Sales and Use tax compliance and reporting has become an even more important area for our clients since the Supreme Court Wayfair decision in 2018. Given its importance, we conducted a recent training session dealing exclusively with the topic.
Here is what makes this area so important:
- The determination of nexus, that is whether a state has the right to tax an entity and require that the entity follow its tax rules and regulations, has been dramatically changed since that Supreme Court decision
- Tax rates can run up to 10% or more.
- In a compliance audit, not only additional taxes can be assessed, but also penalties and interest can be assessed with interest rates much higher today than in previous years.
- Each state has its own rules and regulations regarding the taxability of various goods and services as well as exemptions that may apply.
- Most states have voluntary disclosure programs that can allow an entity to become compliant with less difficulty and expense.
- Under certain circumstances, there could be personal liability for employees similar to the situation that can arise with payroll taxes.
Pre-revenue companies beware! States that have sales tax laws in place also have similar use tax laws.
Pre-revenue companies beware! States that have sales tax laws in place also have similar use tax laws. Requirements for use tax self-reporting become effective when you purchase goods or services that would be assessed sales tax but, for whatever reason, the vendor did not add the sales tax to the invoice. Both your sales transactions and your purchase transactions must be in compliance with these laws. In technology companies, the use tax can also come into play when you are purchasing goods or services from vendors outside of the U. S. for use within a given state.
States are constantly looking for new sources of revenue. While, as a general rule, sales taxes apply to purchases of tangible goods, states consistently look for ways to extend taxability to services or to limit exemptions previously allowed. Goods or services that were not taxed in prior years can become taxable in future years due to these constant changes in the law, the related rules and regulations, and court decisions. Clients and service providers must be constantly vigilant.
What can be done:
- Create issue awareness in the finance and accounting department, especially at time of expansion to multi-state operations.
- Specifically, assign responsibility for compliance to someone inside the company.
- Determine the methods to be used to establish and maintain compliance including:
- Hiring a knowledgeable accounting firm
- Selecting software tools available to determine the taxability of individual transactions and the relevant rates
- Determining the due dates of the filings and the method of preparing and filing returns.
Many technology startups have business models that involve software licensing and/or the provision of “Software as a Service” (“SaaS”) out of the cloud. This is an evolving area for sales taxation with many states having different definitions and determinations of what is taxable and what is exempt.
The taxability of software that is licensed is often based on whether it is customized or “off the shelf” software. Customized software is generally non-taxable in most states whereas “off-the-shelf” software is typically taxable in most states. The method of delivery – usually downloaded but also purchased in a retail establishment – can change the taxable/non-taxable status with many states treating this differently as well.
We cannot stress enough the importance of these best practices to consider implementing:
- Good recordkeeping and transaction documentation to properly interpret and apply a state’s rules and regulations.
- At the time of order acceptance, establish the taxability of elements of the order and acquire and maintain any applicable exemption certificates at the time the transaction is accepted, not later on or when a sales and use tax audit has commenced.
- Consider adding a provision to your terms and conditions of sale indicating that if, for any reason, any order or portion of an order initially believed to be non-taxable is subsequently determined to be taxable, then the customer is responsible for paying the tax amount or provides adequate documentation that the transaction was self-reported for use tax purposes. The purpose of such language is to protect you by requiring the customer to provide reasonable support to you when you are dealing with these issues.
- Stay abreast of tax compliance changes.