Most U.S. states require businesses to collect and remit sales and use taxes even if the business has no in-state physical presence, only an economic presence within their state. Remote sellers, licensors of software, and other businesses that provide services or deliver their products to customers from a remote location must comply with state and local taxes.
Left unchecked, these state and local tax obligations, and the corresponding potential liability for tax, interest and penalties, will grow over time. Moreover, neglecting your sales and use tax obligations may result in a lost opportunity to pass the sales and use tax burden to customers as intended by state tax laws. Review our six steps to address state sales and use tax compliance and contact us for help reviewing your compliance status.
Step 1: Determine Nexus and Filing Obligations
All states that impose sales tax have economic presence nexus statutes for sales and use tax purposes. Sales thresholds range from $100,000 to $500,000 on an annual basis. Some states also have transaction thresholds, however, this trend is on the decline.
Since U.S. tax treaties apply at the federal level but not the state level, foreign businesses selling into the U.S. are subject to states’ economic nexus statutes and sales and use tax collection and compliance requirements.
Step 2: Evaluate Product and Service Taxability
Each state and many local jurisdictions have their own unique laws regarding which products and services are subject to sales and use tax. Companies need to know whether the products and services they sell (and also purchases they make) are subject to sales and use tax in the states and localities where they have nexus.
Step 3: Quantify Potential Tax Exposure
Once a company has established in which states it has nexus and which of the company’s products and services are taxable in those state and local jurisdictions, the company should quantify its outstanding tax exposure for prior periods. This requires estimating — by jurisdiction and by product — tax exposures for sales and use tax using historical sales data. For some companies, the sales and use tax exposure amount may need to be recorded as a liability for financial reporting purposes.
Step 4: Mitigate and Disclose Historical Tax Liabilities
The exposure estimates should then be used to determine appropriate efforts to mitigate and disclose taxes. The course of action may differ for each jurisdiction and may include:
- Sales and use tax mitigation: Historical tax liability estimates are generally calculated before obtaining from customers documentation of favorable adjustments, such as exemption from the tax or the tax having already been paid. Customers generally have an obligation to pay use tax directly to a taxing authority if the vendor does not collect the tax. Documentation from customers (e.g., exemption certificates, proof of use tax payment, proof of payment through audit) may significantly reduce the sales and use tax liability that the company ultimately owes the taxing jurisdiction.
- Voluntary disclosure or amnesty programs: Pursuing a voluntary disclosure agreement (VDA) or participating in amnesty programs (if available) with taxing authorities can significantly reduce the tax, penalties and interest ultimately paid to resolve historical tax liabilities. VDAs and amnesty programs can also streamline registration, tax filings and payment of the historical tax liabilities.
Step 5: Select and Implement a Sales Tax System
With thousands of taxing jurisdictions in the U.S., it is difficult to stay on top of every sales tax rate. For businesses that are manually maintaining tax rates and calculating sales and use tax, tax automation software can help streamline compliance and reduce audit risk.
Sales tax automation focuses on system integration between a company’s ERP/ecommerce system and third-party tax software. Automating sales and use tax compliance reporting can help increase efficiencies and reduce costs.
Step 6: Maintain Sales Tax Compliance
Sales tax compliance can be a labor-intensive and costly process. After a business has determined in which jurisdictions it has nexus and which of its products and services are subject to sales and use tax, and resolved any potential historical tax liabilities, it may need ongoing assistance with prospective sales and use tax compliance obligations. Advanced technology and process improvement can provide cost-effective solutions for sales and use tax compliance, which enable businesses and tax departments to shift their resources to value-added activities and strategic tax planning while minimizing their compliance costs.