Sales tax laws are constantly changing, and sales tax audits have increased since states and local agencies have become creative about finding new ways to generate revenues. If you haven’t made any changes in your sales tax procedures in a while, you are probably at risk.
Know Your Taxability
The taxability of services has grown rapidly as states look to balance their budgets after Federal cuts and other shortfalls. Some states have smaller jurisdictions such as counties and municipalities, making for a total of 10,000 jurisdictions in the U.S., not just 50. Alabama, Colorado, and Arizona are just a couple of the states that have statewide rules as well as taxability rules for localities within the states.
A prime example of a difference would be that data processing services including web hosting and graphics are taxable in Texas but not California. Because of these intricacies, it makes sense to consult an expert in this area. Some states have been taxing certain services for many years now.
Consider Your Nexus Status
The new buzzword in sales tax is “nexus,” which simply means presence.
Globalization and technology together have produced dramatic shifts in the way businesses can look today. Not only can we access a pool of local talent to staff and grow our businesses, but we can also employ almost anyone around the world to work for us. Hiring employees or contractors located in other states can stretch our nexus to include that state.
If your business has a presence in a state, then certain items you sell could be taxable. “Presence” is a little gray, but here are a few examples of some characteristics that the courts have decided to prove nexus.
- If you have employees or contractors working in a state, you are liable to collect and remit sales tax for that state. This can play havoc if you hire virtual or remote workers. Even if they are part-time, you have nexus in that state.
- If you outsource inventory fulfillment in any way (think Amazon sales), you have nexus in states where there is a physical warehouse that houses your products.
- If you own business property in a state, you must file sales tax.
- If you participate in trade shows or are a public speaker, you have nexus in states where the conferences are held.
You might receive a form that looks like a survey and asks innocent-looking questions such as how many employees you have and what state they work in. The surveys don’t look like they are from a state government but they might be. It’s their way of getting you to admit nexus. Please do not let a worker fill these out; it could expose you to a huge liability.
Minimize Your Risk
If you fail to collect taxes where you should, the risk is easy to calculate. Take the potential taxable sales times the sales tax rate, and add any penalties. The numbers get scary if you’ve been in business for several years.
Let’s say your annual revenues are $5 million. You didn’t realize that your Texas sales were taxable, and this amounts to 10% or $500K. Your tax liability is $41,250 per year. If you have been doing it wrong for five years, well, you can add it up. Add penalties on top, and it’s not a small amount. It can wipe out your entire year’s profit.
Sales tax liability becomes more important if you plan to sell your business. A traditional valuation will always include a sales tax risk analysis. Even if you don’t plan to sell, the odds of you getting audited or a disgruntled employee blowing the whistle can be too much to risk.
Because of the high dollar impact on the profitability of your business, it’s best to get a sales tax professional involved in helping you determine the taxability of your items as well as interpreting nexus. Many states are hiring auditors and aggressively pursuing businesses, so due diligence in this area is prudent.
If we can help in any way, please reach out and let us know.