Sales tax revenues represent a significant (and growing) portion of many states’ budgets. For many years after the rise of e-commerce, state coffers were hemorrhaging tax dollars as more and more businesses moved online. It should come as no surprise then that, after the Wayfair ruling, states began aggressively pursuing sales taxes to close their tax gaps.
Here, we’ll discuss some common causes of sales tax headaches and ways to prevent them.
Sales tax audits
There are some clear trends seen in state sales tax audits. Most audits are in one of four large and high-visibility industries: retail, wholesale/distribution, construction or manufacturing.
During those audits, a majority of the revenues collected were due to unreported sales, undocumented sales for resale or purchases from out-of-state vendors that either didn’t charge tax or didn’t charge tax properly. But all these audits began with some form of notice.
There are many types of notices that can be received including administrative notices, account renewal notices and notices related to credits or refunds. Notably, not all notices are bad, nor are they always indicative of some error. Frequently, notices are generated automatically.
Whenever a notice is received, it is critical that you help your client understand what steps they might take to resolve it. This may involve contacting the state or perhaps the tax compliance partner your client works with to get their filings out the door. But the best way to address a notice will always be to prevent it.
Why do sales tax notices arise?
Naturally, failure to register, collect and remit where necessary is one of the leading causes of audits. In the post-Wayfair world, where physical presence is no longer a requirement, companies must be extra vigilant in examining nexus in every jurisdiction in which they do any significant amount of business.
Some clients may be tempted to think that not being registered in a state may make them harder to find, particularly if they may have had nexus in the state for some time. But there are many ways a state can find them including other state registrations, permits, licenses, in-state customers or vendors, company websites/public information, or attendance at trade shows and conferences. Even Alaska is actively seeking out businesses it thinks should be registered in the last frontier but are not.
Likewise, there are many ways a company can create nexus, or an obligation to collect and remit, for sales taxes. It could be physical presence such as having employees, inventory, kiosks, offices, stores, trade show attendance, warehouses, or other physical ties to the state. There could be economic nexus if a company has a certain number of sales and/or transactions in a state or are a marketplace facilitator. Even getting referrals for sales may give rise to an obligation to collect and remit sales or use tax in certain states.
For remote sellers, even if nexus isn’t triggered, some states still impose notice and reporting obligations that require that a retailer notify buyers that they must pay and report state use tax on their purchases. The business may also be required to send purchasers and the state an annual statement of its untaxed sales.
If a company is registered, collecting and remitting sales tax, myriad errors can still give rise to an audit or notice liability. This could be a data or technology mishap such as missing updated rates or rules, integration errors or data management issues. It could be a failure to adapt to new or changing filing requirements, frequencies or pre-pay/direct pay status changes. It could also be a filing or remittance error such as late, incomplete or incorrect data on returns.
Being just one day late on filing or remittance could subject a business to "failure to file" or "failure to pay" penalties, which could be as high as 10% of the tax due. This is by no means an exhaustive list, but you get the idea.
The sales tax landscape is complex and nuanced. Indeed, it could be argued that, if one is in business long enough, a notice or audit somewhere is practically inevitable. So, it’s best for companies to reframe their thinking around sales tax compliance.
It’s a cost of doing business, sure. But it is also a significant value-add. For example, in terms of administrative ease and financial value, a typical audit can take 30-45 days and cost a company $100,000 - $300,000. Additionally, there are the possible effects on licenses, the potential imposition of liens, negative publicity and the impact on the attractiveness of a business when looking to sell it. Finally, businesses must consider the terms of decreased liability and increased peace of mind.
How can notices be prevented?
Maintaining compliance requires constant vigilance to detect impactful changes, accuracy in the analysis of those changes and the agility to react quickly and implement changes. It is crucial for your clients to plan ahead and build compliance into their day-to-day operations.
Of course, complex systems are always error-prone, and it’s impossible to remove the risk entirely. The more manual the process is, the more so this is true. Any manual process inevitably introduces human error into the equation.
Impactful tax changes occur more often than one might think such as rate changes, both state and local, new or expiring exemptions, inclusions, exclusions, or sales tax holidays, and new taxing districts or “enterprise zones”, just to name a few. These changes can also occur with little warning and guidance is often released at the 11th hour.
A great example of this is the now infamous Colorado retail delivery fee. Fortunately, there are a litany of automation and software options available to assist companies in dealing with all this complexity.
My favorite example is the Streamlined Sales Tax (SST) Model 1 program. Qualifying businesses that enroll in this program work with a Certified Service Provider (CSP) to integrate solutions that are certified by the SST states. Once integrated, the CSP handles sales tax compliance from registration to remittance and takes on liability for any discrepancies or errors caused by its state-certified content. Better still, the CSP is compensated for this service by the state rather than the business. But even if a business does not qualify for Model 1 (or doesn’t operate in SST states) there are still options available at many scales depending on the company's particular needs.
For example, there are registration solutions and tax determination solutions, including cloud and on-premises. There are also data file solutions, certificate/data management solutions, filing and reporting solutions (including both software and managed services), remittance solutions, notice handling, and more.
Many of these solutions can be utilized individually or in conjunction with one another to meet the needs of your business. But whatever solution(s) a company goes with, they all have benefits in terms of reducing administrative work by streamlining processes and reducing internal resources dedicated to sales tax compliance, and by mitigating risk and exposure.
While there are no fully “out-of-the-box” solutions, part of what makes a solution work for a particular business is the care taken during setup, implementation and integration. Errors at this stage can invalidate the whole endeavor—as the old saying goes, garbage in, garbage out. Furthermore, just because it’s automated, doesn’t mean set it and forget it. Always keep abreast of tax changes that may affect your clients’ businesses.
Many businesses view sales tax compliance as a hassle and a time and money suck. It very well may be all those things. Unfortunately, it’s a cost of doing business and is unavoidable.
If your clients reframe their thinking just slightly, particularly in light of the potential costs of non-compliance, it becomes clear that the cost of compliance is well justified. Implementing a sales tax solution that fits a company’s needs can be a major value-add, not only in terms of reduced exposure and long-term cost savings but also in terms of a good night’s sleep knowing the business’ sales tax compliance needs are met.
Interested in learning more? On August 4, Sovos hosted a live discussion about sales tax trends. Watch a recording of this information here.