Staying current on sales and use taxes is difficult, as state revenue needs, technology and social attitudes change.
“Sales and use tax laws are complicated. For example, Ohio taxes over 20 categories of services, and several different types of services can fit within each category. Also, the state has over 100 sales tax exemptions, depending on how you count them,” says Stephen Estelle, Tax Manager at Clark Schaefer Hackett. “Then compound that by the laws of each of the 45 states that levy a sales and use tax, which are equally as complex. And no two states are the same.”
Smart Business spoke with Estelle about how to manage sales and use tax compliance.
Why are sales and use tax laws so complex?
Sales and use tax laws balance state revenue needs with economic and social policy. This balance changes as the economy fluctuates, as states need more money or as social attitudes shift, and every state draws different conclusions about what should or should not be taxed.
Technology is also advancing rapidly. When state laws do not change to keep up, tax departments must fit new products and services into old statutory language. This can get confusing. For instance, is cloud computing a good or a service? Where is it located, and which state gets to tax it?
Another factor is the changing intersection between state law and the federal constitution. For example, the U.S. Supreme Court’s recent decision in South Dakota v. Wayfair Inc. held that a business’s physical presence is no longer required for the state to compel the business to collect the state’s use tax. Rather, a business’s economic presence is sufficient. Most states now use a specific number of transactions and/or amount of sales to determine when a remote seller is economically present, but the thresholds can differ from state to state.
What can happen when businesses are non-compliant with these taxes?
State tax departments can conduct sales and use tax audits, just as they conduct income tax audits. If they determine a business has not collected sales tax or self-reported use tax, states can charge interest on the uncollected or unpaid tax and impose penalties.
Penalties vary by state. If a business fails to collect and remit Ohio sales tax, for instance, the civil penalty can be up to 50 percent of the tax. If the business collects Ohio sales tax and keeps it, in addition to a 50 percent civil penalty, the business could be subject to criminal penalties. The person at the business responsible for collecting and remitting tax could also face civil and criminal penalties. If a company is not collecting or remitting sales tax, the statute of limitations in Ohio is 10 years. With use tax, Ohio can go back seven years.
How can business executives minimize their risk of under or over payment?
The first step is education. Business leaders should not start selling into a state, even if it is in the home state of their business, without clearly understanding how the sales tax or use tax laws apply.
With respect to sales tax, complex businesses should consider purchasing sales tax automation software. After the initial set-up, the software automatically incorporates changes in the law. If new products or services are added to the business, they must be integrated into the software.
If a company cannot afford tax automation software, a less expensive approach is to have a tax consultant prepare a cheat sheet that describes when collecting taxes is necessary and when it is not. This information should be updated annually, as well as when business operations change.
On the use tax side, every business should know when vendors should charge tax, as well as which exemptions apply to the business or industry. Each state has different exemptions. When a business expands into a new state, it is necessary to consider these state-by-state tax variations. Using a consultant to navigate these differences can be helpful. For example, accounts payable employees can refer to a summary prepared by the consultant when monitoring vendor invoices. Remember, vendors might also be confused regarding tax requirements.
Because sales or use tax is likely a small amount on each invoice, it may not be top of mind until a business receives an audit letter. A tax consultant can provide critical advice whether the business is handling compliance correctly to avoid future surprises.
Insights Accounting is brought to you by Clark Schaefer Hackett