When dealing with sales of goods and services outside their home states, many business owners are overwhelmed by the complexities of sales tax. Some are clear on their need to account for sales tax in multiple jurisdictions, but not-so-clear on the intricate rules that determine liabilities and filings. Others may not realize the extent to which their operations give rise to a liability.
As tax authorities become increasingly sophisticated in their ability to capture sales activity within their borders, it’s time for businesses to revisit their understanding of their sales tax obligations. The cost of inaction could be a hailstorm of back taxes, penalties, and interest.
What is taxable?
Unless specifically exempted, tangible goods are subject to sales tax at the point of purchase by the end user. If Company A sells component parts to Company B for inclusion in the latter’s product, Company A is not liable for sales tax on those parts. A wholesaler may do business in multiple states through traveling sales representatives, but they won’t remit sales tax if they don’t sell directly to end users. Yet even if your business sells exclusively through other manufacturers, wholesalers, or retailers, you aren’t out of the woods.
The rules presume that all sales go to end users unless the company provides evidence to the contrary. A resale exemption certificate must be secured from each buyer for whom purchases are for resale and not subject to sales tax. Absent this documentation, a state may assess sales tax.
As our economy becomes more service-based, states have adjusted their sales tax laws to include these revenue sources. Whenever a meaningful amount of service revenue is generated you need to consider the taxability in that state.
Who owes the tax?
End users are responsible for paying the applicable sales tax on their purchases. The seller functions as a conduit for collecting the tax and remitting it to the tax authorities.
If a seller does not charge the applicable sales tax on a transaction, consumers are supposed to remit the associated use tax. In reality, very few consumers comply. Since it is far too costly to effect these collections, state laws hold sellers liable for unpaid sales tax.
Where must I pay?
Physical presence has long been the bright line test for whether a state has the right to impose a sales tax collection and remittance requirement on a company. While physical presence certainly includes a brick and mortar location within the state, it also covers activity such as periodic visits from traveling sales representatives.
Given the rise of internet-based retailing, consumers may purchase goods online from a company without a traditional physical presence in their state. In order to adapt, many states have expanded their concept of “physical presence.” For example, if an affiliate company with a brick and mortar presence in a state accepts product returns on the company’s behalf, the internet retailer may be deemed to have a physical presence in that state. A “physical presence” can also be inferred when a commissioned agent located in a state directs internet traffic to a company’s website, even if that company has no other connection to the agent’s state.
The rules are unique to each state and can be murky when it comes to direct sales by internet retailers. The Marketplace Fairness Act is pending in Congress which would require companies without a physical presence to collect and remit sales tax on behalf of their out-of-state consumers. This legislation would shore up the gap in largely underreported use tax by consumers.
What's the tax rate?
Among states that collect sales tax, rates range between 4-7% of sales on average. Local jurisdictions often also impose sales taxes. For example, a teddy bear purchased at the FAO Schwartz store in New York City would be subject to the 4% state sales tax, the 4.5% New York City sales tax, and a 0.375% Metropolitan Commuter Transportation District tax, for a grand total of 8.875% in sales tax.
Just as individual states are empowered to adopt their own tax structures, counties, cities, districts, and other tax authorities enjoy the freedom of sales tax expression. For example, California imposes a state tax rate of 7.5%; an additional local tax of 0.125% to 2% may be tacked on, depending on the jurisdiction.
What should I do about it?
Every business should have a clear understanding of its sales tax obligations and appropriate business processes to ensure timely collection and remittance. Even if your business model does not involve sales to end users, you need a means to secure resale exemption certificates from customers to attest to their intention to resell your goods.
If you have not attended to state sales tax obligations or are concerned that you have fallen short of the mark, a tax professional can work with you to estimate the magnitude of the exposure and develop a strategy for addressing it. Your options may include:
- A Voluntary Disclosure Agreement in which you negotiate with the state anonymously to pay back taxes and interest (generally 3-4 years’ worth) and commit to prospective compliance in exchange for a waiver of penalties
- A (more abbreviated) Named Disclosure in which you file and remit back taxes and interest and request a waiver of penalties without assurance that the state will be accommodating
- An outreach effort to customers to secure proof that they properly self-assessed use tax on their transactions with you
- Filing prospectively and “rolling the dice” on the state’s appetite for investigating and assessing penalties and interest for activity in prior years
The option(s) you pursue will be a function of your total liability, the number of years during which it was accumulated, the affected tax authority, and your risk tolerance. In any event, it’s never too early to have a spirited discussion on the subject with your tax professional.
If you do not have the requisite expertise in-house to navigate these waters, be sure to secure the services of a tax professional at your earliest convenience.