Understanding January 2023 Sales Tax Changes to Keep Your Clients Compliant

If you work in the sales tax game, it is no surprise that the most challenging times of the year come in December and January. December is when state and local governments publish information relating to rate and rule changes effective January 1. January is when year-end filing happens, including those pesky reconciliation returns. If you are in the business of supporting clients in meeting their tax compliance requirements, it's important to understand the changes in the offing for January 1, 2023, and how they fit in the context of some emerging trends in sales tax.

The pandemic, in conjunction with the impact of the Supreme Court decision in South Dakota v. Wayfair, changed how states view sales tax. As you may recall, in the early spring of 2020, commentators were predicting enormous state budget shortfalls, but that never materialized. While some of the pain was removed through federal aid to state governments, even more was alleviated through the taxation of increased consumer spending on physical goods, predominantly through eCommerce channels. The General Accountability Office (GAO) recently reported that sales tax collections from electronic commerce grew from an estimated $3.5 billion nationwide in 2018 to $30 billion in 2021. While the growth of eCommerce has decelerated over the last year, states have taken notice of the value of sales tax in generating revenue.

This realization manifests in legislative action expanding the scope of sales tax by making additional goods, but mostly new services, subject to tax. Sometimes, but by no means always, sales tax expansion is accompanied by a reduction in personal income taxes. More often, in recognition of the regressive nature of sales tax, states have become more energized around enacting exemptions for basic living essentials.

With all of that said, let's talk about what sort of changes are on the horizon for January 1, 2023.

The final piece to the economic nexus puzzle is placed

Effective January 1, 2023, Missouri joins every other state with a sales tax in extending its sales tax to remote (non-physically present) sellers and marketplace facilitators. Under the Missouri rule, remote sellers with $100,000 in cumulative gross receipts of tangible personal property from Missouri sales will be required to register, collect and remit tax. In determining whether a company has reached this threshold, consider the current and previous calendar year. If they haven't crossed yet, be sure to check back every quarter as required under the law.

Missouri is a challenging state from a compliance perspective because, in many localities, sales tax and sellers' use tax rates differ. Some localities have no use tax at all. Not surprisingly, in anticipation of January 1, 41 additional localities in Missouri have adopted sellers' use tax to ensure that local tax, not only state tax, is collected and remitted by remote sellers. After all, cities and counties want their piece of the pie.

Kentucky taxes all sorts of services

Effective January 1, Kentucky will begin taxing a raft of new personal and professional services including, but by no means limited to, cosmetic surgery, photography, website design and hosting, extended warranties, clothing repair and alteration, and perhaps most notably, software as a service (SaaS). In exchange for this substantial expansion of the sales tax base, Kentuckians receive an annual .5% reduction in their personal income tax until the income tax ultimately vanishes.

If you represent or work for a company that sells services in Kentucky, you should review the extensive list to determine if what you sell is now taxable.

Exemptions grow for basic necessities

Sales tax is generally considered to be a “regressive” tax, meaning it has a disproportionate impact on individuals who spend, rather than save, a greater portion of their income. Traditionally, the regressive nature of sales tax is alleviated through targeted exemptions on the necessities of life; and this coming year, we see no shortage of new necessity-based exemptions.

Grocery food, which is either exempt or subject to reduced taxation in 14 states today, will become subject to a reduced state rate of 4% in Kansas and 1% in Virginia starting on January 1. Likewise, the temporary exemption currently applicable in Illinois continues until June 30. If are working with a food seller in Kanas, be sure also to note new local reporting requirements on their sales tax return specifically related to food.
Feminine hygiene products, which are either exempt or subject to reduced taxation in 23 states today, will additionally become exempt in Iowa and Colorado on January 1. In Virginia, feminine products will be subject to a reduced rate of 1%. With respect to Colorado, be aware that this exemption may or may not extend to city-level tax.
Diapers, which are either exempt or subject to reduced rates in 15 states today, will likewise be exempt in Iowa and Colorado starting on January 1 and subject to a 1% rate in Virginia. With respect to Colorado, the same warning with respect to local tax applies here as well.

The digital advertising tax that never was

Last year, a handful of states considered new taxes that were targeted at companies offering digital advertising, data collection, and social media. The momentum was partly fueled by political motives as well as by economic reality. Many technology companies earn substantial revenue by selling advertising and comparatively little from selling the underlying product or service they provide. By way of example, think of internet search engines that don’t charge people to query the web but do charge companies for the placement of digital ads on their site. The digital advertising tax (DAT) enacted in Maryland was designed to increase the tax paid by such companies.

While the DAT became effective last January, most companies subject to the DAT would have been first obligated to remit funds on January 1, 2023. However, in November, a Maryland state court declared the tax invalid because it violated the Permanent Internet Tax Freedom Act (PITFA). Under PITFA, states are prohibited from enacting taxes that don’t tax internet commerce and traditional commerce identically. Because the new Maryland tax applied to digital advertising but not to traditional advertising, the violation was obvious.

While the Maryland DAT will not be enforced as-is, and the pressure is temporarily off, accountants supporting companies offering digital advertising must stay alert. In several states, such as New York and Massachusetts, politicians are contemplating new legislation taxing digital advertising while avoiding the basic PITFA pitfall demonstrated by Maryland.

Looking ahead

Sales tax specialists have a busy year in front of them. The changes taking effect out of the gate on January 1, 2023, are numerous, varied, and challenging. Given the growing importance of sales tax to state economies, it's unlikely the pace will let up any time soon. For some companies, the best long-term answer is the thoughtful utilization of automated tax compliance tools for determinization, filing and/or exemption certificate management.