Some of the biggest compliance challenges facing taxpayers are not found with income taxes, but rather with sales tax. Properly computing, collecting and remitting sales tax in the 45 states that levy such a tax is often highly burdensome and draining on a business’s resources. After income and property taxes, sales tax is the third largest source of state revenue. Below, I discuss seven challenges all businesses confront with respect to their sales tax obligations.
Many businesses rely on zip codes to determine a particular location’s sales tax rate. With over 43,000 zip codes in the United States this technique seems to be a reasonable tactic for the novice business owner. However, counties, municipalities and other special taxing districts do not follow the zip code map when implementing sales tax laws. Consequently, pinpointing the exact sales tax rate for the 150 million United States addresses is an extremely difficult endeavor for many taxpayers.
Most taxpayers are aware that sales tax is generally considered a “destination-based tax,” which assigns the source of the transaction to the address to which the product is shipped. Under this methodology, the applicable sales tax rate and remittance are controlled by the jurisdiction where the product is utilized. Yet, a small number of states apply an “origin sourcing” approach to intrastate sales. In these states, the sales tax rules of the vendor’s location govern the transaction. Retailers bear the burden of identifying the applicable sourcing rules when engaging in sales with customers both in and out of state.
3. Special Taxes
Another obstacle impeding an organization’s sales tax compliance is the number of taxing authorities that impose supplemental taxes on specific industries or tangible property. For example, often states tack on excise taxes in addition to regular sales tax on gasoline, diesel and other types of fuel. Similarly, car rental fees and legalized marijuana distribution are also often subject to additional tax levies. Moreover, many states frequently levy special taxes on other items including alcohol, tobacco and telecommunications.
An additional problem plaguing many taxpayers is applying the draconian sales tax rules to the particular type of property being sold. Even those items that seem inconsequential can impact sales tax application. For example, food products are almost exclusively exempt from tax, whereas prepared foods are taxable. Accordingly, in certain jurisdictions a bagel is itself not taxable, yet when cream cheese is spread on the bagel it becomes subject to tax. Another difficulty in identifying sales tax application is when taxable and nontaxable items are sold together - so called bundled transactions. Typically in situations where two items, one taxable and one exempt, are bundled together, the entire transaction becomes taxable unless the taxable and nontaxable items are separately delineated on the invoice. The taxing of services is also an issue for many business organizations. Services in most states are not taxed, but a growing number of jurisdictions are expanding their sales tax rules to include specifically enumerated services that range from interior decorating to skydiving to landscaping. Finally, taxing authorities have been all over the map when applying antiquated sales tax rules to digital products, such as downloaded software, remotely accessed programs, and Internet advertising.
For vendors of tangible personal property, often the most mishandled aspect of sales tax compliance is properly accounting for tax exemptions and their corresponding certificates. The most commonly claimed exemption is the resale exemption. Goods purchased to be resold to the end user in the same form in which they are purchased qualify for a resale exemption. When that reseller later sells the goods, he is required to collect sales tax on the full selling price of the product. Another tax exemption relates to sales made to nonprofit organizations. Finally, various jurisdictions provide for an exemption with respect to materials purchased for incorporation into an end product, whereas some states extend this exemption to include machinery and equipment used in the manufacturing process. The difficulty for numerous businesses is verifying the kind of exemption claimed by the purchaser and accepting a correctly executed exemption certificate.
States employ tax holidays to reduce or waive sales tax for specific periods of time to incentivize qualified purchases of certain products. State legislatures grant these limited-time holidays for items like school supplies, clothing and footwear, and severe weather preparedness materials. Usually, the qualified sales must be below a mandated price threshold to be exempt. The challenge for organizations is being cognizant of these tax holidays, which can last anywhere from two days to a month, and knowing the cost limitations involved.
Once a business has determined the taxability of a purchase, calculated the tax pursuant to the applicable rate, and accounted for any relevant exemptions, it must file and remit the tax to the authorities. Knowing which form to use, where and when to file, and what to include on the returns can be an onerous task. Taxpayers regularly struggle with tracking the varying state filing frequencies and deadlines, as well as the state specific format requirements. Handling this aspect of sales tax compliance, particularly given the potential exposure that can result from an incorrect filing, creates havoc for many companies. A misfiled form, transposition error or an incorrectly claimed credit may result in significant penalties and increased audit scrutiny.
Accurate sales tax compliance is a challenging endeavor facing many businesses. Consulting an experienced sales tax professional can assist you with staying ahead of your sales tax obligations. If you have any questions regarding sales tax, please contact Alan Goldenberg, Senior Manager of State and Local Taxation and Tax Controversy, at firstname.lastname@example.org or 212-897-6421, or your Friedman LLP tax professional.