Staying in compliance with sales tax laws is no easy feat and seemingly small errors can turn into costly mistakes.
With so many regulations and rules — and recent changes to them — it can be hard to know what tasks to focus on or best practices for tackling them.
Adhering to basic compliance principles and even breaking them down further into a checklist of regular practices can help make sales tax compliance much more manageable.
Where are you obligated to collect sales tax?
Nexus is essentially the connection between a business and state that enables the state to collect sales tax from a business. On June 21, 2018, a United States Supreme Court ruling, commonly referred to as the Wayfair decision, overruled the physical presence nexus rule that obligated sellers to collect and remit sales tax only in states where those sellers had some sort of physical presence.
Now, as a result of Wayfair, there’s a new nexus in town. In addition to physical presence, states can also collect sales tax based on economic nexus, requiring businesses to also be alert to any economic activity — even digital — that they conduct in a state.
This may be news to online sellers, but many states have been eyeing economic nexus as a potential revenue stream for a while. At this point, 43 states have passed economic nexus laws requiring remote sellers to collect sales tax. Five of these laws took effect on October 1, 2019, (two others were significantly updated).
When are you obligated to collect tax?
The thresholds at which a state deems a business obligated to collect vary from state to state and are important to pay attention to. Businesses that conduct less than $500,000 in retail sales of tangible personal property in California in a calendar year are exempt from collecting sales tax. But in Washington, the threshold is $100,000 or more in cumulative annual gross receipts from retail sales and taxable services (cumulative gross income from January 1, 2020, forward).
Manufacturers and wholesalers conducting traditionally exempt transactions must also pay attention to nexus, as some states include exempt sales in their threshold count.
Which products are you obligated to collect sales tax on?
As with sales tax rates and nexus thresholds, businesses must also track state rules to determine which of their products are subject to sales tax. For example, ebooks are generally exempt from California sales tax, but are subject to sales tax in Pennsylvania. Consumables such as food are exempt in many states (e.g., Washington), taxed at a reduced rate in some (e.g., Illinois); and fully taxable in others (e.g., South Dakota).
States can also define products differently, adding complexity. Many states consider soda and candy to be “food for human consumption,” but not Illinois. Furthermore, product taxability rules are subject to change.
Doing business today requires organized record-keeping and proper retention in order to avoid fines or penalties in the event of an audit. Strive to be able to quickly and easily produce any records including exemption certificates, invoices, receipts, permits, etc.
Exemption certificates are worth special note. Without proof that a transaction was tax exempt with a valid (accurate and up-to-date) exemption certificate, a business will have to pay the uncollected tax.
Along with keeping records, make sure to respond to any tax notices in a timely manner. Ignoring them or pleading ignorance usually gets you nowhere when taxes are involved, especially if the tax department reached out to you.
It’s up to each business to know its filing status and when, where, and how frequently it’s required to file returns in order to remit sales tax to each state. An increase or decrease in sales to a particular state can change filing status, frequency, or due dates.
When and how frequently you need to file — monthly, quarterly, annually, or otherwise — can depend on sales.
Prepayment of a portion of anticipated sales tax is sometimes required. This generally applies to businesses with a high volume of sales.
E-File when you can (and when necessary) because states generally prefer businesses to file sales tax online. Some states even require it — though they may make an exception for businesses with limited internet connectivity. Filing requirements for each state can be found in Avalara’s state guides.
If you’re unsure about your filing requirements, don’t hesitate to contact the state tax authority, as interest and penalty charges may apply — even to late prepayments.
Reconciling accounts before you file is a good business practice and can impact your bottom line, not only in consideration of potential penalties, but also for strategic planning and budgeting purposes. Start with the account balance at the beginning of the accounting period, add the amount billed to customers, and subtract the sales and use tax paid. If the result doesn’t match the current balance of your sales tax payable account, look for the discrepancy and solve for it before you file.
There are more than 12,000 sales and use tax jurisdictions in the U.S., and each has one or more sales or use tax rates. Throw in the panoply of differing sales tax rules and requirements among states and you start to understand why sales tax compliance can be so time-consuming and stressful. Automating sales tax calculation, collection, and remittance helps businesses minimize costs and increase the likelihood of getting sales tax right.
Sales tax rates, rules, and regulations change frequently. Although we hope you’ll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.
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