Article written by Ned Lenhart at Interstate Tax Strategies.
I recently met with a growing technology company that had received correspondence from a state concerning its failure to register to collect sales tax on taxable sales made to customers in that state. Correspondence like this is never a good thing. Rather than dealing promptly with the notice, the company ignored the state’s request to complete and return the nexus questionnaire. A few months went by and the second notice was received from the state. This notice had a shorter response date and outlined the consequences if the company did not respond. The company, again, did not respond. True to its word, the state issued jeopardy assessments and demand notices to pay. That’s when I got a call from the company!
When I finally met with the company I was astounded by their explanations about why they didn’t take the notices from the state seriously. Their belief was that they were too small of a company to be of any concern to the state and that the state was just on a fishing expedition to see who they could force into collecting sales tax. If they didn’t respond, the state would just go away. Not a great strategy for dealing with any state.
I also learned that the company had always known that they would need to deal with sales tax but that while they were small, they believed the risk of not addressing the issue was not high and any exposure would be limited. That may have been an appropriate strategy 8 years ago, but at some point, they needed to take serious steps at understanding what needed to be done. While the business, as a whole, may not have been that large, the state that was sending the requests represented 20% of the company’s sales. It was also a state that taxes various SaaS and data processing services. Further, the company had nexus in the state for many years by the presence of employees doing sales and implementation work.
I totally understand that small companies don’t consider sales tax to be a priority and I totally understand that the rules around nexus and product taxability can be confusing. However, at some point, even small business need to assess their situation and determine if ‘doing nothing’ is really the right long-term strategy when it comes to sales tax. As the company found out, even small companies can have big sales tax problems in one or two states. If 20% of your sales are not taxed in one state for several years, that adds up to be a lot of taxable sales and a lot of tax exposure. Because the statute of limitations normally applies only when tax returns are filed, there is no legal limitation in most states for how far back states can assess for unpaid tax. More disturbing was that fact that they were working with a financial consultant who knew that sales tax would have to be dealt with, but only after the company got bigger.
My word of caution to all ‘small businesses’ (however you would define that), is to take sales tax compliance seriously. That does not necessarily mean that you register in every state, but you must be strategic about understanding where your company has nexus (either physical nexus or economic nexus), what tax rules apply to the goods and services you sell, and whether your customers are taxable or exempt. It does not take too many years for even a small business to incur significant tax liabilities in state. Don’t assume that your business is “too small” to have a sales tax obligation or to have some material historical sales tax liability. The states are serious when it comes to capturing as much sales tax revenue as they can, and they really don’t care how small your business may be. In many cases, the taxes remitted by a low number of small businesses can exceed the tax collected by one large company.
Finally, if your business is contacted by a state, take the notice seriously. The states keep very close track of what companies have been contacted and they routinely follow up. It may not be immediate, but states generally do not just let unanswered correspondence die. In many cases, the states may know more about your business than you think, so make sure you answer correspondence truthfully. Be sure to seek professional assistance if you have any questions about what the state is asking.