Three years after the game-changing Wayfair decision from the Supreme Court, companies operating in multiple states still struggle to comply with state laws regulating the collection and remittance of sales tax. The new “economic nexus” rule allows states to require an out-of-state seller to collect and pay sales tax or risk financial and personal liability even without any physical presence in that state.
State laws relating to sales revenue thresholds and quantifiable sales transactions vary widely and can be confusing. There is no shortage of horror stories about business leaders incurring unexpected tax and personal liabilities because they did not register for sales tax in a state or did so without regard to prior exposure or their sales tax advisor. Revenue and transaction thresholds start very low, causing both startup entrepreneurs and corporate titans to pay close attention to each state’s rules and potential penalties that could derail a planned merger or disrupt private equity investments.
As a pass-through tax, sales tax should be simple. Businesses collect the requisite percentage on sales from customers and remit to the state. Unlike income tax, there is no liability if done correctly. However, it is almost impossible to collect tax from customers after the sale. Worse still, a business owner who does not register and properly remit sales tax in states with an economic nexus can be held personally liable for sales tax evasion with no statute of limitations. Yes, business owners and their officers can be held personally responsible without any time limitation.
Since the Wayfair decision reshaped the tax landscape, state government leaders, seeing new revenue opportunities, have invested in sophisticated research and data analytics to discover and pursue companies selling in their states. The more aggressive state tax authorities go so far as to use intimidation tactics such as publishing delinquent company names on websites and asking consumers to help identify the offenders. This escalated scrutiny and enhanced enforcement indicate states are serious about knowing who they rely on to collect their tax money.
Clients often ignore the need to register with state agencies and fix past problems thinking, “it’s not a big deal.” Unfortunately, we have seen cases where the multi-state sales tax exposure started small and grew exponentially in a year or two or as the company’s sales increased significantly.
The first step to sales tax compliance is conducting a Nexus Study to understand the business’s physical and economic footprint and tax exposure to prevent future surprises. A nexus review is critical to identify state sales tax filings and for a company to understand when its business activities exceed federal protections against state income taxes. (A topic for our next State and Local tax article coming out next month).
Conducting a sales tax review during due diligence is more important than ever in today’s busy merger and acquisition environment. On the buy-side, investors want to uncover potential problems before moving forward. Remember, liabilities follow assets. Similarly, sellers should conduct the study to ensure compliance and dispose of liabilities before going to market. Often a requirement of a sophisticated investor, a sales tax nexus review will determine registration, filing, and payment requirements by state, including varying threshold criteria.
Remember that sales tax exposure is not limited to selling tangible personal property but also includes many services such as cloud-based software. Some states use the number of transactions as a threshold, while others use revenue only. Notably, Florida was among the last states to implement its criteria. Effective July 1, 2021, remote sellers with annual sales of $100,000 to Florida consumers must collect and remit sales tax.
Economic nexus applies to all businesses operating or selling in multiple states. It is a misnomer to believe it only affects online companies conducting e-commerce. And it’s not all about economic nexus. If you use Amazon fulfillment and store inventory in their warehouses around the country, you also have a physical presence in-state for back taxes (both sales taxes and possibly income taxes).
Registration poses pitfalls and opportunities. It’s a mistake to think businesses only need to register in a state to cure exposure. In fact, registration alone could instigate scrutiny and lead to state audits and large-scale assessments. Companies should consult a specialized sales tax advisor to conduct the nexus study and devise a sales tax strategy based on their unique situation.
Consulting with a sales tax specialist allows remote sellers to minimize look-back potential while ensuring compliance. Sales tax advisors can also advise on voluntary disclosures that often help reduce penalties and prevent ongoing attention.
There are many solutions to “stop the bleeding.” The Sales Tax specialists at Daszkal Bolton work hand in hand with clients to help identify potential pain points and evaluate the materiality and possible exposure of any liabilities. Based on our experience working with multiple states in the post-Wayfair environment, we recommend compliance and remediation strategies to ensure the business continues to thrive and succeed in another version of our new normal.