For the majority of businesses located in the United States, collecting and filing sales tax is an unavoidable responsibility. There are only five states that don’t collect sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. The other 45 states have established a multitude of rules regarding taxable products and services. In addition, some municipalities also charge sales tax above and beyond their state leve sales tax.
But what do donuts have to do with sales tax? They are a perfect example of the complex and somewhat arbitrary sales tax rules that business owners must attempt to safely navigate.
Did you know? In some states, if you purchase 5 donuts or less, you would pay sales tax, but if you were to buy a half dozen or more, you would not need to pay tax. In other states, it would depend on where you consumed the donuts, or whether it was served with a napkin or not! Hard to believe? Google it for yourself – this is no joke!
If a simple donut can cause havoc to the sales tax system, imagine the difficulties faced by the businesses responsible for collecting these taxes. This is no small matter, because almost a fourth of the state and local revenues comes from sales tax collections. If businesses fail to collect the required tax from their customers, they may well experience the fury of their local Department of Revenue.
Sales tax is a special kind of tax considered a trust fund, like employee payroll taxes. Managing trust funds is a weighty responsibility, since they are collected by the business from a third party. Businesses and their accountants need to clearly understand the rules regarding sales tax in order to avoid serious consequences. If they plan to sell to clients across state lines, they will need to educate themselves regarding the sales tax rules of all the states involved.
As a result of recent Supreme Court decisions, state agencies have received more authority over sales of products and services made within their states by businesses from other states. In 2018 a case known as Wayfair vs South Dakota established the concept of economic nexus, and many states have since adjusted their taxation rules to include economic thresholds for out-of-state businesses making sales in their state.
As if it wasn’t already a burden on businesses to collect and pay sales tax within their own state, imagine how tedious tracking and filing sales tax returns in multiple states each month could become!
At the moment 24 states participate in a simplified arrangement for registering and filing sales tax called Streamlined Sales Tax. The remaining states have decided to maintain their own independent systems for registering and filing taxes. Some states provide online platforms which allow accountants to more easily access and file sales tax declarations for their clients.
Let’s return to the subject of nexus. There are two types of nexus in sales tax: physical presence and economic presence. It’s pretty obvious that a business would need to collect sales tax for sales made in their own state. But there are other factors besides actual location that can establish a physical presence in another state, such as employing persons or utilizing sales representatives who live in that state.
Economic nexus can throw an even wider net because no physical presence or connection is necessary. If an out-of-state business makes substantial sales within a particular state, nexus may be established. Each state has its own rules regarding the number of transactions and/or dollar amounts allowed before the business has met their economic threshold requirement, so it’s important to research the rules thoroughly in order to avoid potential problems.
Now that I have given you sufficient reasons to take this matter seriously, here are some basic tips that can help you create an adequate process for managing sales tax.
Do your research first:
- Determine which products and services could be exempt from sales tax in the principal location of the business and in what circumstances.
- Register the business with the Department of Revenue in your primary state before making any taxable sales of products or services..
- Find out what exemptions are allowed and what documents are required to qualify for the exemption (such as resale and not-for-profit exemption certificates)
- Confirm what are the applicable sales tax rates and what the requirements are for filing and paying sales tax. Some states have different rates according to the type of product or service being sold, while others have different regional or municipal rates.
- Analyze potential sales in other states and decide whether there are legitimate reasons to register in those states. Determine whether the physical presence or economic threshold rules would apply, and whether there are agreements between other related states that would automatically create an obligation to collect and file.
Prepare the accounting system:
- Establish the necessary sales tax rates and assign them to their applicable tax agencies (normally by state). If there is a requirement to report types of exempt sales as well, additional sales tax rates can be created with zero tax percentages.
- Review the list of products and services to establish which ones will be taxable or not.
- Determine a default tax rate for clients. It is easier to return money to customers than to collect it after-the-fact, so stay on the conservative side when establishing defaults.
- Analyze the sales categories within the Chart of Accounts to determine if more categories will be necessary. It may be safer to separate the taxable sales from the nontaxable sales directly on the financial statements.
- Select the default reporting period for filing sales tax returns according to the schedule assigned by the tax agency (monthly, quarterly, annual). Based on filing history, agencies may change the frequency of filing or payments, so make sure to update your settings accordingly.
Once you have established a good system, keep up to date regarding sales tax legislation. The tax rates can change as well as the rules regarding taxable products and services. Be proactive so as to avoid becoming responsible for uncollected tax.
This is only a general guide. Do your research with the applicable tax agencies. If you must register and collect sales tax in various states, consider using a third party filing service such as Avalara to simplify the process.
We have gained considerable experience with sales tax over the years and are registered as tax preparers in a number of states. We regularly prepare sales tax returns for many of our clients and would be happy to help you establish or refine your own sales tax procedures and systems. Feel free to reach out for some assistance.
In the meantime, continue to enjoy that sweet and gooey donut while you carefully scrutinize your sales receipt to determine whether you paid sales tax on it.
– Written by Gina Palacio, Owner of Level & True Accounting Services LLC