Sales tax laws can feel like a labyrinth at times. And as if journeying into that realm wasn’t daunting enough, things get even more complicated when you happen upon the hidden sales tax risks that are scattered along the way.
But those hidden exposure risks no longer need to threaten your compliance. As long as you keep your head, keep your eyes peeled, and stick with us. We’ll get you to the other side in no time.
Understanding Sales Tax Basics
Nexus essentially means “connection”. This connection is pivotal in determining a business’s tax obligations across the 45+ US states, where each state interprets nexus uniquely.
Two primary types of nexus exist: physical and economic.
Physical nexus hinges on a business’s physical presence or activities within a state, encompassing factors like offices, employees, or temporary events.
Economic nexus, on the other hand, is triggered by a business’s financial ties to a state, often through sales thresholds. For example, California’s Nexus threshold is reached at $500,000 in sales only, whereas, in Arkansas, you can trigger an economic nexus at $100,000 in sales or 200 transactions.
Once you’ve established a nexus in a state, you need to register to collect sales, calculate the accurate amount to collect on each sale based on the state rate, remit the collected sales tax to the applicable tax authorities by the due date, and file your returns on time.
Understanding these foundational principles lays the groundwork for deciphering the hidden sales tax risks that modern businesses face.
The Complexity of Sales Tax Laws
Complexities surrounding sales tax compliance arise primarily due to the decentralized nature of US sales tax laws.
Each state has its own tax laws and regulations, with sales tax rates and taxable goods and services that differ from state to state. On top of that, local jurisdictions are allowed to add local sales tax rates on top of the state sales tax in most states.
In California, for instance, the state tax rate is 7.25% with local rates that average at roughly 1.60%. This can bring the total sales tax rate up to 8.85%.
On the other hand, you have a state such as Alaska that does not charge any statewide tax, but does allow local taxes that range up to 1.81%.
And then there are states such as Connecticut, Indiana, and Kentucky who have a single statewide sales tax rate and do not allow local jurisdictions to add their own rates.
What further complicates matters is the rise in borderless online sales platforms and the increase in remote business operations. These decentralized business models serve clients in multiple states and as a result, companies can create a nexus in multiple states quite easily. This can be through a physical presence nexus or exceeding the minimum threshold for a state’s economic nexus laws.
Because of this decentralization, there are hidden sales tax risks that companies may not be aware of in their compliance journey.
Hidden Risks in Sales Tax Compliance
Sales tax compliance is a nuanced and intricate matter that requires a panoramic view of your company’s sales tax nexus and its tax obligations.
On that journey there are multiple hidden sales tax risks that slip through under the radar of many companies’ compliance departments.
Here are some of the biggest hidden sales tax risks you need to be on the lookout for:
Look out for hidden nexus triggers
While nexus definitions are simple when stated broadly, there are obscure triggers that could result in a nexus without a company’s knowledge thereof, especially when it comes to the cross-border business operations.
Employing remote staff or contractors in another state can trigger a physical nexus in the states these people work from. Attending trade shows can also result in a nexus when sales are conducted at the shows.
The use of affiliate links can result in an affiliate nexus that is created when a business relies on affiliate marketing with a company from another state. A click-through nexus can be triggered when a commission-based partnership exists with a third-party seller or referral agent in another state.
Understand the nuances of shipping risks
Sales tax regulations on the sale of physical goods are anything but straightforward. So it’s no surprise that sales tax regulations on shipping are even more complex in various states.
In Arkansas and Connecticut, for example, freight, shipping, and transportation are all seen as part of the sale. This means if the sale is taxable, shipping costs have to be taxed too.
This means that the shipping tax of mixed shipments (that contain both taxable and non-taxable goods) has to be calculated proportionately in Arkansas. But in a state such as Illinois mixed shipments are generally subject to sales tax in their entirety.
In Alabama, goods delivered by the USPS or common carriers are exempt from shipping tax. Delivery charges are only taxed when the delivery vehicle is owned or leased by the seller.
Side-stepping SaaS sales tax exposure
SaaS sales tax is a muddled mess at the moment with states still deciding how the product should be defined and under which regulations it falls. The changes that are rapidly emerging surrounding SaaS taxability in various states means companies often work according to outdated compliance guidelines.
And because of this, tax authorities are keeping a keen eye on SaaS tax compliance to ensure companies aren’t skipping out on tax responsibilities claiming ignorance as the reason.
The global SaaS market is expected to grow from USD 317.55 billion to USD 1,228.87 between 2024 and 2032. It’s an industry that’s thriving and one that is ripe for tax evasion and fraudulent activities in light of the gray areas that surround its taxation laws.
This makes it crucial for SaaS providers to adhere to the specific SaaS taxation guidelines of the states they have a nexus in, to avoid any semblance of fraudulent activity.
Don’t get too comfortable with exemptions
Tax exemption isn’t a one-size-fits-all scenario. Each state has its own services and physical goods that are exempt from sales tax. Just because a product is exempt in the state in which you have a physical nexus, your primary state of business, it doesn’t mean your service or product is necessarily exempt in other states.
For instance: In Minnesota, clothing items (excluding accessories) are exempt from sales tax no matter their cost. In New York City, however, clothing items priced at $110 and above are deemed luxury goods and subject to sales tax. Rhode Island has lifted that threshold to $250.
When we look at medical sales tax, Texas exempts medical equipment, including orthopedic and prosthetic devices, yet Alabama taxes durable medical equipment even if it is prescribed by a medical professional.
In the agriculture industry, Kansas offers tax exemption of farming machinery and equipment while Oklahoma exempts a variety of agricultural supplies from sales tax, including feed, fertilizer, pharmaceuticals, biologicals, seeds, and plants.
If you fail to collect sales tax from a sale that was actually taxable, you are left liable for the outstanding sales tax amount and the exposure that could come with non-compliance. And it’s easy to see how easily that slip up can occur.
Juggling out-of-state resale certificates
Sales tax exemption is rarely a get-out-of-Sales-Tax-free-card. It requires a fair amount of due diligence and paying careful attention to each state’s exemption laws. For instance, California exempts nonprofit organizations from sales tax on fundraising activities but does not offer them blanket exemption.
And when working with resellers, companies need to know whether out-of-state buyers get the same exemption treatment as they would in their home states.
States such as Alabama, California, Florida, and Massachusetts (as well as the District of Columbia), do not accept out-of-state certificates from buyers. This means buyers either need to register as a reseller within the state of pay sales tax on their purchases.
And the onus of confirming that acceptability and accuracy of these resale certificates lies with you, the seller. Just as the risk of non-compliance rests with you.
Avoiding the perils of marketplace and eCommerce exposure
As one of the biggest commercial industries, there are a few hidden sales tax risks for eCommerce sellers. Missed filing deadlines, mismanaging exemption certificates, errors in sales tax calculations, or unconfirmed physical and economic nexus. And the always present marketplace rules that regulate vendors in different marketplaces.
When selling online through marketplace facilitators (i.e. marketplace platforms like Amazon, eBay, Walmart or Etsy), vendors are governed by marketplace rules that differ for each facilitator and each state. These rules place a number of sales tax obligations on the facilitator organization, to accommodate small-scale sellers. But a number of sales tax compliance steps still remain with you, the seller, once you trigger a nexus in a state you’re selling to.
This makes monitoring of eCommerce sales tax obligations tricky, where sellers need to adhere to two sets of rules.
Mark your calendar for sales tax holidays
Sales tax holidays are there to temporarily exempt certain products from taxation to provide softened circumstances to buyers in periods where these products become necessities. In general, these holidays exempt products in categories such as back-to-school necessities and natural disaster preparation goods.
But sales tax holidays can vary significantly from state to state.
Tennessee offers a sales tax holiday for apparel priced under $100 while Ohio’s threshold is $75 for the same exemption.
Back to school tax exemptions align with each state’s academic calendars, and as such the times differ greatly. And when two tax-free periods exist, companies may only qualify for one in some states.
Severe weather or disaster preparedness sales tax holidays also coincide with the periods just before a state’s disaster season. Alabama, for instance, has its tax holiday in February, while Florida has two, one between May and June and the other between August and September.
And then a state like Texas has four sales tax holidays: emergency preparation supplies sales tax holiday (April), Energy Star sales tax holiday (May), water-efficient products sales tax holiday (May), and an annual sales tax holiday in August.
These tax holidays cover multiple industries and allow companies from multiple sectors to benefit their clients. But if you’re unaware of them, you could be charging sales tax to customers in periods where sales are exempt. When this comes to light during a sales tax audit, it could be as bad for your company’s reputation as if you didn’t collect sales tax at all.
Navigating Hidden Sales Tax Risks
Hidden risks are so so dangerous precisely because of the fact that they’re hidden and not easily identified if you’re not intently looking for them.
The first step to finding out whether you are at risk of these hidden sales tax obligations is to conduct a sales tax risk assessment that analyzes the integrity of your current sales tax compliance infrastructure. From there, tailored tools and protocols can be created that address the specific needs of your operational ecosystem.
By outsourcing sales tax compliance and using sales tax automation software to monitor your nexus and sales tax obligations in real time, your compliance is safeguarded against these hidden risks.
Schedule your sales tax risk assessment today and let’s find out if you’re exposed to any of these hidden risks.
