Leverage a Holistic Approach to Sales Tax Compliance to Elevate Tax Planning
Ongoing ecommerce and technological advancements have opened new doors of opportunity for countless businesses. While this progress brings numerous advantages, the expansion of sales into multiple states adds layers of complexity to the already challenging landscape of state and local sales tax compliance.
Achieving compliance goes beyond mere adherence to tax laws; it requires a strategic and proactive approach. From assessing historical transactions to implementing automated tax solutions, businesses must traverse a multifaceted journey to ensure ongoing compliance.
Navigate the complexities of sales tax with confidence and efficiency with insights into the intricacies of sales tax compliance, from laying the foundation, to navigating inflection points and beyond:
Background Work: Setting the Foundation
Before diving into the intricacies of an ongoing compliance plan, it's crucial to first take a closer look at the historical sales and use tax exposures that can potentially exist due to historical nexus footprints that weren’t identified in the past.
Registering and collecting tax prematurely, without first examining historical liabilities, may disqualify your business from participating in state-run voluntary disclosure programs or other mitigation opportunities. These programs often waive penalties on past due liabilities and limit lookback periods to 3-4 years, presenting potential savings while getting into full historic compliance. While the allure of immediate compliance can be strong, the first step should always be to review past transactions.
Reviewing past transactions involves three main areas: nexus, taxability, and exposure.
The objective of examining nexus, taxability, and exposure is to shore up past transactions and lay the groundwork for building an automated, efficient process for ongoing tax compliance. A solid understanding of your sales tax compliance footprint is essential for ensuring a smooth tax compliance trajectory for your business.
Nexus
Identifying where your business has established historic nexus before initiating sales and use tax filings to a jurisdiction can be a strategic move, potentially. Economic and physical factors play a role in triggering nexus, and historical evaluation helps provide a comprehensive understanding of your filing obligations.
Physical factors extend beyond office or warehouse location and includes:
- Employee or independent contractor’s location
- Sales team member’s travel destinations
- Inventory location
Economic nexus emerged following the 2018 South Dakota vs Wayfair Supreme Court case, with the majority of states setting a filing threshold of $100,000 in sales or 200 transactions. Both nexus factors should be evaluated when determining where you have a filing obligation. Take note that the sales used to determine the factors vary from state to state, as in some states look to gross sales, some look to sales subject to sales tax under state law, and some look just to sales of TPP, among other unique variations; the bottom line is merely determining whether an out-of-state taxpayer has more than $100,000 in state-source sales is but part of the analysis to determine whether nexus exists.
Taxability
Understanding the taxability of your products and services is equally critical and can be nuanced, with different jurisdictions classifying offerings as taxable or non-taxable. Contrary to popular belief, services are not always exempt. Most states have an enumerated list of the services that are taxable within the state.
Clarity on the taxability of your revenue streams lays the groundwork for determining the gross amounts of taxable sales in jurisdictions where nexus exists. Alternatively, you may have identified nexus, but a review of your products and services finds they aren’t taxable in the state, possibly meaning you potentially don’t have an obligation to register and file for sales tax in that jurisdiction.
Exposure
If you haven't collected and remitted tax on your taxable sales in jurisdictions with established nexus, there's likely exposure – the amount of tax that should have been collected and remitted but wasn't. Mitigating exposure involves exploring options, each assessed on a jurisdiction-by-jurisdiction basis. For instance, participating in a Voluntary Disclosure Agreement (VDA) program may make sense in some states, with its limited lookback of generally three to four years along with the advantage of penalty abatement opportunity.
Alternatively, if the historical exposure is relatively not significant in a jurisdiction, you may consider registering and filing the back period returns and remit those taxes.
Choosing between registering and remitting back taxes or participating in a VDA program requires thoughtful evaluation for the most efficient and cost-effective approach to mitigation.
Tax Engine Software Integration
After gaining a comprehensive understanding of past transactions, the next step is to strategize for future compliance. Sales tax software, with its automated tax calculations and seamless integration into your business system, makes an excellent ongoing compliance solution.
An automated tax software solution's effectiveness is intrinsically tied to its implementation. Understanding the business facts that trigger system configuration requirements distinguishes a seamless, accurate implementation from a troublesome, potentially costly one.
A collaborative process in software integration with a technical sales tax advisor significantly enhances the prospects of achieving sales tax compliance success. This collaborative approach brings forth several benefits, including:
- Tailored Integration. Exploring the current state of the business and its future growth goals provides crucial insights for a tailored integration.
- Registration Considerations. Delving into registration considerations, from the extremes of not collecting in any jurisdictions verses registering and collecting everywhere, ensures a strategic approach to compliance.
- Operational Factors. Considering operational factors during software configuration, such as capacity of your team’s involvement, business workflow, and distinguishing between B2B and B2C sales, enhances the software's alignment with business needs.
- Technical Considerations. Addressing technical sales tax considerations, where customization may be necessary, ensures comprehensive compliance.
- Timing Considerations. Determining when to register and initiate tax collection, while keeping mitigation strategies in mind, contributes to a well-paced and thoughtful integration.
- Peripheral Awareness of Sales Tax Implications. Maintaining peripheral awareness of broader sales tax implications—such as those arising from expanding into new jurisdictions or adding products and services—is essential for a holistic and sustainable integration.
Adopting a holistic approach to software integration, one that extends beyond the configuration outlined in product documentation, ensures accurate, efficient, and sustainable sales tax practices that evolve with the business.
Encouraging collaboration and allowing tax specialists to pose critical questions uncovers considerations vital to a successful software integration and a streamlined sales tax compliance process.
Successful Software Integration
Engaging a technical sales tax specialist from the outset lays the groundwork for a successful integration. Beyond ensuring sales tax accuracy, an effective integration hinges on fundamental product configuration, which begins with selecting the appropriate system.
System Selection
A comprehensive discovery process is vital for unearthing all business requirements. This process helps identify software needs and guides system selection. Key considerations include:
- Required business system integrations
- Exempt sales and certificate management
- Complexity of your products and services
- Reporting requirements
These insights drive informed decisions about software and associated products that align with business needs.
Where Tax is Collected
Following discovery, software integration commences by first selecting where – and on which revenue streams – you will be collecting tax, which is a pivotal step to keep in mind with mitigation efforts as discussed above.
Exempt Customers
Choosing how to manage exempt customers and their certificates depends largely on the number of exempt customers. Different software providers have products for managing exempt customers and collecting new or updated certificates.
Whether you use a dedicated exemption certification management product as an add on to your tax engine, utilize your ERP, or another method, you will need to indicate the customers who are exempt from sales tax – generally based on the collection of exemption certificates – and therefore should be excluded from the tax calculation, in whole or in part. It’s recommended to only mark customers as exempt when you have a valid exemption certificate on file.
Product to Tax Code Mapping
At a high level, when a business system sends a tax calculation request, the software assesses nexus first, then customer tax exemption status, and finally product or service taxability.
Accurate tax collection on your products and services relies on careful mapping of revenue items to tax codes, which determine tax applicability and rates. Tax codes are set by the software provider and serve to identify what you’re selling and the tax implications in the jurisdictions you’re selling into.
System Integration and Testing
Integrating sales tax software with your business system, where invoicing occurs, is required for automated tax calculations to display on a customer invoice or checkout cart. Most software providers offer pre-built integrations to major ERP and ecommerce platforms. Integrating systems entails connecting via an API, conducting quality assurance testing in a sandbox environment, and migrating to production post-testing to ensure seamless functionality.
In addition to technical tax considerations, partnership in implementation extends value to practical tasks included in each milestone of the implementation process. Leveraging their experience, tax specialists anticipate challenges, proactively mitigate them, and act as the project manager, ensuring timely delivery of an accurate and comprehensive solution through collaborative efforts.
Post-Implementation World: Navigating Inflection Points
Once past transactions are reconciled and an automated tax solution is successfully implemented for ongoing compliance, the path forward generally appears smooth. However, certain factors warrant consideration regarding sales tax obligations:
- New Products or Services. Understanding the tax implications of new products and services before their launch in the market is crucial. Mapping these new revenue items to appropriate tax codes with a sales tax engine is required.
- Exempt Customers. Establishing new exempt customers for tax purposes and regularly reviewing existing customers' certificates for accuracy and validity, either manually or through automated software, is necessary.
- Monitoring Nexus. Reaching a physical nexus threshold or surpassing an economic nexus threshold in a new state necessitates registration and configuring tax software to start collecting taxes there. While many sales tax software providers monitor economic nexus thresholds, determining where and when you have nexus as well as tracking physical nexus creation is your responsibility.
- Changing Business Systems. If you switch the invoice system linked to your sales tax software, reintegrating and configuring the new system for tax calculation purposes becomes necessary.
With the foundational work complete, maintenance mode ensues, allowing you to address sales tax-related situations as they arise.
Next Steps
Navigating the complexities of sales and use tax demands a comprehensive approach rooted in understanding, collaboration, and proactive planning. From reviewing past transactions to selecting and configuring automated tax solutions, each step shapes the foundation for ongoing compliance.
Partnering with experienced sales tax professionals with sales tax automation expertise not only ensures technical accuracy but also mitigates risks and streamlines the integration process. As businesses evolve and encounter new challenges, attention to product launches, customer exemptions, nexus thresholds, and system changes remains paramount.
By embracing a proactive stance and leveraging the insights gained from this journey, businesses can navigate the sales tax landscape with confidence, ensuring compliance, efficiency, and long-term success.
We’re Here to Help
To learn more about how integrating a holistic tax compliance framework can help your business successfully navigate the sales tax landscape, contact your firm professional.