The careful art of keeping up with sales and use tax can be incredibly complicated for many businesses. The primary challenge is that there are countless sales tax rules that require in-depth attention in order to avoid paying hefty penalties. Here we’ll explain the basics of sales and tax compliance to help you understand the challenges that your individual business is facing.
The information presented in this webinar from August 13th, 2015 was hosted by Accounting Today and sponsored by Avalara. In this session, moderator Danielle Lee and presenter Mark Giddens, Director and Tax Technology Expert at Avalara, delve into the challenges of sales tax compliance for businesses.
Why Sales Tax Matters
Sales tax makes up about 47% of total state revenue, which is more than the amount that states receive from income tax payments. Unfortunately, more than half of all states are forecasting deep budget deficits in the future. That’s one reason why states are focusing on increasing their revenue stream by taxing every business and enforcing compliance through increased audits. (States are constantly hiring more auditors, too.)
The Myriad of Sales Tax Challenges
Sales tax requirements are challenging. Every business is at risk for an audit and it’s only a matter of time before it’s your company’s turn. Keeping up with sales tax regulations is labor-intensive, prone to human error, expensive, and difficult because the rules are constantly changing. Unfortunately, audits can result in back penalties and interest payments for non-compliant businesses.
Constantly Changing Regulations
How challenging is it to keep up with sales tax regulations? There are over 35,000 different sales, use, and rental tax rates in the United States alone. In addition to that, there are over 30 million different product or service exemptions and more than 750,000 buyer and seller exemptions.
Incredibly Complicated Sales Tax Rules
Another problem with sales tax is that taxing jurisdictions don’t follow ZIP codes. Individual counties and municipalities levy sales taxes in addition to state tax rates. What this means for you is that the sales tax rate might vary significantly within the same ZIP code. As a business owner, you risk under-collecting and running afoul of tax authorities or over-collecting and creating customers service issues and becoming too expensive to compete.
To make matters even more complicated, sales tax rules vary within industries, too. For example, software is taxed differently than dietary supplements. Food is often taxed at a lower rate. But not even the rules on food taxation are clear-cut. For example, a candy bar might be taxable depending on whether or not it includes flour. Similarly, a non-carbonated beverage with a supplement label might be taxable whereas a non-carbonated beverage with a nutritional label could be exempt from sales tax.
The Added Costs for Businesses
Even though sales tax regulations constantly change, many companies (more than half of all businesses surveyed in a 2013 Wakefield Research study) don’t even remember the last time they revised their sales tax processes. On top of that, the same percentage of companies think consider it likely that an auditor would find a mistake if their business were to be audited. The scariest part is that a sales tax audits costs businesses an average of $114,147.
The Importance of Nexus
Nexus is the connection between a state and a company. Having nexus allows a state to compel an out-of-state company to collect sales or use text. In previous years, nexus simply meant that your business had a substantial physical presence in that state. But nowadays, your business doesn’t have to own property in order to create a nexus in a state. In fact, the list of nexus-creating activities is constantly growing. Here are some examples of these types of activities:
- Multi-state locations
- Maintenance/ service / repairs
- Own / lease rental property
- Hosted data centers
- Field sales / service staff
- Charging licenses / royalties / fees
- Direct and / or online sales
- Affiliates
- Tradeshows
- Commissions to resellers
- Investors / board members
- Marketing / web advertising
- Drop shipments
Unfortunately, being a remote seller doesn’t exempt you from sales tax requirements. Pending legislation might create an online sales tax in the future, too. But in the meantime, certain states have already passed laws requiring companies to collect sales tax from their business transactions.
What about Use Tax?
Sales tax is typically collected by the seller. Regular sales tax is an intrastate tax, collected by the seller on the gross receipts from the retail sale. Then there is the seller’s use tax, which is a sales tax that is collected by an out-of-state company that has nexus in the state.
Last but not least, there is use tax. A use tax applies when the seller doesn’t have nexus and isn’t required to collect the sales tax. In that instance, businesses and consumers have to pay their own use tax on this type of transaction. One example would be buying equipment from out-of-state to be used for your business.
Who Is Exempt
There are 2 different type of exemption in a customer-based transaction. Both require exemption certificates. The exemption is either entity-based or use-based. An entity-based exemption means the transaction is exempt based on the customer, such as a non-profit organization. A use-based exemption can apply when products and services are used for a particular purpose.
Avoid These Mistakes
If you want to stay compliant with sales tax regulations, then you should avoid the following mistakes:
- Forgetting to file a sales tax return
- Forgetting to report sales (even exempt sales must be reported)
- Taking excessive credits or exclusions on a return
- Filing a return with errors
- Reporting different sales amounts on your sales tax return and on your income tax return
- Making mistakes during an audit
- Misusing exemption certificates
How to reduce audit risk
Every company wants to know how to avoid getting audited. While there is no way to pass when it’s your turn to be audited, there are some things you can do to decrease your audit risk:
- Do a nexus study
- Stay up to date with rates, rules and boundary changes
- Report consumers’ use tax
- Be compliant from day one
- Automate sales tax collection with technology
- Understand your filing requirements
- Triple-check calculations
- Keep detailed sales records
- Put a process in place for managing exemption certificates
- Get Product taxability coverage
Are Services Taxable?
Services generally fall into one of the following three categories: services performed on tangible personal property, real property services, or professional services. Most states tax telecommunications and amusement parks. Many states also tax cable television. Most states enumerate the specific types of services that are taxable. States that tax most services include Connecticut, Hawaii, New Mexico, South Dakota, and West Virginia. States that don’t tax many services include Alabama, Florida, North Carolina, Oklahoma, and Utah. But keep in mind, these rules constantly changing. When you bundle services with a tangible product, understanding regulations becomes even more challenging.
Automate the Process for Your Business
The easiest way to ensure sales tax compliance for your business is to automate the process via cloud computing. Now you can integrate Sales Force with your eFileCabinet solution to help you manage your sales tax obligations conveniently online, no matter where those sales originate. Fill out the contact form today to receive your 15-minute demo of eFileCabinet.