Smart, successful businesses are always looking for ways to increase profits by increasing sales or reducing costs. One of the most significant (and often overlooked) costs of doing business today is managing the collection and remittance of sales and use tax.
As a revenue source for states, sales tax is one of the most common, along with property tax and income tax. And states aren’t the only jurisdictions hungry for revenue; cities, counties, and other municipalities often require their own pieces of the revenue pie. During recessions and periods of slow growth, revenue shrinks and scrutiny of tax returns increases, placing your business at a higher risk if you don’t properly collect and remit sales and use tax.
READ MORE: The Difference Between Sales and Use Tax
Most people accept the costs of doing business and try to follow the rules. Complexity is the challenge most companies face in complying with the regulations associated with sales and use tax, because “complex” barely describes the regulations.
One common theme comes through as you read this chapter: The only universal truth associated with sales and use tax compliance is that nothing is uniform; rules, rates, and responsibilities change not only over time, but also between jurisdictions.
Understanding Nexus
Rules exist that define when you, the seller, must collect sales tax from a customer. So, let’s start by considering whether you’re legally responsible for collecting sales tax.
There are a variety of reasons why a customer may not pay sales tax, described in the section “Covering Your Bases with Exemption Certificates.” If a customer doesn’t pay sales tax, he’s probably liable to pay use tax, described in the section, “. . . And Then There’s Use Tax.” Sometimes, sellers are also buyers, so they’re affected by both sides of the equation: collecting and remitting sales tax and calculating and remitting use tax.
If a customer doesn’t pay sales tax, he’s probably liable to pay use tax.
Click To Tweet
Nexus is the connection between a business and a state in which the business operates; as a function of the connection, the business acts as an agent for the state’s tax authority and collects and remits sales taxes accordingly. You can think of nexus as a seller’s obligation to collect and remit sales tax where business is conducted. Generally speaking, almost every business has to calculate, collect, report, and remit sales tax to some extent.
More than likely, you’re already collecting, reporting, and paying taxes in your state and local jurisdictions. However, what happens when you sell something across state lines? Are you required to collect sales tax and, if so, how much? And to whom do you remit the tax? And when must you remit it?
Almost every business has to calculate, collect, report, and remit sales tax to some extent.
Click To Tweet
Nexus rules are established by individual states, and every state defines them uniquely, making nexus one of the most misunderstood, misinterpreted, and underestimated issues when it comes to complying with sales tax regulations. Succinctly put, nexus isn’t static.
Determining exactly how a rule applies to a business is critical. At one time, companies could use a decision by the U.S. Supreme Court in Quill Corporation v. North Dakota (1992) as a guideline. As a result of that case, states couldn’t require companies to collect state sales tax unless those companies had a significant physical presence, like a warehouse or storefront.
And then e‐commerce began to emerge as a driving force. Initially, e‐commerce merchants didn’t have to charge sales tax because they were selling across state lines but not necessarily maintaining a physical presence.
Several bills have been introduced to level the playing field between online and offline merchants.
Click To Tweet
But that situation began to change. To increase state revenues, many states have redefined nexus, and several states have begun to urge Congress to also redefine nexus. Several bills have been introduced as attempts to level the playing field between online merchants and merchants who own brick‐and‐ mortar stores. For the seller, tax planning has become much more complicated, and the potential for increased nexus errors has driven up the risk of audit. For example, if you hire a new employee outside your state who works from home, or you send a sales representative into a different state, you may find that you now have nexus in that state.
The top three activities that lead to nexus errors are:
- Having customers who are exempt from sales tax
- Attending a trade show in the last 12 months
- Having a remote sales force
However, there are a host of other business activities that can trigger nexus. Chapter 2 covers these in more detail. If you have concerns about whether your business activities are creating nexus, consider having a nexus study done.
There’s Sales Tax…
Sales tax is a tax a customer pays on items he purchases for his own use at the time he makes the purchase. And when a customer makes a purchase, he pays the tax and his responsibility pretty much ends. But if you, the seller, have nexus, your responsibility begins, because you collect the tax and then send it to the appropriate taxing authority along with a tax return that explains how you arrived at the amount you’re remitting.
Sounds simple enough, but then you start running into potential complications, such as, “Do you need to collect taxes only for products and not for services?”
Sales tax is a tax a customer pays on items he purchases for his own use.
Click To Tweet
Enter the jurisdictional issues. Even if you sell in one location primarily, you may need to collect tax for multiple jurisdictions — your state, your county, and your city — and different jurisdictions have different tax rates.
Gone are the days when you could use zip codes to identify taxing jurisdictions and their associated tax rates. Both zip codes and jurisdictional boundaries change constantly. Studies have shown that 28 percent of reporting errors are due to customers being invoiced using an incorrect sales tax rate.
Things get even more complicated if your business operates in multiple states, because — you guessed it — each state has different rules, tax rates, and remittance requirements.
Things get complicated if your business operates in multiple states.
Click To Tweet
Sellers are obligated to collect sales tax using the rules of the location where the sale takes place. Sellers use sourcing rules to establish the location where the sale takes place and to determine, for interstate transactions, which state dictates the taxability of a particular transaction and the rates and rules that apply to the transaction. Remember: Nothing is static; everything changes.
The tax on sales made within a single state is almost always calculated based on the seller’s location.
As a general rule, most states in the U.S. use a destination model, which means that you, the seller, charge sales tax using the rules in place at the customer’s location. For those states using an origin model, you, the seller, charge sales tax using the rules in place at your business’s location.
You, the seller, charge sales tax using the rules in place at the customer’s location.
Click To Tweet
For manufacturers, wholesalers, and distributors, particularly those that operate in multiple states, the supply chain complicates sales tax liability. Read more on this issue in the sections, “Let’s Not Forget the Supply Chain” and “Covering Your Bases with Exemption Certificates.”
Last, but certainly not least, in the discussion of sales tax, you need to know when and where to remit the tax. In some cases, you remit all the tax you collect to the state, which then divvies up the tax between various other taxing jurisdictions within the state. In other cases, you remit directly to each individual taxing authority.
Does your head hurt yet? Keep reading
…And Then There’s Use Tax
Typically, if you make a purchase in your home state, you pay sales tax at the time you make the purchase. But if you purchase something and don’t pay sales tax, use tax comes into play.
Use tax is tax on the use of tangible personal property not otherwise subject to sales tax. Use tax is imposed by most states in the U.S. on both individuals and businesses. Like sales tax rules, use tax rules vary by state (remember that theme).
A buyer owes use tax on taxable items purchased on which the buyer paid no sales tax.
Click To Tweet
Generally speaking, a buyer owes use tax on taxable items purchased on which the buyer paid no sales tax or less tax than the applicable sales tax rate. Unlike sales tax, the remittance responsibility lies with the buyer (either a business or an individual).
You (both individuals and businesses) are liable for use tax if you purchase an item that you use, give away, store, or consume in your home state without paying sales tax to your home state. In some cases, the purchaser may be a business, such as a manufacturer or a distributor, buying goods outside the state or online, to use, give away, or consume as tangible personal property.
For example, you should pay use tax if you
- Buy something in another state and bring that item into your home state.
- Buy something from someone not authorized to collect sales tax, such as buying a couch through a newspaper ad.
- Buy an item by phone, by subscription, or from a mail‐ order catalog company without being charged sales tax.
- Businesses must also pay use tax on goods they withdraw from inventory for their own use or give away as donations or promotions.
Use tax is typically assessed at the same rate as sales tax. It is an individual’s and a business’s responsibility to self‐assess and pay use tax to the state and/or local tax authority.
The perils of not recognizing a use tax liability
Here’s the situation: Oil refineries purchase crude oil to refine it into saleable products. Refineries typically refine all the crude oil; they don’t use any of the crude oil in its unrefined state, and no crude oil is left over after the refinery process is complete. However, refineries can’t successfully refine all the crude oil into saleable products, and some of those products have no market value.
Three by-products of the refinery process typically aren’t resold in any form, but they can be (and usually are) used in the refinery process. Two of them — catalytic coke and process gas — are waste products that have no market value. The third, heavy oil, is a by-product that is sold to heavy industry as a high sulfur fuel, but heavy oil commands a much lower market price than the “premium products” produced by the refinery, such as gasoline, jet fuel, diesel fuel, and home heating oil.
Businesses usually need to file a special return often referred to as a sales and use tax return.
Click To Tweet
Although two of these by-products don’t have any market value, and the third has a very low market value when compared to the prices of premium products, all three by-products can be (and typically are) used by most refineries in the refining process to generate the heat needed to produce the premium products. The question here is, “Do you owe use tax on waste products that you reuse?” The courts have determined that, in most states, yes, you do. And if you don’t pay use tax on the money you earn because of the waste product, you can expect a tax auditor to charge you back taxes as well as penalties. Yep, garbage may be taxable.
Businesses usually need to file a special return often referred to as a sales and use tax return. Individuals usually report and pay use taxes with their state income tax returns, but in some cases, individuals must also file sales and use tax returns for larger transactions such as vehicle purchases that are subject to use tax.
Individuals must also file sales and use tax returns for larger transactions such as a vehicle.
Click To Tweet
Some states allow deductions for sales taxes paid to other states on the items purchased and may also exempt some items or transactions from use tax, such as food and prescription medications. Purchases made by government agencies and nonprofit organizations are generally exempt from use tax but not necessarily from sales tax.
Let’s Not Forget the Supply Chain
Many people believe that sales and use tax are relevant only for retail sales and then only at the point of sale. Not true. Noncompliance with sales and use tax rules can surface in companies all along the supply chain and in diverse business processes and departments.
Tax compliance along the supply chain is, as you may imagine, difficult.
Click To Tweet
Manufacturers, wholesalers, and distributors are participants in the supply chain, a term describing the process of efficiently moving raw materials and end products from one point to another until they end up in the consumer’s hands. Participants in the supply chain include raw materials vendors, manufacturers, wholesalers, distributors, resellers, retailers, and finally, end consumers. Different kinds of technologies — such as strategic sourcing systems, enterprise resource planning (ERP)/order management systems, and ecommerce — exist within the supply chain to simplify procuring and moving goods.
Tax compliance along the supply chain is, as you may imagine, difficult, particularly those that operate in multiple states:
- As described earlier in this chapter, every state and jurisdiction has its own rules for defining nexus, product taxability rules, and order sourcing rules to determine taxability of the product being sold.
- Jurisdiction boundaries change regularly, along with state and jurisdiction tax rates, various tax exemptions, and a myriad of specific product taxability rules.
- Every company functioning in a supply‐chain process understands “tax compliance” in a different way, based on its products.
- Different procurement, order entry, and e‐commerce technologies are used within the supply chain.
- Automated tax technologies vary in sophistication.
Participants in the supply chain often use drop shippers, which can change the taxability of a transaction. A drop shipper is a third‐party shipper that delivers goods directly to the customer from the manufacturer. Typically, a seller accepts an order from a customer, places the order with a third‐party manufacturer or wholesaler, and directs the third party to deliver the item to the customer. The third party may deliver the item using its own truck, arrange for delivery by common carrier, or arrange for the customer to pick up the item from a warehouse location.
Use of drop shippers can change the taxability of a transaction.
Click To Tweet
So, the first question is, “When using a drop shipper how do you determine the sales or use tax obligation?” As you may expect, the answer lies with nexus:
- If the retailer has nexus in the state where the sale occurs, the retailer collects sales tax from the customer, even if the retailer engages a third‐party drop shipper to deliver the product who also has nexus in the state where the sale occurs.
- If the retailer doesn’t have nexus in the state in which the sale occurs, but the drop shipper does, the drop shipper may need to collect sales tax. Most states don’t consider the transaction between the retailer and the drop shipper a taxable transaction, as long as proper documentation — a resale certificate — is provided to the third‐party drop shipper. However, several states do hold the third‐party drop shipper responsible to collect sales tax when the out‐of‐state retailer lacks nexus.
- If neither the retailer nor the drop shipper has nexus in the state where the sale occurs, the customer is responsible for paying use tax.
Next, you may want to know if the activity of drop shipping is a nexus‐creating activity. In some states, using an in‐state drop shipper by an out‐of‐state retailer can create nexus for the out‐of‐state retailer, creating an obligation for the seller to collect sales tax on the taxable sale.
To add to the confusion, the taxable amount of the sale varies from state to state. Some states consider the retail value of an item taxable, while other states tax only the wholesale price. Finally, you need to deal with tax exemptions.
Covering Your Bases with Exemption Certificates
After everything you’ve read in this chapter, guess what? You don’t always need to charge or pay sales or use tax — just another example of how there are no hard and fast rules when it comes to complying with sales tax regulations. But don’t get too excited; managing exemption certificates can be as overwhelming as trying to comply with sales tax regulations.
You don’t always need to charge or pay sales or use tax.
Click To Tweet
Exemption certificates are typically presented to a seller by a customer. Properly completed, an exemption certificate relieves the seller of the responsibility of collecting sales tax from the customer.
At the same time that taxing jurisdictions are hungry for revenue, businesses are equally devoted to reducing their tax liabilities to increase their profits. Undercharging or overcharging sales tax can impact customer satisfaction and loyalty.
Undercharging or overcharging sales tax can impact customer satisfaction and loyalty.
Click To Tweet
Generally, certificates are needed for exemptions based on the customer’s business or how the customer will use the purchase. But here comes that theme again: The forms for exemption certificates vary by state. Sometimes one form works for all exemptions, and sometimes there are specific certificates for certain sets of exemptions. Plus, in some states, some exemption certificates expire and need to be renewed to continue to be valid, but other exemption certificates never expire. (The theme reappears, in all its glory: Nothing is the same and things keep changing.)
There are several different types of exemptions, and most states have the following exemption categories:
- Resale: The resale exemption certificate is valid when the buyer intends to resell the purchase or use it as an ingredient in something he will manufacture.
- Agriculture: The agriculture exemption certificate is valid when the buyer intends to use the purchase in farming, cattle, or nursery‐type activities; this exemption category sometimes includes forestry and aqua‐culture.
- Direct payment: The direct payment exemption certificate is valid when the buyer and the state have agreed that the buyer can pay their use taxes directly, relieving the seller of the responsibility of collecting sales tax.
In addition, many but not all states offer the following exemptions; these exemptions are not as universally available as the ones listed previously:
- Nonprofit organizations: The nonprofit organization exemption certificate is valid when a charitable organization has registered with the state and provides the certificate to the seller for tax‐free purchases.
- Government: Government agencies are often exempt from paying tax on purchases; these exemptions are often documented by paperwork such as contracts or purchase orders, but states do use certificates for this exemption.
- Manufacturers: Manufacturers can provide exemption certificates for purchased equipment and supplies they intend to use in the manufacturing process.
Less often, you may see exemption certificates in other areas, including commercial fishing, mining, out‐of‐state custom printing, enterprise zones, and research and development.
Not all exemptions are available in all states. The biggest impact of exemption certificates — besides saving the buyer money in taxes and the seller paperwork in remitting them — is the collection and management of the certificates.
The biggest impact of exemption certificates is the collection and management of the certificates.
Click To Tweet
When you consider that sales tax in the United States is typically imposed on the customer, you realize that every tax‐exempt step along the supply chain involves either a manufacturing exemption or a sale for resale. Each company in the supply chain, except for the retailer, has to both issue and collect an exemption certificate. After all, both the buyer and the seller have to be able to prove to an auditor that a particular sale did not require the collection or payment of taxes.
Most states don’t consider the transaction between the retailer and the drop shipper taxable if the retailer provides a resale certificate to the drop shipper. And many states allow out‐of‐state certificates. For example, if a drop shipper is in New York and the retailer is in Washington, New York will accept the retailer’s Washington State resale exemption certificate number.
Both buyer and seller have to prove to an auditor a sale’s exemption status.
Click To Tweet
So, managing exemption certificates is no simpler than complying with sales tax regulations. It’s also safe to say that manually managing tax‐exempt sales and associated paperwork not only increases risk of audit, but also ultimately costs more in manpower and other resources than outsourcing does.
The Streamlined Sales and Use Tax Agreement
In 2000, an effort began to find solutions to simplify the existing complex state sales tax systems; the end result was the Streamlined Sales and Use Tax Agreement. To date, 24 states have adopted the measures in the agreement, which focuses on four major requirements to simplify state and local tax codes:
- Sales taxes should be remitted to a single state agency, and businesses should no longer need to submit tax returns for each state in which they conduct business.
- Each state is required to make their jurisdictions use the same tax base, so that the goods and services would be taxed or exempt the same way within each state. Each state retains the choice of whether an item is taxable and at what rate.
- The same tax rates are applied across a state’s tax jurisdictions, with exception rates for food and drugs.
- For in-state sales, the seller is expected to use origin sourcing rules and collect the tax rate for the vendor’s location. For interstate sales, the seller is expected to use destination sourcing rules and collect the applicable statewide rate for the destination state. States that participate in the Streamlined Sales and Use Tax Agreement can use the Streamlined Sales and Use Tax Agreement certified exemption certificate for exempt sales.
Chapter 1 excerpt of Sales & Use Tax For Dummies®, Avalara Special Edition Published by John Wiley & Sons, Inc
These materials are © 2015 John Wiley & Sons, Inc. Any dissemination, distribution, or unauthorized use is strictly prohibited. Download the entire book here.
The post Understanding the Sales Tax Landscape Today appeared first on The Bigcommerce Blog.
