State and Local Taxes-Sales/Use Tax
February 28, 2020
Of all the state and local taxes, sales tax has probably been the most prominent in the news over the last couple of years. In June of 2018, the Supreme Court ruled on the Wayfair case, which created changes in the taxation of remote sellers in most states. Even before the Wayfair verdict, sales and use tax has been a very complicated area for taxpayers. The rules vary greatly by state, including the taxability of items, rates, administration, etc. As with income tax, the first step in sales tax compliance is determining if a business has sales tax nexus within a jurisdiction and is required to assess, collect and remit sales tax on behalf of that jurisdiction.
Unfortunately, sales tax nexus is not necessarily the same as income tax nexus. The old sales tax nexus standards were based on a brick-and-mortar economy and relied on physical presence. Under the old physical presence standard, a business having a presence in their home state and shipping items via common carrier into other states (with no physical presence) would be required to assess, collect and remit sales tax only for sales to customers in their home state. As with income tax, the sales tax nexus standards are migrating more towards an economic nexus standard, with the Wayfair case having a profound impact on sales tax nexus.
Prior to Wayfair, states were not able to force sellers without a physical presence under the old nexus standards to collect sales tax. Congress had not made changes to address the changing business landscape and all the sales tax dollars the states were losing due to the then current sales tax laws. Finally, South Dakota took Wayfair to the Supreme Court to force a decision on the sales tax collection responsibility of remote sellers. By definition, a remote seller is a business that is selling into a jurisdiction without having a physical presence in that state. Under the Wayfair decision, states can require remote sellers who exceed a set threshold, to assess, collect and remit sales tax. In theory, under most state laws this should not have created a change in sales tax revenue since most states have complementary use tax statutes. If a consumer was not charged sales tax at purchase, use tax would be self-assessed and remitted by a taxpayer for the consumption or use of something in a state. However, since use tax compliance is very hard for jurisdictions to monitor, many individuals and businesses where not complying with the use tax provisions, so states were seeing a steady decline in sales tax revenue.
So far, approximately 75% of the states have enacted remote seller nexus standards. The thresholds vary by state, but the most common standard being adopted is $100,000 in sales and/or 200 separate transactions. While a $100,000 threshold appears to be deceptively easy to monitor, there are nuances that must be taken into consideration. The sales threshold may be based on gross sales (all sales), retail sales (all sales, except for sales to a reseller), or taxable sales (only sales that are subject to sales tax). This can be very onerous for businesses that have a variety of sales types, such as taxable, non-taxable and service sales. Another complication is the timeframe for measuring the sales/transaction thresholds. Some of the periods are prior calendar year and/or current calendar year, rolling prior 12 months, etc.
Taxability of Transactions
Sales tax is a transaction based tax. Each transaction should be looked at individually to determine if sales/use tax applies.
Examples of things that should be considered as they may impact the sales taxability of a transaction:
- Does the seller have nexus in the jurisdiction of the sale?
- Where does the title transfer
- Is the item being delivered, if so, using what method?
- Is the item being withdrawn from inventory to fulfil a contract?
- Is the buyer a sales-tax exempt entity? If so, has a current exemption certificate been obtained?
- Does the item qualify for any specific exemptions or special sales tax rates related to this particular item?
These are just a few of the things that could impact the sales tax on a transaction. As a company doing business, you may have a requirement to assess, collect and remit sales tax on behalf of taxing jurisdictions. With the rules varying by state, it is important that transactions are analyzed accurately to ensure the correct sales tax is being assessed, collected and remitted. If not, the company could be liable for any underreported sales tax.
As mentioned above, use tax is the complement to sales tax and in many states, the use tax rate is the same as the sales tax rate. It is the responsibility of a business to self-assess and remit any use tax on items that are being consumed in the jurisdiction for which sales tax was not collected at the time of purchase. This could include items withdrawn from inventory for use in the business directly or in the performance of a contract or items purchased online where no sales tax was collected. As with sales tax, special exemptions or use tax rates should be considered when self-assessing use tax.
Sales/use tax is a very complicated area that seems to increase in complexity every day. Sales tax nexus must be carefully considered given all the recent nexus changes. Once it is determined that nexus is established in a state, sales taxability should be determined on a transaction by transaction basis. Finally, purchase invoices should be reviewed to determine if a purchase is subject to sales tax, and if so, was sales tax appropriately assessed. If not, use tax should be reported and remitted.
A by-product of the sales tax law changes is more audit activity in this area. A business should be aware that sales tax noncompliance could result in a large tax/interest/penalty liability. This could also become an issue if the owners decide to sell the company. With SALT due diligence also on the rise, this could result in a loss of purchase price to cover potential SALT noncompliance liabilities.
If you have questions about sales/use tax or how the Wayfair case impacts your particular situation, please contact Kim Tarnakow at firstname.lastname@example.org or at (205)733-8265.