Is Your Sales And Use Tax House In Order?
Is your business remitting the proper amount of sales and use taxes to the appropriate state and local jurisdictions? Many business leaders and even some tax departments may be surprised to learn that, on average, organizations pay more in sales and use taxes and other state and local non-income-based taxes than they pay in state and local income taxes.
In addition, the Tax Foundation noted in a 2020 report that sales taxes account for about one-third of state tax revenue. A comprehensive review of your organization’s sales and use tax practices, along with improving and automating the necessary processes, may ultimately save your business time and money. A sales and use tax review can be especially advantageous where these taxes are managed from multiple locations with no centralized oversight, the business’s accounting systems do not track the appropriate data, or the tax department lacks the necessary resources.
Some businesses may regard the process of collecting and remitting sales taxes as a routine administrative function, without considering the potential for planning opportunities — or exposures that might result in additional taxes that could affect their bottom line. Furthermore, some businesses either do not pay required use taxes, pay the tax to the wrong jurisdiction, or fail to consider potential refund opportunities.
- Businesses with property or employees in multiple jurisdictions (even for short amounts of time) or that sell goods and services across jurisdictions should review their sales and use tax nexus footprint, the taxability of their products and services, and whether they are charging the appropriate tax rates to ensure they are paying the correct amount of tax to the correct states and localities. A review of sales and use tax processes can help identify potential areas of tax exposure or overpayment.
- Automating the sales and use tax process via third-party software solutions can help a business create efficiencies and improve the accuracy and timeliness of tax returns and payments, thus reducing costs. Automation can also help manage the risk associated with manually keeping track of tax rates, which items and services are taxable, and to which states tax is owed.
- Businesses that do not have the time or resources to comply with the various jurisdictional reporting and filing requirements may want to explore outsourcing their sales and use tax function.
Is Your Business Correctly Determining Its Sales Tax Obligations?
Sales tax is imposed on the retail sale of taxable tangible personal property (TPP) and certain services. Although usually collected at the point of sale from the end-user or final consumer, the liability to remit sales taxes ultimately rests with the seller. If audited, a state will typically assess the seller any sales tax due without first attempting to collect the tax from the customer. Because practically speaking a business will rarely go back and ask the customer to pay any sales tax that it didn’t collect, it is important that businesses collect the correct amount of sales tax from their customers to avoid the cost of any shortage.
Businesses should consider the following questions when determining their sales tax obligations:
Where does your business have sales tax nexus and, therefore, a collection and remittance obligation?
The rules for determining sales tax nexus are complex and can vary by jurisdiction. In addition to physical presence — e.g., the presence of property, inventory, employees or other representatives in a state — a business’s economic presence within a state can also create nexus.
Are your business’s goods and services subject to sales tax in each state, and do any exemptions apply?
In general, states impose sales tax on the retail sale of TPP, unless a specific exemption applies. States provide many exemptions and partial exemptions, including based on:
- The nature of the TPP (e.g., groceries are typically exempt because they are considered a necessity);
- How the TPP is used (e.g., in manufacturing activities or in the case of items held for resale); or
- The type of purchasing entity (e.g., nonprofits and government agencies).
Services are usually nontaxable unless specifically enumerated by statute. Nontaxable services or exempt TPP sold along with taxable items as part of a bundled transaction may make the entire transaction taxable, depending on the true object of the transaction.
Does your business have a process in place to collect and retain exemption certificates, such as resale certificates?
Businesses are required to charge their customers sales tax on taxable transactions unless, and until, the proper documentation (exemption certificate or resale certificate) has been received in good faith from the purchaser. Businesses should ensure they have a process in place to collect (and retain) exemption certificates in conjunction with completing the transaction, to avoid having to collect the tax or deal with the issue on audit.
Is your business sourcing its transactions to the correct taxing jurisdictions?
Sales tax is typically owed to the state where the TPP or service is delivered. If a business’s systems are not set up to track this information, the business could run the risk of sourcing its sales to the wrong state, e.g., to the state of the customer’s billing address or to the customer’s main office location.
Is your business charging the correct state and local sales tax rates?
Sales tax rates can change frequently. In addition to state sales taxes, there are over 13,000 local jurisdictions — counties, cities, special districts, transportation districts, etc. — that impose sales taxes at various rates.
Is your business properly registered and filing returns in each jurisdiction where it is subject to tax?
Most jurisdictions require returns to be filed monthly, or at least quarterly. Failure to timely file and pay could result in interest and penalties. In addition, businesses that are unnecessarily registered for sales tax in a state risk examination by the state’s tax authorities, which could extend to other taxes as well.
Don’t Forget About Use Tax
Use tax is a complementary tax to sales tax and is imposed on the purchaser for using, storing or consuming taxable TPP or services in cases where no sales tax was charged. Unlike sales tax where the seller is responsible for calculating, collecting and remitting the tax, the purchaser is responsible for calculating and self-remitting use tax to the proper taxing jurisdiction. Use tax is payable to the state where the item or service is used, stored or consumed.
Issues to consider when determining use tax obligations include:
Where is the purchased item or service delivered or used?
Purchasers should ensure they calculate and self-remit use tax to the state where the item or service is delivered, stored or consumed. This could prove challenging in cases where the business’s systems do not automatically track this information, where the item is used in multiple jurisdictions, or where the item is initially shipped to a location where it is temporarily stored until being shipped to another location.
Does the transaction qualify for an exemption or reduced rate?
When calculating use tax, each jurisdiction’s rules should be analyzed to determine the taxability of the particular item or service. As with sales tax, there are numerous use tax exemptions. However, use tax exemptions may not always be the same as those allowed for sales tax.
Businesses should ensure they have procedures in place to identify which purchases are subject to use tax and where the tax is owed, as well as properly report the transaction and remit the tax. Automating or outsourcing the use-tax processes can help improve the accuracy of tax reporting, thereby also helping to manage underpayment and overpayment risk.
A use tax audit may be an opportune time for businesses to perform a refund analysis (also referred to as a reverse audit), since they are already being audited for underpayments. If the business self-remitted too much use tax during the audit period, a refund claim should be filed in most scenarios.