Sales Tax

As an e-commerce seller, you are responsible for understanding and implementing the correct tax strategies to minimize your tax liability. This blog post will discuss three common tax strategies that sellers can use to reduce their taxable income. Implementing these strategies can help you save money and comply with the law.

1. Understand Your Tax Obligations As An E-commerce Seller

The IRS has particular rules when it comes to taxes and e-commerce. As an online seller, it is your responsibility to understand these rules and comply with them.

One of the most important things to understand is that you are responsible for collecting and remitting sales tax on your transactions. This includes any items that you sell through your website and any third-party platforms like eBay or Amazon.

Collecting and remitting sales tax can be a complex process, so it’s vital to seek professional help if you’re unsure how to handle it. There are many Tax Strategies available for e-commerce sellers, so finding one that works for you is crucial.

Don’t let the complexity of taxes scare you away from selling online – with the correct Tax Strategy in place, you can be sure that you’re compliant and won’t run into any problems down the road.

2. Deduct Expenses Related To Your Business

If you sell products online, you can use a few tax strategies to deduct expenses related to your business. As an e-commerce seller, you can deduct the cost of goods sold (COGS) and other business expenses like shipping, marketing, and website development costs.

To deduct the cost of goods sold (COGS), you’ll need to keep track of all the inventory you purchase for resale and the costs associated with each item. When it comes time to file your taxes, you’ll calculate the COGS for each product and deduct that amount from your total sales.

Other business expenses like shipping, marketing, and website development costs can also be deducted from your total sales. To deduct these expenses, you’ll need to keep track of all the receipts and invoices associated with each expense. When it comes time to file your taxes, you’ll total up all these expenses and deduct them from your total sales.

3. Use The Correct Accounting Method For Your Business

As a business owner, it’s essential to use the correct accounting method to keep track of your finances. Depending on the type of business, there are different methods you can use. Tax strategies also come into play when choosing an accounting method:

E-commerce sellers have a few options when it comes to accounting methods. The most common is the accrual basis, which recognizes revenue when products are shipped to customers. This is the preferred method for businesses that sell physical goods because it provides a more accurate picture of sales and expenses.

Another option for e-commerce sellers is the cash basis, which only recognizes revenue and expenses when exchanging money. This method is more straightforward and may suit low sales volume businesses or for selling digital products.

COVID-19 pandemic seems to play havoc with the economy and taxes. The impact has been huge on state and local tax revenues. The level of impact is no less severe than any other recession. If you go by statistics, you will find that the pandemic has adversely impacted the economy, shrinking state sales tax revenue by about $6 billion. This amounts to 21 percent compared to the revenue during the same period last year. A lockdown situation, with closed businesses, rising coronavirus causalities, and extension of sales tax filing and payment deadlines have all contributed to this quagmire.

The Real Impact on State Tax Revenue

Total state tax revenue shot to the highest level since the 2007-09 recession during the final quarter of 2019. Thanks to the tax collection growth during this period post-recession that each state was able to allocate its funds for the economic shocks inflicted by the pandemic.

As more people are forced to stay home, sales tax revenues have come down drastically due to a lowered consumption rate. That means a drop in taxes and fees imposed on airports, hotels, and highway tolls. Therefore, tax revenue has dropped drastically due to a lowering of fees imposed on the travel and tourism industry. There has been a drastic reduction in the revenue generated from taxes. Further, other sources of state revenue, such as vehicle registration fees, transportation funds, and gas taxes, are declining.

Similar to economic recessions, the pandemic has adversely affected state and local revenues. However, the decline in income tax revenue has not been drastic. The reason is that employment losses are primarily concentrated on low-wage workers, who contribute less to the income tax coffer.

Blame the coronavirus pandemic for triggering a severe state budget crisis. State revenues are falling rapidly while there has been a spike in the costs of commodities as there is no production and many businesses are shut down. Add to this, the rising unemployment rate and the economy is declining rapidly as a result of the COVID-19 pandemic.

Substantial State Tax Revenue Shortfalls for 2020, 2021

The rapidly declining state revenue projections are a reminder of the times we are all set for in the near future due to the pandemic-induced downturn.

States grapple with the financial crisis and are working hard to balance overstressed budgets. The crisis is agitated due to no to low productivity, rising need for healthcare services, and allocation of separate funds to fight against the pandemic.

State and local income tax revenues are expected to drop to 7.5 percent or $37 billion in 2021 as the pandemic has taken a toll on revenues.

When the pandemic struck, states began to balance their budgets by making cuts and tapping reserves. While COVID-19 continues to wreak havoc with life, the stock market has remained unaffected thus far and the job loss among high-wage earners has not been much. This has ensured that revenues have not dropped by as much as were anticipated in some states. But that does not mean there have not been revenue shortfalls for states. With the federal aid for businesses ending, the crisis might deepen further.

States Imposing Cuts; Need Federal Help

State estimates project a drastic drop in revenues for the present fiscal year beginning July 1.

To make matters worse for states with oil-related industries, the coronavirus recession has brought along a decline in economic activity. As a result, tax collections have suffered due to plunging oil prices.

It remains to be seen as to how long states can survive on their budget reserves, including rainy day funds. Sadly, things might become worse financially for state tax revenue if more employees are laid off, public services are cut, and government contracts for businesses are canceled. States might be forced to impose damaging cuts. Georgia, Maryland, and Florida have already started with the cuts on schools, colleges, and behavioral health.

Now states look up to federal policymakers to provide assistance to deal with the ongoing COVID-19 pandemic.

Atlanta tax services; Interstate Tax Strategies, P.C. is your “go-to” tax service provider for multistate sales and use tax.  Though we are located in Atlanta, we provide tax services to companies throughout the U.S. with single state and multistate sales and use tax issues. Atlanta is the home to countless multistate businesses. Sadly, only a small percent of these businesses get the tax services needed to safeguard their company from the risks posed by this complicated area of taxation. Most CPAs don’t offer the comprehensive or strategic tax services offered by Interstate Tax Strategies, P.C.

February 2020
By Ned A. Lenhart, MBA CPA
Interstate Tax Strategies, P.C

Is your business sitting on a state tax time-bomb that could explode at any minute?   Do you even know?  Business owners and investors dream of the day when they sell their business for a high cash-flow or earnings multiple. Successful business exits are life-changing for the owners and are the tangible reward for their dedication in building an enterprise appetizing to someone else. Exit strategies are generally structured as “asset” or “equity” sales. There are tax, legal, and business benefits and pitfalls to both types of exit strategies which require sellers and buyers to carefully evaluate the type of ‘deal’ best suited for the future operations of the organization and for the parties involved.  Regardless which structure is chosen, no seller wants to be surprised about unknown and undisclosed state and local tax (SALT) liabilities that may reduce the business sales price and cost precious time and money to fix.  The time has come for business sellers to take control of this SALT due diligence process.  Identifying and correcting SALT liabilities early can increase the target company’s value and streamline the business exit transaction.   

Stock or equity sales involve the sale of the owner’s interest in the underlying assets and liabilities of the target enterprise.  This normally requires the new business owner to assume most the business liabilities of the target.  To avoid assuming these liabilities, transactions can be structured as an asset sale where all or part of the assets (tangible and intangible) of the entity are acquired and certain specific liabilities are assumed.  General liabilities of the business remain with the surviving business entity and its owners.    

Successor Liability

By structuring the transaction as an asset sale, most advisors believe that all of the known and unknown liabilities of the seller remain with the seller and are not transferred to the asset purchaser.  While this strategy is generally true for most general business liabilities, it is NOT TRUE concerning known and unknown state and local tax (SALT) liabilities.  The legal theory governing the transfer of SALT liabilities from the asset seller to the asset purchaser is known as ‘successor liability’.  Nearly every state considers the business asset purchaser to inherit any known or unknown SALT liabilities of seller unless specific statutory procedures are followed to eliminate the successor liability.  State law does not generally allow the buyer and the seller to contractually limit successor liability or to put dollar limits on how much liability is assumed by the purchaser.    

Buy-Side SALT Due Diligence

To identify and quantify SALT liabilities (primarily sales tax), asset purchasers generally include a specific SALT data request and work plan as part of their tax due diligence process.  Having conducted buy-side sales tax due diligence for 25 years, the process generally includes a detailed review of the target’s multistate business activities, a full understanding of the goods and services sold by the target, scrutiny of current tax returns filed, analysis of exemption certificates, a review of open or planned state tax audits, and a detailed review of current sales tax collection rules and procedures.   Depending on the business being evaluated, SALT due diligence procedures can be completed quickly or may be quite protracted and detailed.  Quite often, buy-side sales SALT due diligence reveals problems, risks, and undisclosed liabilities.  SALT liabilities identified by the purchaser usually means less money going into the pockets of the seller and a slower close.  In some cases, the SALT liability can be so large that the deal is cancelled.  More often, the SALT liabilities identified are not so material that they kill the deal, but they are large enough to require an escrow of funds until the problem is resolved.    

It is surprising how many sellers are unaware that there is any SALT problem at all.  Once the liability is identified and quantified, the purchaser will generally control how and who will resolve the SALT problem.  In many cases, the SALT liability is added to the general escrow amount and held back by the purchaser until the seller resolves the problem.  In more dramatic cases, the purchaser may actually reduce the price they are willing to pay for the assets being acquired.  Either situation can lead to less money going to the seller and a delay in closing the deal and getting paid for the assets they are selling. The normal SALT due-diligence procedures put the seller on the defense and allows the purchaser to dictate the terms of resolving the problem.

Sell-Side SALT Diligence

The time has comefor sellers to become proactive and take control their SALT exposure in advance of selling their business.   There is no excuse for a potential buyer of your business to be the first to tell you that your SALT procedures are inadequate and that your business has a material contingent liability.  Sell-side SALT diligence must be part of a seller’s exit planning process so there are no surprises when the buyer conducts their SALT diligence.  Identifying and resolving SALT issues before buyers starts their review will maximum the price you get for your business and streamline the closing process. 

Business sellers normally work with brokers and business valuation specialist in advance of actually putting their business on the market.  These professionals examine each element of the business and coach the seller on strategies to maximize the value of their business and make it attractive and appetizing to potential investors and purchasers.  Using these valuation, HR, IT, and financial professionals can add significant cash to the pocket of the seller and provide a significant ROI on the cost of these efforts.  At some point in this business assessment process, the sellers must devote intentional effort to proactively determining their SALT liability.  This may include sales tax, payroll tax, property tax, and other SALT liabilities that normally survive an asset sale and absolutely survive an equity sale.   

Sell-side SALT diligence should be started 12 months before any proposed transaction.  I suggest this for several reasons.  First, depending on the sophistication of the seller, it may take some period of time to gather the required information specific to the SALT diligence.  The data needed for this review may not be easy to gather, especially if the review is for multiple years and requires the use of IT resources to obtain. In most cases, there is no statute of limitation for unpaid taxes, so a review of four or more years is quite common. 

Second, if the review identifies significant SALT liabilities and compliance errors, it may take several months to quantify and resolve the specific issues.  One of the primary methods used to resolve historical liabilities is by engaging in a process called “voluntary disclosure”.  This will be discussed in more detail below, but the voluntary disclosure procedure may take three to six months to complete.  

Finally, if new SALT compliance procedures are required, it may take several months to get billing systems integrated into new tax software and for other compliance procedures to be implemented and for A/R and sales personnel to be trained concerning new SALT compliance rule. A proper documentation of these processes must be developed and provided to the purchaser. Finding and fixing SALT errors before a potential buyer may improve the overall profitability of your business and increase the sales price.  

Even if no material deficiencies are identified during the sell-side due SALT diligence, a report showing the processes conducted, the documents reviewed, and the basis for the conclusions reached may provide the buyer with sufficient comfort that the buy-side SALT diligence can be streamlined.  This analysis also shows the potential buyers that the seller was insightful in evaluating these SALT issues which may allow for a better bargaining position by the seller. 

Sell-Side Diligence Procedures

Sell-side due diligence looks a lot like buy-side due diligence.  To coin the old sports adage, ‘the best defense is a good offense’ and that is exactly the case when it comes to seller’s being proactive to identify and resolve SALT issues before buyers start their review.  The goal of buy-side due SALT diligence is to find SALT procedural and compliance mistakes and to portray these errors in the worst possible light. Most diligence work is done for the buyer with the goal of communicating the worst-case scenario to the buyer. The diligence report prepared by the buyer’s team may make assumptions and projections that are not reasonable in an effort to drive the value of the business down or to adjust the sales price lower than it needs to be.  If the seller is not prepared to counter these assertions, they may unknowingly allow the buyer to 

When seller’s initiate their own SALT review as part of the exit planning strategy it allows them to have an advisor who is working just for their interest.  This does not mean that SALT liabilities will be ignored if identified.  Rather, a SALT advisor working for seller can develop strategies for the seller to minimize or even eliminate identified liabilities before the buyer’s team starts their work.  If one of the issues identified by the seller’s SALT advisor involves missing documentation to support untaxed sales, the seller can implement procedures to secure the proper documentation from customers before the buyer’s diligence process starts.  A potential major problem has been averted.   

Because sales tax is industry and transaction specific, it is vital for the seller’s SALT advisor to develop documentation about the sales tax procedures used by the seller, so they are easily communicated to the buyer’s SALT advisor.  SALT due diligence reviews are stressful and time consuming if accurate facts are not properly conveyed to the buyer’s team.  This is especially common with service providers and technology companies where language in the contracts and invoices may be in conflict with what the seller has described their business to be.  For example, if the seller portrays their business as a software-as-a-service (SaaS) enterprise, the buyer may conduct diligence using that SALT rules for SaaS.  If, however, the seller’s SALT advisor believes the seller is providing a web-based service that may not necessarily be treated as SaaS for sales tax purposes, then this must be adequately communicated to the buyer to avoid confusion and the possible calculation of a liability that is not valid. 

Because of some very significant recent changes in the requirements for businesses to be filing sales tax and income tax returns in other states, seller’s may not be fully aware that their compliance obligations have changed.   Having the seller’s SALT advisor evaluate and document the company’s multistate filing obligation in light of these new and evolving standards may assist the buyer in performing their due diligence.  

Finally, because the seller’s SALT advisor will be reviewing most of the same documents as the buyer’s SALT advisor, it can be a time saving effort for these documents to be submitted to the data room when requested by the buyer.  Seller’s that have access to a skilled SALT advisor will be able to defuse or minimize any issues identified by the buyer’s SALT diligence team.  

Voluntary Disclosure Agreements

As mentioned above, one method to resolve a sellers’ SALT liability is through a program called voluntary disclosure.  Most states have procedures whereby unregistered businesses come forward voluntarily to resolve past due taxes. Some states also allow voluntary disclosure agreements for companies that are registered for sales tax.  Most states limit the look back period for which tax is due to three or four years.  In addition to limiting the look back period for which back taxes are owed, the state will abate the penalties due on the tax paid under the voluntary disclosure agreement.  As such, sellers with multiple years of SALT exposure can eliminate their exposure for years prior to the earliest look back period.  Depending on how long the business has operated in that state, the historical savings can be significant.  

Voluntary disclosure is available only when the company seeking an agreement in a specific state has not been contacted by that state concerning the tax liability.  If the seller was contacted previously by the state or is under audit, there is no possibility of completing the voluntary disclosure agreement.  

Conclusion

For decades, SALT due diligence was solely the territory of the business acquirer.    The power held by the buyer in this due diligence process put the sellers on the defense and positioned the buyer to control the quantification of the SALT liability and the tax resolution.  With the advent of seller focused business exit planning consulting services, the time has come for sellers to include SALT diligence as part of their exit planning process. Unknown liabilities can make your business “SALty” and maybe unappetizing to some buyers.  Knowing how “SALTy” your business is before the buyer starts reviewing your SALT documents and tax filings can position the you (the seller) to take control of the liability and to resolve any material issues before the buyer completes their business proposal.  Identifying and tackling SALT liabilities before your business is sold allows you to be in control of the process and may put more money in your pocket at the closing.      

For more information concerning this topic, please contact me at nlenhart@salestaxstrategies.com for a free 30 minute discussion. 

Sales Tax Obligations

Article written by Ned Lenhart at Interstate Tax Strategies.

Most of the business community is now aware that the U. S. Supreme Court, in South Dakota vs. Wayfair, Inc. 138 S. Ct. 2080, (2018) (“Wayfair”), greatly expanded the authority states have to require out-of-state businesses to collect and remit sales tax on taxable sales made into their state.  This opinion was issued on June 21, 2018.  As I outline below, the Wayfairopinion also allows states to impose other sales tax compliance obligations on companies that don’t generally make taxable sales.  The full impact of the Wayfairdecision is still being evaluated by states and taxpayers, but some aspects of the Wayfair decision are clear and all companies need to analyze the impact of this decision in light of their current business practices. 

As of January 1, 2019, 31 states will have implemented some form of ‘economic nexus’ rule. By mid-2019 each of the 46 jurisdictions (45 states and D.C.) that have a sales tax will have some type of economic nexus rule. Under these rules, companies with sales into the taxing state exceeding some state specific threshold (i.e. $100,000, $250,000, or $500,000) are deemed to have nexus in the state even though the company does not have any type of physical presence in the taxing state. 

Much of the attention to date on analyzing Wayfairhas been directed to companies selling at retail to end-users.  In these cases, remote retailers with economic nexus in the taxing state are obligated to collect tax on sales shipped into the taxing state.  My focus of concern in this posting is on the impact Wayfairhas on wholesalers in general and drop-shippers in particular. 

Basic Drop Shipment Sales Tax Rules (Pre-Wayfair)

Drop shipments or third-party shipments are a mainstay in the supply chain fulfillment mechanism for both wholesale and retail sales.  A drop shipment transaction involves at least three separate participants and at least two separate sales.  For example, “Retailer”, located only in Georgia, accepts an electronic order from a customer (“Customer”) where customer requests the product be delivered to its Indiana location.  Retailer does not currently have Customer’s item in stock, so Retailer contacts its supplier (“Supplier”) and instructs Supplier to ship the product directly to Retailer’s customer in Indiana. Supplier is only located in Florida.  Supplier ships via common carrier the product to Indiana from its Florida inventory. Supplier invoices Retailer $500 for the product it sold to Retailer but shipped to Indiana. Retailer invoices Customer $675 for the product it sold to them.  For purposes of this example, we will assume that Customer is the end-user of the product being purchased. 

In this example there are two separate sales.  The first sale occurs when Supplier sells the product to Retailer. Retailer cannot sell the product to Customer until it has first purchased the property from Supplier.  The second sale happens when Retailer sells the product to Customer.  Both sales occur when the property is delivered to Customer’s door step in Indiana.  The sale from Supplier to Retailer is a nontaxable “sale for resale” and the sale from Retailer to Customer is a taxable retail sale.  Because Retailer does not have physical presence in Indiana, Retailer believes it does not need to collect sales tax from the Indiana customer. Further, because Supplier does not have a physical presence in Indiana it also believes it does not need to charge tax on this sale or collect an Indiana resale certificates. The only hope the state of Indiana has for collecting the sales tax on this transaction falls to Customer to pay the use tax directly to the Indiana Department of Revenue.  

Basic Drop Shipment Sales Tax Compliance–Post-Wayfair 

Under the physical presence nexus standards in place for the past 26 years, the tax collection assumptions expressed above by Retailer and Supplier are likely accurate.  However, under the economic nexus rules embraced under the Wayfair doctrine, the sales tax dynamics of this drop shipment transaction have changed.   The state of Indiana is one of the 31 states that has adopted (as of January 1, 2019) rules concerning when companies have created sales tax economic nexus in the state only having sales which exceed a certain minimum dollar threshold in the taxing state.  Indiana’s nexus threshold is $100,000 of sales or 200 separate transactions per year. 

If we change our example a bit by assuming that “Supplier” and “Retailer” each have Indiana sales in excess of the $100,000 economic nexus threshold, the drop shipment transaction profiled above would change in the following respect. 

1. Supplier would require Retailer to provide a resale certificate that is valid in Indiana.  Fortunately, Indiana will accept the Georgia resale certificate (Retailer’s home state) from Retailer.  This will allow the initial sale of property to be exempt from Indiana sales tax as a ‘sale for resale’.  If Supplier does not have a valid resale certificate from Retailer, then Supplier will be obligated to charge sales tax to Retailer on this initial sale.  
2. Because Retailer is selling to an end-user in Indiana and because Retailer has Indiana economic nexus with the state of Indiana, Retailer is be required to register with the Indiana Department of Revenue and collect the 7% sales tax on the sale it makes to Customer. 

If the drop shipment described above were the only one that Retailer and Supplier had, then this scenario is easy to administer.  In reality, this drop shipment scenario happens dozens or hundreds of times a day for both Supplier and Retailer and involves shipments to customers in many different states.  Supplier likely drop ships property for multiple Retailers to multiple states in any given day.  Retailer likely has multiple suppliers shipping products to customers in multiple states in any given day.  As a seller with possible economic nexus in multiples states, Retailer’s sales tax obligations have changed significantly under the Wayfair rule. 

Advanced Drop Shipment and Sales Tax Compliance-Post Wayfair 

For companies like Supplier the impact of Wayfairis subtle but may create significant issues for companies that provide drop shipment services. Most states consider all sales of tangible personal property to be taxable until the seller obtains an exemption certificate from its customer documenting the sale as not taxable. This resale certificate must be valid in the state to which the property is shipped since that is the state where the sale from the Supplier to the Retailer occurs.  In most cases, the certificate provided is a resale exemption certificate.   Failure to have a resale exemption certificate from Retailer that is valid in the destination state causes the seller (Supplier in our example) to be liable for collecting sales tax on the sale.  If tax is not charged and it is determined under audit that Supplier did not have a valid resale certificate, the Supplier will likely be assessed back sales tax and interest on the price charged on the drop shipment sale made to the Retailer.  

In many cases, the destination state will accept the ‘home state resale certificate’ or the ‘home state registration number’.  Indiana, as used in our example is one of these states. So long as the Supplier has the home state resale certificate from Retailer, Supplier is protected and has no obligation to collect tax.  There are 36 jurisdictions that accept this ‘home state’ registration number or some other alternative documentation to support the resale claim. 

The issues become more serious and a bit more complicated for Supplier and Retailer in the 10 jurisdictions that do not accept the home state registration number or resale certificate.  Suppliers making drop shipments to these states must insist on receiving resale certificates valid in the ‘ship to state”.  In most cases, this requires Retailer to register with the ship-to state and obtain a registration number which is used on the state specific resale exemption certificate. (Note: some states permit the use of the Multijurisdictional Resale Certificate, but it must include the registration number issued by the ship-to-state). Jurisdictions that do not generally accept the home-state resale certificate include: California, D.C. Florida, Hawaii, Illinois, Louisiana, Maryland, Massachusetts, Tennessee, and Washington.

There may be situations where Supplier exceeds the economic nexus threshold in the ship-to-state, but Retailer has not created economic nexus in the ship-to-state.  Assume that Retailer (from the above example) instructs Supplier to drop ship products to a customer in Washington. Washington has a $100,000 sales threshold economic nexus and Supplier is registered in Washington because its total sales exceed that amount.  Retailer, however, only has $30,000 of sales per-year in Washington and does not meet that economic nexus threshold and therefore is not registered.  Because Washington will not accept the Georgia home-state resale certificate from Retailer, Supplier must charge Retailer sales tax on the wholesale price of the products it drop-ships to Washington.  To avoid being charged this tax, Retailer must register with the Washington Department of Revenue and provide Supplier with a valid resale certificate once the registration is processed (which may take 30 days or more to complete).  Once registered with the Washington Department of Revenue, Retailer will be obligated to collect tax on allsales shipped to customers in Washington even though Retailer does not meet the economic nexus threshold of the state. 

This presents a significant dilemma for small retailers. Under the rules in states that do not accept the home state resale certificate but have economic nexus rules in place, retailers that fall below the thresholds will be required to obtain a sales tax registration in that state to provide a valid resale certificate and avoid being charged sales tax by their supplier.  In some cases, it may be more economical for retailers to simply pay the tax to the supplier rather than to incur the compliance costs related to collecting and remitting the sales tax. Requiring retailers under the economic nexus threshold to secure a Washington registration number so that a valid resale certificate can be issued also appears to violate the benefit of imposing the $100,000 sales level which is supposed to provide a ‘safe harbor’ for small businesses.   

If Supplier has economic nexus with a state that does not accept a home state resale certificate and it does not charge sales tax to their customer, the Supplier will be liable for sales tax due to that state. Once Supplier obtains economic nexus in Washington, or any other state that does not accept home state resale certificates, it is obligated to collect tax on all sales shipped to that state unless the Retailer provides a resale certificates that is valid in the delivery state.  As noted earlier, if the ship-to state does not accept the ‘home state’ resale certificate, retailers must register with the taxing state to obtain a registration number that can legally be used on a resale certificate.  Once registered, tax must be collected on all future sales shipped to customers located in that state; not just those sales that are drop shipped into the state. 

As countless direct and drop shipments are made daily into states that do not accept home state resale certificates by companies having economic nexus, the sales tax risk is significant and real if these shippers do not immediately implement policies to require the correct resale certificate at the time the sale is made.  States like California are vigilant in enforcing this rule on audit and are constantly looking for companies that should be registered for sales tax but are not. 

Conclusion

Retailers and suppliers making drop shipments into states with the economic nexus rules are now required to comply with a wide variety of rules that, heretofore, they have not been required to follow.  Failure to understand the economic nexus rules and to evaluate the obligations your company has for collecting resale certificates or for charging sales tax will create a real and potentially material financial liability for your company.  All wholesalers and retailers MUSTcarefully evaluate the drop shipment relationships they have and adjust their sales tax policies as needed to meet the rules in states that do not accept home state resale certificates.  

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.