With the holidays rapidly approaching, retailers are focused on product development and marketing planning to prepare themselves for the busiest season of the year. But what about your sales tax strategy? Making sense of complicated tax jurisdictions may not be much fun, but it is a critical compliance requirement to avoid fines and costly audits.
Byzantine sales taxes have been around since the end of the Great Depression. State coffers were bankrupt, and the sales tax was introduced in an attempt to collect much needed operating funds. Fast-forward to 2014, and states are still losing an estimated $23 billion a year in uncollected sales taxes from Web retailers.
Amazon’s explosive growth galvanized states to implement local laws to try to force the online retailer to pay sales tax for items sold to its residents, even if Amazon wasn’t based in that state. Called “Amazon Laws,” states sought to place the burden of sales tax collection firmly on Amazon, not the consumer.
Before Amazon Laws, sales tax was computed based on a complex set of rules based on a business’ “nexus” for retailers operating in multiple states. Nexus is a tax law term to describe a situation in which a business has a presence in a state, whether it’s a main office, a branch, or a retailer outlet. If a business has a nexus in a state, it’s subject to that state’s income and sales taxes.
This is why it’s important to ask questions like: Do you hire marketers or sales people that operate outside of your HQ? Do you attend trade shows in another state? Do you operate warehouses across the country? If you do, you’re operating a nexus in those states, making you subject to local and state tax laws.
How do the Amazon Laws impact online retailers doing business in multiple states? In addition to nexus, if you sell goods in CA, NY, FL or TX, you are legally required to pay sales tax on orders shipped to those state, regardless of where your company is physically located. And more states are implementing similar legislation to try to hold online retailers responsible for sales tax collection and remittance.
There are 11,000 tax jurisdictions in the U.S. alone; each state and municipality has their own tax rules. Not only that, but different products are taxed differently in different jurisdictions. For example, take food and beverages. Beverages should be tax-exempt, right? Not if it’s soda pop, which bizarrely means “fizzy water” needs to be taxed.
What if your customers place an order with both still water and fizzy water? What about wholesale orders? And if you ship internationally, does that mean you have additional tariffs to deal with as well? It’s important to figure out the right way to apply sales tax to your products, because businesses that don’t get it right can face stiff penalties.
One of the most difficult and time-consuming parts of implementing sales tax software is connecting each product category, and in some cases individual product SKUs. Besides the complexity associated with trying to figure out taxes down to the product level, online sellers are at risk for time-consuming, expensive audits. On top of that, IRS audits are not limited to the current tax year: the IRS may ask for all of your sales tax records retroactively for the past 6 years. And as you grow, the IRS takes a more active interest in your business. Even if you’ve got your sales tax buttoned up now that you’re a $10MM business and you can afford an experienced accounting firm, will you be able to weather an audit into your first two years as a start up?
To get around this, many ecommerce platforms recommend that sellers increase the product price to bake in a flat rate tax buffer (“All applicable taxes included in the price!”) This way brands avoid being targeted for unfair business practices by the “Main Street” merchants and collect some amount of tax revenue. However, that pushes the heavy task of figuring out your actual tax liability until the end of the year.
Beyond that, charging a flat tax on all items means that some customers are paying too much tax, and some customers aren’t paying enough tax. If you’re overtaxing customers, it means that you are needlessly raising prices on your products, which puts you at a competitive disadvantage.
Without automation, brands have to manually reconcile sales tax at the end of the year. This can involve filing extensions, hiring expensive accountants, and due to the manual process, increased risk for mistakes that could trigger an audit. For the reasons stated above, even if you charged a flat sales tax on every order, you still could end up owing a sizable tax bill to the IRS that comes directly from your bottom line.
The benefits of sales tax automation are manifest. Automating sales tax calculation saves time, money and effort. Sales tax software should instantly apply the correct sales tax based on accurate product and locality taxability rules.
- Set the codes once, then let the software do the rest.
- You can relax if you don’t actually know the tax codes. Most software only require that you know how to properly categorize your products (shoes, umbrellas, soda, nutritional supplements, etc.)
- Enjoy automatic rate adjustments. If tax rates change for a particular tax, your customers will start paying the correct rate as soon as the software updates the database (which is often). Since they specialize in taxes, they can update codes across jurisdictions faster than most individual companies.
- Tax season’s less scary when you know you have your ducks in a row. Many software providers can pull all your tax info directly into your tax software.
- Going international? Many solutions come with VAT and International taxing built-in. So when you’re ready to sell overseas, you can do so without worrying about how to charge taxes.
Since taxes are not a revenue stream, we believe strongly that high growth brands should figure out how to use technology or outsource arduous tasks like these to maximize efficiency. For sales tax software, the name of the game is to minimize the chances of getting an audit, reduce the time required to file taxes, and focus core business resources on revenue producing activities.
After fighting Amazon Laws in multiple states, Amazon reversed its position, and now, along with Walmart, supports the Marketplace Fairness Act, which Amazon hopes will standardize the tax structure and avoid state-by-state laws for all internet retailers – not just Amazon. The key takeaway is that tax laws are changing to include all online retailers – not just the big guys.