It goes without saying that companies grow and evolve over time. They acquire new entities, open new channels, offer new products and services, build, buy or lease new facilities and hire new employees. However, some companies fail to create a systematic process to understand how their growth may impact sales tax compliance. Ideally, this is done in real-time with sales tax experts that are “kept in the know” with respect to any major changes as they happen. Even so, things can fall through the cracks, and once the December tax returns (including those pesky annual returns) are out the door, the time may be right for an annual compliance review. By so doing, companies put themselves in the best position to account for a change before audit penalties and interest begin to rack up.
As accounting professionals, you are in a great position to support your clients in standing up an easy-to-execute but effective annual review protocol.
Step 1: Start with nexus
A company’s nexus footprint is not cast in stone. As a company grows, expands and evolves, its sales tax nexus likely follows suit. To properly account for nexus changes these days, both physical and economic presence must be evaluated.
A company must collect and remit sales tax in any jurisdiction where it has a physical presence, which is, essentially, when you have people (e.g., employees, contractors) or property (e.g., buildings, inventory, equipment, delivery vehicles). Under this standard, all sorts of everyday business activity could create expanded nexus, including opening a new office or warehouse. In most states, housing inventory in a third-party facilitation center also creates physical presence nexus. Similarly, if a company allows employees to “work from anywhere,” they could be creating physical presence nexus everywhere, even if those employees are not involved in the sales process.
It’s been more than four years since the landmark Supreme Court decision in South Dakota v. Wayfair, and today, every state with a sales tax has adopted a rule obligating sellers to collect and remit sales tax based on economic factors. While the particulars vary from one state to the next, most standards examine the volume of gross sales. Others also consider the number of independent transactions. As a quick reference guide, please feel free to use the chart located here. Some states give taxpayers a little time to get their ducks in a row after they cross an economic nexus threshold so they can register and begin filing, but many states technically require compliance on the very next transaction. If a company is close to a threshold at the time it conducts its review, maybe it’s best to register there and then, so it doesn’t need to obsessively track transactions for the rest of the year.
In several states, such as Alabama and Texas, economic nexus sellers can request permission to collect and remit sales tax under a simplified scheme that lets them disregard local tax rates and apply tax at a simplified combined state and “local” rate. If a company chooses to take advantage of these two simplifications, remember that should they create physical nexus for themselves in the future, they will likely become ineligible to use the simplification going forward. Moreover, under the Illinois “Leveling the Playing Field” rules, the requirements change depending on whether a seller has an economic or physical presence. An economically connected seller charges the retailers' occupation tax based on where their customer is located. However, a seller that is physically present in Illinois is only required to charge the 6.25% state-level seller's use rate, even when the sale originates from outside of Illinois.
Step 2: Update your tax rates
If companies are managing their own sales tax compliance and not updating their tax rates, they are likely not collecting tax properly. While state rates are pretty static (New Mexico was the last state to change its standard rates earlier this year), sales tax rates at the city, county, and district levels change all the time. In fact, during CY 2022, there were 534 local sales tax rate changes. In the same vein, remember annexations. Cities and towns are always annexing unincorporated areas, and when they do, that means any city tax now applies within the previously unincorporated location.
Step 3: Review your products and services
The rules vary across the country regarding whether certain products and services are subject to sales tax at the standard rates or whether exemptions or special reduced rates apply. The last year has been particularly active with respect to taxability changes, some of which were intended to lessen the impact of inflation. For example, a handful of states created new exemptions or reduced rates for groceries, diapers, and feminine hygiene items. In the same vein, sellers of consumer items need to be worried about sales tax holidays. In 2022, there were a total of 40 sales tax holidays across 21 states, eight of which were brand new for this year. For a retailer, there is nothing worse than a customer complaining about being charged sales tax incorrectly during a holiday.
If a company keeps its own taxability matrix, it should make sure it’s been updated with the latest rules. Likewise, if new products or services were added, it should ensure that a taxability matrix has been developed for those items. If you are using tax automation (which will bring us to our next point), sellers should review how their SKUs are mapped to the product identifiers provided and maintained by the engine and, even more importantly, should make sure any new SKUs are mapped. If a SKU isn’t mapped, the seller doesn’t have a prayer of properly accounting for any exemptions or special rates.
Step 4: Consider tax automation
Most, if not all, of these steps are easier when a company utilizes third-party tax automation. A good tax engine will have tools that can tell you where you stand vis-à-vis economic nexus thresholds and can readily generate reviewable reports on existing SKU mappings. An engine will likely use address enhancement and resolution services that accurately correlate every street address to its proper taxing jurisdictions and apply the appropriate tax rates and product taxability rules.
However, even the best engine can start to provide bad results if you don’t periodically review the setting and configurations contained therein. Of course, if a company does not use automation at all, the time may be right to consider automation with respect to either tax determination, filing, and/or exemption certificate management.