Are You at Risk of Surprise Sales Tax?
Most business leaders are comfortable discussing things like risk, ROI, and market share. They are less comfortable discussing sales tax, but it’s a conversation that needs to happen. States are getting increasingly creative about finding new revenue sources through sales tax. Businesses can easily incur “surprise” tax liabilities without realizing it. Assuming sales tax rules are the same across all your territories can be an expensive mistake.
What is Nexus
Sales tax starts with something called “nexus”. Nexus is the relationship a business must have with an authority (like a state or local government) in order for that authority to collect taxes.
Let’s simplify that. Imagine you have a store in Nebraska: you own your building, pay employees, and complete business transactions in the state. All these things give you nexus in Nebraska, and the state will collect sales tax from your business.
Say you have a customer “Jim” who works in Iowa but comes to Nebraska to purchase his materials. You probably don’t have nexus in Iowa just because your customer works there. But let’s change the situation. Jim calls in his orders from Iowa and your employees deliver materials to his jobsites in that state. Now Iowa might argue you have nexus in their state and you owe them sales tax.
The problem businesses face lies in the words “probably” and “might”. Each state has different nexus “triggers”. If your Nebraska store sells an item to people in two different states, you may have nexus in one but not the other. Things like buildings and equipment are almost universal triggers, but many states are starting to define nexus based on activity rather than physical presence. Sending an employee to a trade show, industry conference, or training seminar can all give you nexus in a state. You can establish nexus in Arizona if an employee spends two days of the year there. If your Nebraska store has a lot of Iowa customers like Jim, Iowa might argue you have an “economic nexus” in their state, even if all your sales take place in Nebraska.
Delivery of Goods
Delivering purchased items is a common nexus trigger, but there are a variety of ways states approach the issue. In Georgia, the “taxable event” takes place at the ship-to location, but in Kansas, it occurs at the ship-from location. In some cases, just delivering an item may not trigger nexus, but offering a service can. (It’s the difference between delivering a door, and delivering and installing a door.) The method of transportation may be a trigger as well. Are you using you own fleet, a common carrier like FedEx, or a third party vendor? The bedding store Mattress World is an excellent cautionary tale about ignoring delivery-related sales taxes.
Mattress World is located on the Oregon-Washington border. Many Washington residents would cross the border to purchase and pick up mattresses. Mattress World started offering delivery and set-up service to their Washington customers through a third-party vendor. But hiring and sending that third party vendor across state lines created nexus under Washington’s tax code. The company didn’t plan for this and ended up with a $1.7 million (plus tax) debt to the sate.
We’ve been discussing nexus triggers as a state-by-state issue. The truth is you can create additional nexus within the same state by crossing into new tax jurisdictions. States might define their tax jurisdictions by cities or countries, but the boundaries aren’t always so clear. To further complicate the matter, some states allow jurisdictions to set their own sales tax rules. Getting business from a new area in town means you could owe a completely new sales tax to a completely new authority. Colorado is notorious for this: they have 6 different rates in a single zip code!
What’s in a Name
Definitions are one of the stickiest points in sales tax, in part because they can seem so arbitrary and absent of common sense. KitKats, Twizzlers, and Whoppers are not “candy” under the Streamlined Sales Tax definition because they all contain flour. Indiana categorizes marshmallows as “candy” (taxable) and marshmallow crème as “food” (exempt). Pennsylvania does not tax clothing, but it does tax “fur articles” which include “articles made of woven animal hair or wool which resembles fur in appearance”. (Presumably a wool sweater would be exempt, but a coat with sheepskin trim would not.)
California’s 2013 tax on “certain lumber and engineered wood products” is a great example of definition-related chaos. Under this rule, “fencing, railing, and decking” are subject to the tax, but bamboo fencing, pre-constructed railing sections, and “deck packages” are all exempt. Retailers spent countless hours determining which items in their catalogs were taxable. It was a huge investment of time and money for these businesses, but it needed to be done. Shortly before enacting this new rule, California announced a plan to hire 300 auditors. Businesses are held responsible for complying with tax rules, even if those rules are almost impossible to understand.
The Take Away
- Check the nexus triggers for every territory your company interacts with. Don’t assume you need a building or permanent employee in a state to owe sales tax there.
- Check the tax rules regarding deliveries for every area you deliver to. You may need to collect additional sales tax from customers in some areas but not others.
- Check the jurisdictional boundaries for every state you do business in. Make sure you’re collecting the correct amount of sales tax for each jurisdiction and remitting payment to the correct authority.
- Pay attention to definitions attached to sales taxes. The distinctions between taxable and exempt items may seem arbitrary and silly, but the state is going to be very serious about collecting fines and penalties.
Sales tax is incredibly complicated. You need a good tax consultant to make sure you follow the rules in all jurisdictions where you have nexus. But once you know what you’re supposed to do, the next step is doing it consistently.
Automating tax calculation is a great strategy because it virtually eliminates the risk of human error. Services like Avalara work with your ERP system and calculate the appropriate rate for each transaction. Your software platforms should be robust yet flexible enough to handle the inevitable changes in sales tax rules. (California’s lumber tax impacted products so inconsistently that most POS programs couldn’t apply it correctly. Many businesses resorted to calculating sales tax by spreadsheet. Agility software was the exception. It adapted to the change easily, and customers like Peterman Lumber and S&J Lumber were able to incorporate the tax without a problem.)
You may not want to think about this topic, but it’s far better to discuss sales taxes now with your colleagues rather than later with an auditor.
This article originally appeared in Building Products Digest in January, 2014.