Sales tax regulatory change continues to accelerate across all jurisdictions, meaning compliance remains a fast-moving target. You might think that the pace and rate of compliance changes slowed down during the COVID-19 pandemic, but the evidence proves just the opposite. Since July 2020, there were more than 640 rate changes and in the 2020 calendar year, 657 of the more than 1,400 forms we track for our clients were revised in some way, shape or form.
In addition, state governments are beginning their own digital journey – although it is slow to manifest. They are working toward understanding that data and technology can enable expanded audit abilities and stricter enforcement. It's a nasty combination.
So, it is important to stay educated on all three sides of your clients’ sales tax compliance obligations. In an earlier article, we discussed how to support companies in determining their nexus footprint. Nexus is what creates the obligation to become sales tax compliant for a given state. However, once you recognize your clients’ compliance obligation and register for sales tax, sellers need to start thinking about accurate determination and compliant reporting/remittance. Failing to do either one of these correctly creates audit risk.
As you look to help your clients better understand how they can achieve manageable, affordable and sustainable sales tax compliance, remember that while there is no one size fits all approach, there are foundational pillars that must be considered to start your clients on the right track.
Accurate determination is fundamental
With notable exceptions in Brazil, Canada and a handful of other locations, the rest of the world uses a value added tax (VAT) system, which is administered by the national government. This means rates and rules are pretty much consistent no matter where in the country you may buy or sell. Here in the U.S. though, each state (and sometimes each locality) can enact their own tax with their own rates, rules and requirements. The complexity that this creates is astounding. Given that sales tax in the U.S. can apply at the state, county and even district level, there are more than 12,000 possible jurisdictional rate combinations. Keeping up to date on just U.S. state and local rate changes for a nationwide seller is more than a full-time job.
But tracking rates is not enough. Every state has its own set of rules on which goods (and sometimes services) are subject to tax, and the distinctions between what is and is not can often be excruciatingly subtle. For example, let’s look at Pennsylvania’s approach to clothing. Pennsylvania, like a handful of other states, exempts clothing from its sales tax but excludes “formal clothing designed for formal functions and not normally worn except while attending a formal function.” So, while a wedding guest may be able to buy a new suit or dress tax free, neither the bride nor the groom is so lucky if they opt for a traditional wedding gown and tuxedo. A business that only sells clothing in Pennsylvania is certainly capable of knowing and applying this distinction but managing product taxability gets harder as companies expand their geographic scope and product mix. On top of all that, new legislation or regulations can change existing rules in an instant.
Sellers must review all of their product categories, evaluate how they are taxed in every state and establish a process that ensures taxability rules are reviewed periodically to catch any changes. While manual processes and custom solutions may have been suitable in past environments, increased levels of speed, oversight and complexity now demand a more sophisticated approach.
Timely and correct filing and remittance is crucial
The tax a seller collects is not their money. Rather, they hold it in trust for the applicable state or locality until it's time to remit. Sellers should never be tempted to use tax revenue to meet expenses. Collecting tax and then failing to remit it to the state is flat out tax fraud.
More often though, taxpayers are simply challenged with the more mundane requirements of reporting sales tax on the right return, the right line of return and submitting the return (and the funds) on time. State revenue authorities are pretty good at telling you what form you should file (some states have different forms for sales tax versus sellers use tax versus consumer's use tax) and what frequency you should file (annually, quarterly, monthly). But you won't get the same level of assistance in completing the form accurately and submitting it on time.
For example, there is the hidden complexity of the TPT-2, which is Arizona’s standard transaction privilege (sales) tax return. While the form itself has a modest number of boxes and schedules, there are more than 300 possible “deduction codes” that need to be considered in properly classifying exempt or specially taxed sales.
If you are a monthly filer, most states require that you file and remit before the 20th of the month (whether it be electronically or by paper - depending on the state). Of course, many states also have “prepayment” obligations, which require some taxpayers to make an earlier remittance based on historical collections. States are quick to penalize taxpayers for late filings and payments. It’s no great feat of technology for the department of revenue (DOR) to track when electronic returns are submitted and to send a delinquency notice to a taxpayer if a return is filled even just a few seconds after the deadline.
Massachusetts is in the process of taking things one step further. Under its new “Advance Payment” directive, sales tax returns are now due on the 30th of the following month, which is actually a little later than before. However, taxpayers that have annual sales tax liability exceeding $150,000 are required to make an advance payment on the 25th of the month for tax collected from the 1st day of the month to the 21st. While obligated sellers don't need to file their monthly sales tax return for July transactions until August 31, they must remit the actual tax collected from July 1 to July 21 on July 25. Tax collected between the 21st and the end of the month is remitted with their return. While Massachusetts provided a safe harbor that allows taxpayers to estimate their advance payment for 2020, that option will not exist in 2021. Sellers will need to understand exactly how much tax they collected during the first three weeks of the month and be ready to pay it four days later.
While the jury is still out on whether the new Massachusetts rule represents a challenging outlier or the beginning of a trend, increasingly complex and shorter-term compliance requirements are surely in the future.
Providing your clients thoughtful and impactful advice
Helping your clients get their sales tax under control will alleviate a substantial amount of stress and burden for them. Understanding their current sales tax liabilities, based on a nexus analysis, is an important first step. Once you understand the liabilities, it’s time to formulate a plan to achieve compliance in the areas that expose the business to the highest levels of risk. For many taxpayers, working with a sales tax automation partner is an important foundational step.