax and Small Businesses
Unlike behemoth ecommerce entities, there are tens of thousands of online resellers across the country that are small businesses, often with a micro-sized staff. While under most state’s implementation of Wayfair sales tax systems, these businesses (with low revenues) are not obligated to collect and report sales taxes in all of the states where their customers are. However, they are still required to report their sales to these states.
Overall Sales Tax Complexities
The challenges of sales and use taxes can snowball quickly, and the penalties can, too. Just as many small business owners turn to their public accountant to help them with payroll and wage reporting laws, there is a broad market for these professionals to provide sales tax compliance services for their clients.
For the smallest of retailers, keeping up with the occasionally changing sales tax rate in their area is fairly simple, and small business accounting systems are designed so that they can easily make these changes. But when the business gets larger and faces the challenges of reporting and collecting sales taxes across many jurisdictions and states, it is necessary to implement a more proactive approach to sales tax compliance.
An automated sales tax solution that integrates with their online accounting, point-of-sale, or ecommerce systems is now an essential tool for online sellers. Fortunately, this is included in most online sales platforms.
Sales Tax is Not Just for Retailers
While most people consider the issue of sales tax to be one that primarily affects retailers, it can affect many other types of businesses. Most noteworthy are service providers who may also sell products that they install or maintain. From heat and air conditioning contractors to auto mechanics and other trades like painters and pool cleaners, these businesses often sell products that are subject to sales taxes. It can be further complicated if the service takes place at the client’s location as opposed to in a singular retail shop. Likewise, many states also tax services provided, as well as rented or leased products.
Sales Tax Options for Small Businesses
Fortunately, sales tax compliance systems are often online and have kept up with the mobile nature of today’s businesses and professionals. In general, the options fall into three categories:
State-run websites for small businesses with low compliance requirements;
Simple online programs for reporting to multiple states;
And comprehensive collection and reporting systems that automate the process of collecting and reporting sales taxes to many or all states and localities in the U.S.
For the smallest retailers and service providers, state-run websites offer a free and generally simplified way to report sales, exemptions, and taxes collected, along with online remittance options. These are generally used after a monthly or quarterly period has been closed, with appropriate reports run and on-hand while entering the data. The business is responsible for keeping their accounting system updated with correct sales tax rates and applying the tax to appropriate transactions.
Simple Online Programs
Similar to the state websites, simple online sales tax reporting systems let a small business report sales taxes to a few states and their sub-jurisdictions. This low-cost option is also an after-the-fact reporting scenario, like the state websites, in which the business is responsible for keeping their software up-to-date with sales tax rates, and applying taxability rules.
Automated Sales Tax Management
For businesses with sales across a broader range of states and jurisdictions, automated sales tax systems can greatly reduce the burdens of keeping up with potentially hundreds or thousands of sales tax rate and rule changes. Offered as online applications, these systems tie into a business entity’s sales or ecommerce platform, automatically applying the appropriate sales tax rate to a transaction.
These systems are comprised of massive sales tax databases (sometimes called matrices) that include rates for all jurisdictions in the nation, as well as special taxability rules, such as when gum, clothing, or food is taxable and when it’s not. The databases are maintained and updated by the software vendor, such as Avalara, which has hundreds of staff keeping their program up to date. These systems also include options for automatically preparing sales tax returns for review and electronic submission, along with digital tax remittance.
Sales Tax Management as a Revenue Generating Service
How would your retail and service-based clients fare during a sales tax audit? With states becoming more aggressive in sales tax compliance enforcement, it may be time you talked to your clients about how you can help them.
How can you convince them it’s time to find a better solution to their sales tax compliance needs? If they are incurring penalties for non-compliance or late filings, that’s a good sign. Even if they aren’t, however, it may be that managing the sales tax reporting process is too tedious, time-consuming, or worrisome, and it is something that they just don’t want to do anymore.
Accounting firms are likely to have clients who could find value from each of the three types of sales tax compliance systems, but those clients may still seem insecure about whether they are truly meeting their compliance needs. This presents an excellent opportunity for client service.
Similar to professional payroll services, the systems include tools for managing multiple client entities. By overseeing the compliance process for them, you can help eliminate errors and reduce penalties, while strengthening the relationship between your firm and the client. And since the process can be handled on a regular basis by lower-paid paraprofessional staff and can be automated for the larger, more complex clients, it presents a potentially profitable revenue model for your firm.