The Changing Landscape of Sales Tax Compliance

A short while ago, Sovos published its 2022 Annual Report, “The Continuing Evolution of Sales Tax.” In the report, Sovos details the volume of sales tax rate, rule and form changes, as well as the ever-increasing volume of proposed and enacted legislation impacting sales tax compliance across the country over the last 12 months. The numbers, which show a modest uptick, only tell part of the story.

Here is a look behind the numbers.

Ask anyone working in the sales tax compliance arena and they will tell you that keeping their organizations compliant and safe from audit risk is becoming tougher by the day. Understanding the source of their pain is a critical first step for any practitioner hoping to provide thoughtful wisdom and advice to their clients.

Some of the pain is internal. “The Great Resignation,” which is perhaps better characterized as “The Great Reshuffle,” has created a substantial brain drain inside many tax teams. If their leaders didn’t have processes and procedures well documented, these teams were likely left scrambling to perform the most basic function of a tax department – getting tax returns out the door on time – never mind taking the extra step of ensuring their accuracy and completeness.

In this environment, process improvements become a virtual impossibility. Maybe the moment isn’t quite right just yet, but at some point soon, if your clients experienced resignation-related compliance challenges, they may find a conversation about the importance of process documentation incredibly valuable.

Which states are making sales tax changes?

Mostly though, the pain is external. With budget coffers still brimming due to pandemic-fueled e-commerce spending (at least for now), states have seemed more comfortable making changes to their tax rules that appear fueled by social and political concerns, as opposed to budgetary objectives.

Take, for example, the new retail delivery fee in Colorado. While the bill enabling the fee was passed in 2021, Colorado didn’t issue substantial guidance until its effective date (July 1, 2022) was close at hand, creating serious compliance challenges for Colorado taxpayers.

The fee, which adds at least $0.27 to an invoice when the items are delivered, via road transport, to Colorado customers is the first levy of its kind, with many subtle nuances. For example, the fee applies even if the shipping is free and if the shipping charge itself is not subject to Colorado tax; so long as one of the items on the invoice is taxable under Colorado law. In addition, many, but not all, cities and districts in Colorado hold that the fee itself is subject to their local tax. For example, an invoice with a $10.00 item and a $.27 delivery fee may represent a $10.27 taxable amount in City A but only a $10.00 taxable amount in City B.

While this fee will undoubtedly generate some revenue, the social and ecological objective behind this fee is evident. If it successfully takes root in Colorado, sellers should prepare for other states to jump on the bandwagon.

Other states have altered their tax rules on firearms and related safety devices. While the annual Mississippi Second Amendment Sales Tax Holiday continues, other states, like Tennessee, have enacted “gun safety” sales tax holidays, exempting items such as gun safes and trigger locks. Similarly, states like Maine are creating permanent exemptions for gun safety equipment.

States are also continuing to enact laws aimed at neutralizing what they see as gender inequality in sales tax. Today, exemptions for feminine hygiene products exist in 22 states with three new states (New Mexico, Louisiana, and Michigan) joining the chorus so far this year.

The number will rise to 23 when a new Nebraska rule exempting feminine hygiene goes into effect this coming October and then to 25 when the new Iowa and Colorado exemptions come into effect on January 1, 2023. And it’s certainly possible that legislative proposals in Hawaii and South Carolina will increase that number even further before we close out the calendar year. At this very moment, there is a bill on the governor’s desk in Virginia that would exempt personal hygiene products as of January 1 that is very likely to be signed as well.

Diapers and baby feeding items are also in the spotlight. While several states have exemptions or special rates applicable to sales of clothing, disposable diapers may not be eligible. Today, there are exemptions for disposable baby diapers in 18 states. This year, Florida enacted a one-year “tax holiday” that included diapers and permanent exemptions have been enacted in Maryland and Louisiana.

In January 2023, new exemptions will come into effect in Colorado and Iowa. Likewise, New York is changing its diaper exemption in 2023. Today, diapers are exempt as clothing, and as such, subject to a $110 limitation and sometimes will have local tax applied. Under the new rules, diapers will be exempt, regardless of price or location. Also, that bill in Virginia noted above would also fully exempt incontinence products come this January. If your client is in the diaper business, you should be on the lookout for subtle distinctions in the rules. Some states treat cloth diapers differently from disposable diapers, and adult diapers (including incontinence garments) differently than baby diapers.

With respect to baby feeding, there are seven states exempting breast pumps and related feeding devices today, including exemptions that were enacted this year in Illinois and Pennsylvania. Rhode Island also enacted an exemption for breast pumps and related collection and storage supplies, which becomes effective on October 1.

Sales tax and inflation

The most disruptive set of changes happening this year are directed at curbing the impact of inflation. Sales tax is a consumption tax and consumption taxes are considered regressive. That means they impact spenders far more than savers. Initiatives that seek to reduce the cost of items that individuals (and voters) purchase most frequently are often met with rousing support, especially so in times of inflation. With that in mind, it’s no surprise we have seen an incredible uptick in enacted and proposed law changes surrounding the tax paid on fuel and groceries, as well as a significant expansion in the number of sales tax holidays available this year.

In 2022, we have seen (or will see) temporary suspensions of state fuel taxes in Connecticut, Florida, Georgia, Maryland, and New York. Legislation is still being debated in Alaska, Illinois, Maine, Missouri, Rhode Island, and South Carolina, meaning a few more states will likely be added to the list.

While fuel may be a specialized item, impacting only a specific handful of taxpayers, traditional sales tax holidays are also definitely on the rise. In 2022 there are 35 holidays across 21 states, and that’s excluding holidays on food and fuel. There are eight new sales tax holidays this year, including five new holidays in Florida, as well as in Illinois, New Jersey, and Puerto Rico.

Finally, let's talk about groceries. When we began 2022, 14 states plus the Commonwealth of Puerto Rico applied either their standard rate or a special reduced rate to the sale of food and food ingredients. However, the rules have changed this year.

Illinois just implemented a one-year “tax holiday” eliminating its 1% special rate applicable to groceries. Kansas fully taxes grocery items today, but it will apply a reduced rate of 4% starting on January 1, 2023. The rate will further decrease to 2% in 2024. Groceries will become fully exempt in Kansas in 2025. Tennessee, which normally taxes food at the reduced rate of 4%, is having a month-long grocery tax holiday this August. The Commonwealth of Puerto Rico had a sales tax holiday this last June, which included “non-perishable” food. No other U.S. jurisdiction had previously singled out non-perishable food for special tax treatment.

Legislative proposals regarding the tax treatment of food were ubiquitous this year, including a creative proposal in Tennessee that would have fully exempted fruits and vegetables. There is also a strong political movement in Alabama to exempt food. In Hawaii, all the top democratic gubernatorial candidates support a food exemption, and in Utah, Republican lawmakers are already planning to re-introduce a bill exempting food (even though similar bi-partisan bills failed earlier this year). Lastly, the Virginia bill with respect to diapers and personal hygiene products would also fully exempt grocery food as of this coming January.

What comes next?

The numbers may not show the full picture. Sales tax compliance has been incredibly disruptive and challenging this year, with changes both big and small. So far, sellers of items such as groceries, feminine and baby products, fuel, and food have been disproportionately impacted. Retailers have been hit with a slate of new sales tax holidays and a challenging new delivery fee in Colorado.

Last year, the prime driver for complex changes was initiatives aligning compliance requirements between in-state and remote sellers. This year, it is social, political and economic factors causing serious disruption. Next year, it will be something else.

Working with the right sales tax partner can help overcome the pressures of sales tax demands. More importantly, the right partner will do all of the research on sales tax changes so you never need to worry about being in compliance. 

Interested in learning more? On August 9th, Sovos hosted a live discussion about sales tax trends which contained valuable information. Watch a recording of this information here.