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Sales tax is a tax imposed by the government on the sale of products and services. The tax is typically collected by the seller at the time of purchase and is then remitted by the Seller to the appropriate taxing authority.
Sales tax affects every transaction in the world, but calculating it is not as simple as you might think. Your sales tax rate depends on the what, where and the who. There are many other factors that come into play, like your sales history and tax exemption rules across the states. In the United States Sales tax is not federal. Sales Tax in the US is determined by local governments, who determine the tax rates as well as the different sales tax rules and schemes.
Your sales tax rate depends on the what, where and the who.
In fact, Sales tax can get so complicated that companies push off collecting sales tax until long after it becomes a problem. Many early companies kick the can down the road since ‘it’s not a now problem’, or giving up on it completely thinking it’s too complicated. This can create financial and operational issues. For once, if you are not collecting sales tax from your customers, you are paying that cost out of your own pocket. Moreover, an unexpected sales tax audit can also be a major burden and expense at a critical time.
Understanding where you owe sales tax and where you must collect sales tax is non-trivial. Just because you sell a taxable item in a jurisdiction doesn’t mean you owe sales tax. Each jurisdiction - a country, state, zip code, transportation district, or other defined area - defines its own rules for when the level of economic activity is taxable. The economic activity threshold is called a ‘Nexus’ and is defined by each jurisdiction. You can think of Nexus as the level of connection between a tax jurisdiction and your business. Notice that your legal entity does not matter for Nexus, so you can be a British or German company, and still establish a nexus in the US.
There are several types of Nexus types, with two primary types: Physical Nexus: historically, Nexus and was determined by having a physical presence in a state, such as an office, warehouse, inventory or employees. Economic Nexus: defined by sales thresholds, which vary by state. For example, in New York state, item sales above $500,000 in volume and above 100 units in quantity puts you above the Nexus threshold. Other Nexus types include Click-Through, Affiliate and Marketplace, but we won’t get into those in this blog.
Companies must evaluate both their physical footprint and their sales data to determine where they have a tax collection obligation. When a Nexus in NY is established, for example, it requires a seller to: a) register for a sales tax license, b) calculate and collect taxes in that state, c) emit the money you collected to that state.
Companies must evaluate both their physical footprint and their sales data to determine where they have a tax collection obligation.
Understanding your outstanding obligations is a complicated process because it requires you to link together various disparate systems: customer locations from your CRM, past transactions from your accounting system, and where your employees are physically located.
Once one determines their outstanding tax obligations, there are three steps to fulfilling them: a) voluntarily disclosing outstanding sales taxes, b) paying outstanding taxes, c) registering for a sales tax license in the relevant jurisdiction. This process can be tedious, with each state having its own set of rules and forms. Notice that the obligations after reaching a nexus also differ from state to state - some say that the obligation starts the next dollar after the economic threshold, and some will say the next period, e.g., next month or quarter post-nexus.
A Voluntary Disclosure Agreement (VDA) is a legal tool used in the tax world, especially in sales tax. It's designed for businesses that have discovered they owe taxes, often due to not understanding the complexities of tax regulations or simply making inadvertent errors in their tax filings. In return for coming forward voluntarily, the tax authority often agrees to waive certain penalties or reduce interest charges. This can result in significant savings compared to being discovered during a surprise tax audit.
Each jurisdiction has its own processes and requirements for registering for a sales tax license. This may include specific forms, documentation, and information about your business. Before registering for your license, make sure you review all requirements and fees. Keeping track of your sales tax license renewal dates is also important since missed renewals can lead to fines and penalties.
Each jurisdiction has its own processes and requirements for registering for a sales tax license. This may include specific forms, documentation, and information about your business.
The last step is an ongoing one, where it's up to you to ensure you stay tax-compliant and pay your dues on time. Following these three steps below is the key to ongoing compliance.
Sales tax rates can vary not just by state but down to the city or district level, or products and services. There are over 12,000 sales tax jurisdictions in the US and sales tax laws change almost every day. Businesses should actively manage their sales tax obligations to ensure accuracy and compliance. There are also different sales tax exemption rules from state to state.
After collecting sales tax, you must remit it to the appropriate tax authorities. You can file and pay your taxes online, by mail, or by depositing your payment in a designated drop box. It is important to make sure you pay your taxes on time and in the correct amount.
Sales tax laws are not static. They can, and do, change. It's crucial to stay informed about these changes to remain compliant. Keeping your sales records updated and audited regularly helps you avoid paying too much tax. It's also important to make sure your policies and procedures are still compliant with the latest tax laws. Lastly, stay on top of the news and keep an eye out for potential tax changes.
Mastering sales tax intricacies is crucial for responsible business management. Businesses would be wise to adopt a proactive approach, regularly monitoring law changes, updating records, and auditing procedures.
We've covered three key steps: understanding current tax obligations, catching up on tax obligations, and maintaining ongoing compliance. By following these three steps, businesses can navigate sales tax complexities and avoid pitfalls.
From determining Nexus, calculating tax rates, and filing returns, to staying up-to-date with law changes, sales tax software makes sales tax one less problem on your plate.
Sales tax software can also be easily integrated with Received's billing system and takes just a few clicks to set up. Once you're done, the tax software will run in the background ensuring you always stay tax compliant.
With an easy-to-integrate, comprehensive solution handling your sales tax obligations, you can focus on scaling your business, safe in the knowledge that your transactions are compliant, and your tax liabilities are in order.
Saleh Hindi is the Founder & CEO of a startup in the Sales Tax space. After speaking with dozens of finance teams and founders, he has gained a deep understanding of the best practices they use to remain Tax-Compliant. If you're having issues with Sales Tax, he would be happy to chat with you and offer insight into how other companies are dealing with this issue.
*Note: This blog is intended to provide a general 101 explanation. Received is not an accounting firm, and the foregoing should not be construed as accounting advice. You should consult with an accountant before setting up any accounting policies or procedures.