Sales tax is usually imposed by states on the sale of tangible personal property and certain services. Typically calculated as a percentage of the purchase price, this tax is collected by the retailer at the point of sale and then remitted to the government on either a monthly, quarterly, or annual basis.
With the rise of ecommerce, remote work, and economic sales thresholds, sales tax compliance is now more complex than it ever has been, subjecting companies to new filing obligations as they do business across a multitude of state and local jurisdictions.
Tangible Personal Property (TPP) refers to physical items that have a tangible form and can be seen, touched, and moved. Unlike real property, which includes land and buildings, TPP encompasses portable objects that are not permanently attached to any real estate. Examples include furniture, vehicles, equipment, electronics, jewelry, and artwork. These items are often subject to sales tax at the point of purchase or delivery. Unlike intangible property, such as stocks or patents, TPP is defined by its physical presence and portability. Its classification is crucial when determining if a certain purchase is subject to sales tax or if the purchaser will be able to utilize an exemption certificate for the purchase.
Historically, only tangible personal property was subject to state sales and use tax, however, states continue to expand their potential sales tax base by levying sales tax on certain enumerated services. Unlike the sale of TPP – which is subject to sales tax unless expressly exempt by the state, services must be specifically enumerated by legislature to be subject to sales and use taxes .
Services concerning software and cloud-based solutions have been a recent target of many states subjected those services to sales and use tax. The remote nature of software licenses adds another layer of complexity to sales and use tax compliance.
Nexus refers to the connection between a business and a state or jurisdiction that establishes the obligation to comply with tax laws, including collecting and remitting sales tax. A nexus determination is primarily controlled by the U.S. Constitution, in which the Due Process Clause requires a definite link or minimal connection between a state and the entity it wants to tax, and the Commerce Clause requires substantial presence. What constitutes whether a taxpayer has a “substantial presence” has been interpreted by state legislatures, state supreme courts, and even the United States Supreme Court.
Nexus can be established in a number of ways, below is a breakdown of the different types o nexus for sales tax purposes:
This occurs when a business establishes a tangible connection to a state or jurisdiction through its physical activities or assets. Historically, this was the primary standard for determining whether a business was required to collect and remit taxes in each state, as established by the U.S. Supreme Court in Quill Corp. v. North Dakota (1992).
A business is deemed to have a physical presence nexus if it has a direct, physical footprint in the state. Examples include operating a physical storefront, office, or warehouse; having employees, contractors, or sales representatives working in the state; or maintaining inventory or using a fulfillment center located within the state. Other activities, such as participating in trade shows or conducting regular in-person business activities in the state, or having a remote employee, can also create a nexus.
This is a legal standard that establishes a business’s obligation to collect and remit taxes in a state based on the extent of its economic activity, regardless of whether the business has a physical presence in that state. This concept became prominent after the 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., which allowed states to require tax compliance based on economic activity alone.
The use of bright-line thresholds has been adopted by virtually every state and local jurisdiction that levies a sales tax since the decision in Wayfair.
Under the use of bright-line thresholds, a business will have economic nexus with a state if generates more than $100,000 in annual sales or completes 200 or more transactions with customers in the state. (However, many states are repealing the 200-transaction count and determining nexus solely based on the $100k threshold alone)
Generally, states who levy and collect a sales tax utilize the $100k threshold established in Wayfair, absent some outliers such as CA and NY.
Due to the large number of state and local taxing jurisdictions in the United States with various rates, rules and regulations, the Court first established the physical presence test in National Bellas Hess v. Illinois, 1967 and upheld this standard 25 years later in Quill Corp. v. North Dakota, 1992.
Due to a rapidly growing retail market on the internet and declining sales tax revenue, South Dakota’s state legislature, in defiance of the physical presence standard established in Quill, passed a economic nexus standards standard which set bright-line thresholds of $100,000 in sales or 200 transactions to state residents which if exceeded gave businesses a sales tax collection and remittance obligation with the state.
Ultimately, the economic nexus standard enacted by South Dakota was challenged claiming the economic nexus standard was unconstitutional. While the South Dakota Supreme Court declared the law unconstitutional based on the Quill decision, the U.S. Supreme Court granted certiorari on appeal and agreed to hear the case where they ruled the economic nexus thresholds as being constitutional.
In the opinion drafted by Justice Kennedy, it appeared that the South Dakota law’s safeguards against discrimination and undue burdens on interstate commerce were persuasive. The respective safeguards include:
· A safe harbor for small sellers who do not meet that annual economic threshold of $100,000 in sales or 200 transactions;
· No application of the law retroactively; and
· Sales tax simplification features that come with membership in the streamlined sales tax agreement, such as a single state-level tax administration, uniform definition of products and services, simplified tax rate structures and other uniform rules. The state also provides sellers access to sales tax administration software paid by the state. Sellers using this software are immune from audit liability.
Many states have updated sales tax collection regulations post-Wayfair. Below is a summary of the changes made in certain states immediately after the Supreme Court ruling was issued.
California enacted new legislation increasing the sales threshold from $100,000 to $500,000 and eliminating the 200 individual transaction thresholds. This change is retroactive to April 1, 2019 and extends to marketplace facilitators effective October 1, 2019.
New Mexico enacted new economic nexus standards for remote sellers and marketplace providers of at least $100,000 in sales. All receipts from doing business in New Mexico are subject to gross receipts tax, including sales, leases and licenses of tangible personal property, and sales of licenses and services or licenses for the use of real property that are sourced to New Mexico. Marketplace sellers, may deduct receipts from transactions facilitated by a marketplace provider. To take the deduction the marketplace seller must get documentation from the marketplace provider showing that the marketplace provider is registered with the Taxation and Revenue Department and has remitted or will remit taxes for those transactions. Marketplace sellers choosing to exercise the deduction should issue reliable information to marketplace providers. If not, the Department may determine that the marketplace provider is not liable for the tax on the marketplace seller’s transactions. The marketplace provider’s taxability depends upon the information provided by the marketplace seller. This legislation is effective, July 1, 2019.
Source: Tax Foundation
Hawaii enacted legislation extending their economic nexus standards to marketplace facilitators. The legislation applies to sales of intangible property and services as well as tangible personal property. The legislation’s definition of “marketplace facilitator” is any person who sells or assist in the sale of tangible personal property, intangible property, or services on behalf of another seller by: 1) providing a forum, whether physical or electronic, in which sellers list or advertise tangible personal and intangible property, or services on the behalf or another; and 2) collets payment from the purchaser either directly or indirectly through an agreement with a third party. This legislation is effective January 1, 2020.
Indiana’s Department of Revenue released a ruling regarding an out-of–state bake goods manufacturer reaffirming that once an economic nexus threshold is reached (when a retail merchant’s gross revenue exceeds $100,000; or 200 or more separate transactions in the state), the remote seller is required by law to register and file zero returns, even if all of their retail sales are exempt. Revenue Ruling No. 2018-06 ST, Indiana Department of Revenue, January 7, 2019, released March 2019.
Arkansas’ House of Representatives have passed economic nexus standards for remote sellers and marketplace facilitators that made sales into the state during the previous or current calendar year that exceeds either $100,000 or 200 individual transactions. Should the bill be enacted, it would become effective July 1, 2019.
Georgia’s Senate passed an economic nexus bill (H. B. 276) that reduces the economic nexus sales threshold from $250,000 to $100,000 and eliminates the 200 transaction threshold. The Senate amended the Bill to make a marketplace facilitator a dealer on sales it facilitates that are sourced to Georgia, unless the marketplace seller, or a retailer or dealer, pay the sales taxes. Other amendments bar Georgia class action lawsuits against marketplace facilitators regarding the over collection of sales tax and moves the effective date of the changes from July 1, 2019 to January 1, 2020.
Idaho enacted legislation for remote sellers and marketplace facilitators who lack a physical presence in the state to register and collect Idaho state level sales tax once they reach an economic nexus threshold of $100,000 in sales within the state. The state will provide liability relief for marketplace facilitators who collect the incorrect amount of tax by reason of the retailer or retailer’s authorized agent providing misinformation. Customers are barred from filing class action lawsuits against marketplace facilitators to recover refunds for over collected taxes. This law becomes effective on June 1, 2019.
West Virginia expanded their economic nexus standards of $100,000 in gross revenue or 200 or more separate transactions to marketplace facilitators and referrers. Marketplace facilitators are people who contract with one or more sellers to facilitate, for consideration, the sale of the seller’s product through a physical or electronic marketplace operated by that person, regardless of whether the consideration is deducted as fees from the transaction. A referrer is a person who contracts or otherwise agrees with the seller to list or advertise for sale one or more items in any medium, including a website or catalog. They receive a commission, fee or other consideration from the seller for the listing or advertisement. The referrer also connects the purchaser to the seller electronically or through other means to complete the sale but does not collect receipts from the purchaser for the transaction. Businesses that provide internet advertising services and do not provide the marketplace seller’s shipping terms or advertise whether a marketplace facilitator charges sales tax are not considered referrers. This standard becomes effective on July 1, 2019.
Knowing which products or services that are not subject to or are exempt from sales tax is crucial for accurate reporting where exemptions can vary greatly across different industries. Common exempt activities include providing certain services, manufacturing, processing, research and development, pollution control, sales of items to be resold, sales to exempt organizations, and a host of other activities Additionally, states vary widely in the items they elect to impose sales tax on. For instance, software as a service (SaaS) is taxable in only about half of the states that impose a sales tax.
Since sales tax rates often vary between location and type of product or service sold, many organizations prefer to work with qualified specialists, such as Schneider Downs, to determine and manage their sales tax exemption certificate needs.
Understanding the specific criteria and documentation required for these exemptions is crucial for businesses to ensure compliance and optimize their tax liability.
Exemption certificates are essential documents that businesses utilize to claim sales tax exemptions on eligible purchases. Proper completion and retention of these certificates are crucial for compliance. Sales tax exemptions and exemption certificates vary state by state, therefore due diligence must be done in order to stay compliant with sales tax obligations concerning exempt sales and purchases.
The following are the most common types of sales tax exemptions:
Goods purchased with the intent of resale are exempt from sales tax, eliminating the burden of tax on items procured for the purpose of resale to customers. Sales tax will then be collected on the purchase by the ultimate customer.
Products directly used or consumed in the manufacturing process qualify for sales tax exemption. This includes raw materials and components that integrate into the final product.
The “direct use” concept mandates that goods must be used immediately in the production process without intermediate steps, ensuring that materials contribute directly in the manufacturing process or consumed in making the finished product.
Non-profit organizations benefit from sales tax exemptions on purchases relevant to their charitable, educational, or religious missions, aiding in operational cost reduction and resource allocation.
Government entities are afforded sales tax exemptions on purchases made for public use, covering items utilized in government facilities, vehicles, and services.
Agricultural products and supplies that are directly employed in farming operations are exempt from sales tax. This encompasses seeds, fertilizers, and equipment necessary for crop and livestock production.
Specific construction-related purchases, especially those used in public works or qualifying projects, may also be exempt from sales tax.
Often sales and use tax includes specific considerations based on the industry where the goods were sold. To add to the complexity, often states offer additional considerations to specific industries outside of the general market. Be sure to check for additional considerations within your specific state for additional incentives concerning your industry. Examples of industries with specific sales tax exemptions are packaging, transportation, public utility, R&D, and quality control, to name a few.
Pennsylvania offers significant sales tax exemptions for manufacturing companies, but navigating these exemptions can be complex. To maximize these benefits, manufacturers must carefully consider the specific requirements and maintain detailed records to substantiate exempt purchases.
Ohio has specific sales and use tax rules for manufacturing companies that can significantly impact their tax liability.
Sales and use tax considerations for packaging can vary depending on the specific jurisdiction and the type of packaging involved.
Sales and use tax considerations for construction companies can be complex and vary depending on the specific state and local jurisdictions where they operate. Adding even more complexity, the type of construction contract often dictates the sales tax treatment of the corresponding invoices. For instance, a time and materials construction contract will often be subject to sales tax on the materials only if the construction services are exempt from tax. On the other hand, a lump sum construction contract will not be subject to sales tax since the contractor pays sales tax on their materials and factors that it into their corresponding construction bid.
Equipment and Machinery: The taxability of equipment and machinery used in construction can vary depending on the specific item and its intended use.
The ever-evolving landscape of sales and use tax can be particularly intricate for software companies. To ensure compliance, it’s crucial to understand the key factors that may impact your business:
Remote Purchases: If your company purchases software for use in a state where you don’t have nexus, you may be liable for use tax. This tax is typically the responsibility of the purchaser, but sellers may be required to collect it in certain circumstances.
Remote Workforce: The presence of remote workers can create nexus in certain states, impacting your sales and use tax obligations.
Subscription-Based Models: The tax treatment of subscription-based software can be complex and varies by state. It’s important to understand the specific rules for recurring revenue models.
Retail companies Sales and Use Tax regulations vary significantly by state and locality. Understanding your locations core considerations is important.
Marketplace facilitator laws impose an obligation on the platform that facilitates the sale (the marketplace facilitator) to collect and remit sales tax on behalf of the marketplace seller. These laws are significant because they shift the obligation to collect and remit sales tax from the seller to the marketplace platform.
Sales tax audit complexity is compounded by states becoming more aggressive and strategic in auditing taxpayers to recover tax dollars and fill budget gaps. As a result, businesses must understand their sales tax exposure, mitigate risk and past exposure, and establish processes and systems to ensure ongoing compliance.
Recent sales tax audit trends show an increased focus on remote sellers and the use of technology. States are actively targeting online retailers and businesses with remote employees to ensure they are properly collecting and remitting sales tax. Additionally, tax authorities are leveraging advanced data analytics tools to identify potential non-compliance issues, such as discrepancies in sales records or product classification errors. To mitigate audit risks, businesses should maintain accurate records, stay informed about changing tax laws, and consider using tax automation software to streamline compliance processes.
Sales tax audit strategies have become increasingly sophisticated, leveraging advanced data analytics and technology. State tax authorities are utilizing data mining techniques to identify potential non-compliance issues, such as discrepancies in sales records, product classification errors, or inconsistencies in tax rates. Additionally, there is a growing emphasis on remote seller audits, particularly targeting businesses that may not have a physical presence in a state but are required to collect and remit sales tax due to economic nexus.
State tax authorities are scrutinizing refund claims more closely, particularly for businesses with complex operations or those claiming significant refunds. This increased scrutiny often involves detailed reviews of supporting documentation, such as purchase orders, invoices, and tax exemption certificates. To mitigate risks and maximize refund opportunities, businesses should maintain meticulous records, stay informed about changing tax laws, and consider consulting with tax professionals to ensure accurate and timely filing of refund claims.
Sellers are still responsible for collecting and remitting sales made outside of a marketplace platform, including on an ecommerce site, at a trade show, or from a physical location.
As a business owner, understanding state and local tax laws is crucial to ensure compliance and minimize your tax liability. Here are some key questions to consider:
Generally, businesses are subject to state and local income tax, sales tax, property tax, and potentially other taxes like excise taxes or franchise taxes.
The method of calculating state and local tax liabilities depends on the type of state and local tax (i.e. income, sales & use, property) and varies across the thousands of tax jurisdictions within the United States. Navigating the ever-changing state and local tax landscape requires deep expertise.
Available state and local tax credits and incentives vary by state, industry, and the type of activity being incentivized. Commonly, tax credits and incentives are available for capital investment, hiring or retention of employees, employee training, relocation or new facility development, manufacturing of emerging technologies, and a host of other activities. Securing state and local tax incentives and credits requires familiarity with compliance obligations required by a state or local tax administrator to be awarded the tax credit or incentive.
Your business’s location, the nature of your products or services, and the specific rules of your state and locality all need to be evaluated whether your business has “nexus,” the taxable presence necessary for a state to impose their sales tax and require a business to collect and remit the tax. Nexus and the resulting tax obligation can arise from having a physical presence in the state (i.e. employees or property) or even having an economic presence in the state by exceeding a particular sales revenue threshold – generally $100,000
Knowing which products or services are not subject to or are exempt from sales tax is crucial for accurate reporting and exemptions vary across industries. Common non-taxable or exempt activities include providing certain services, manufacturing, processing, research and development, pollution control, sales of items to be resold, sales to exempt organization, and a host of other activities Additionally, states very widely in the items they elect to impose the sales tax on. For instance, software as a service (SaaS) is taxable in only about half of the states that impose a sales tax.
Sales tax rates can vary based on location and the type of product or service. Keeping up to date on state and local sales tax rates is necessary to achieve accurate sales tax compliance.
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Evaluating if your business is required to file an income tax return in a state starts with determining whether your business has nexus in the state sufficient for the state to tax your income. Generally, state income tax nexus is derived through physical presence in a state, such as the presence of assets or employees, including those employees working remotely in the state.
The method of taxation varies based on how the business is structured from a legal entity perspective and where the business is located. State income taxation can vary widely based on whether your business is a corporation or pass-through entity. Additionally, states may tax different varieties of income differently, such as the taxation of goods vs. services, and impose varying taxing methodologies, adding further variations to the taxes your business may be subject to.
State income tax methodologies vary amongst the various states, with differences in the treatment of key components to the tax calculation, such as the tax base, apportionment of income, conformity to federal tax provisions, tax rates, and a host of other factors. A multistate business faces the complicated task of navigating the myriad of state tax regimes.
Business property is generally taxed according to whether it is real property or business personal property. Real property tax and business personal property tax generally have different rates and nuances in how the tax is calculated. Exemptions are also generally different between the two taxes.
Some jurisdictions offer tax exemptions for property tax. Some common exemptions include property used in manufacturing, property used by a small business, research and development, pollution control, and agriculture.
Payroll taxes include federal and state income tax withholding , Social Security tax, Medicare tax, and other employment-related taxes depending on your state and locality, such as state unemployment insurance. Remote and hybrid employees bring their own distinct challenges, such as the proper jurisdiction to withhold.
Understanding the payroll tax calculation rules is crucial for compliance as each state and locality’s withholding rules differ greatly. Accurate payroll tax compliance is important since failure to collect and remit the proper payroll taxes may result in hefty penalties and interest and could even lead to the businesses’ owner with personal liability for the tax not being withheld and remitted.
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