As I reflect on the type of sales tax consulting projects I’ve completed over the past 30 years, most of them fall into what I would call the “clean-up a mess” category. That is, I was hired to fix tax problems, resolve material tax liabilities, protest audit tax assessments, and to file refund claims for overpaid tax. In working with these companies, I’d eventually hear the statement, “if only someone had told us we needed to collect tax (or whatever), we would have done it”. Whether that is true or not, the statement certainly highlights my belief that many companies get into serious sales tax trouble by not doing some type of foundational sale tax analysis during their startup phase. For this purposes, I’m treating the startup phase to be the first three years of business. In this blog entry and in others to follow, I want to highlight some of the essential steps every startup should take to minimize the long term sales tax risk to their business. In too many cases, by the time I’ve been hired to assist the company, the damage done has been so material that business survival is in question. Following are five foundational points that startups need to understand.https://www.salestaxstrategies.com
- Know exactly what your business does. Sales tax rules are not generic to all business categories. The sales tax obligations of a service business are different than the sales tax obligations of a wholesaler. Before you can begin to identify what sales tax obligations your business has, you must identify the specific business activity that you will conduct and how the revenue from that activity is generated. In some cases, it may be clear. You are an attorney and you are opening a law firm. In other cases, it may not be so clear. For example, your business develops and sells software on a subscription basis with various support agreements. You also charge for consulting, training, and technical support and you have customers across the U.S. Sales tax is a transaction tax and each sales transaction your business conducts requires some type of sales tax decision. This decision is required for each state where you are doing business.
- Pay attention to your invoices. Sales tax is governed by state law and each state has unique rules that govern how the sales tax is applied. Fortunately, the rules are relatively similar but here are significant nuances that must be identified. One rule generally applied to each of the 46 jurisdictions that have sales tax, is that the language on the customer’s invoice will be the primary (but not exclusive) source to determine which sales tax rules apply. For sales of personal property, the rules are pretty clear. If you sell office furniture and your invoices indicate that you sold six chairs then the presumption is that tax is due on the invoice price unless specific laws dictate otherwise. If you deliver the chairs, then separately stating the delivery charge on the invoice may be important because many states do not tax delivery if separately stated. However, if you combine the sale of six chairs, their delivery, and assembly for a single price, most states would consider the total invoice price to be taxable even though you may be providing certain nontaxable services. The format used for invoices can make a significant difference in the sales tax obligation of your company. Pay attention to the invoice language and get professional help to make sure your invoices are clear and properly reflect the sale tax rules of your state.
- Many states tax services. One of the most common statements I have heard over the years is, “we perform services so there is no sales tax issue”. Says who? Services are widely taxed by most states. This normally does not apply to personal services such as legal, medical, accounting and such, but services such as admissions to entertainment, temporary accommodations, data processing, staffing, security, installation, construction, repair, and other services can be taxed in many states. If your business provides services on a multi-state basis, don’t assume the rules are identical in each state. Check it out to be sure and make sure your invoices are clear about the type of service you provide.
- Know if you are a multistate business. As a startup, your focus may be on only the state where your office is located. Over time, though, you may get ambitious and start to solicit customers in other states or start some sort of online business that is selling property to customers across the country. As a business, the states assume you are either knowledgeable about the tax obligations of your company or that you can find out what those obligations are. This can be critical when it comes to doing business across state lines. When your business meets certain criteria in another state, it is said to have ‘nexus’ with that state. When your company has nexus in another state, your sales tax obligations are similar if not identical to those in your home state. If you start traveling into other states to meet with customers, delivery property into the state on your own trucks, perform services in the other state, or any other activity that takes you into another state, you may be creating nexus for your business. The same rules apply if you use independent contractors to solicit sales for you or perform services on behalf of your company. Knowing where your company has nexus is vital to managing your multistate sales tax obligations.
- Get and retain exemption certificates: There is nothing more frustrating then to work with wholesalers or retailers that have made sales of property without charging tax and who don’t have all the resale or other exemption certificates needed to support these nontaxable sales. Without valid exemption certificates to support the nontaxable sales, these are deemed to be taxable sales. Under audit, nontaxable sales without support of resale certificates will be treated as taxable sales and the business will be assessed tax. This is inexcusable! Getting and retaining resale certificates at the time of the sale is the easiest thing a wholesaler or retailer can do to protect themselves. If a customer goes out of business you have no opportunity to get any missing resale certificates. Failing to have valid resale certificates has been the demise of many solid businesses when these businesses were audited. Learn and follow the rules of your state with regard to exemption certificates.
Conclusion
The stress of starting a business is intense. There seem to be an unending number of decisions that need to be made and money you spend to get started can be extreme. Of all the decisions you need to make, I’m hoping that asking about sales tax is somewhere on the top 25 of those questions. Unlike income tax which is computed at the end of the year, sales tax is determined on each purchase and sales transaction your business makes. You can’t wait until the end of the calendar year to determine what your sales tax obligations are. The five points outlined above are the very basic points you need to pay attention to. The list can grow dramatically depending on your specific business and the number of states you work in. Get professional help on this issue. DO NOT attempt self-serve yourself when it comes to sales tax. This is a legal issue with significant implications if you misunderstand your obligations. You should review this on an annual basis.
Ned Lenhart, CPA President