By Diana DiBello
Let's face facts. Many small businesses devote energy to providing a service or product, with little time left over to devote to back-office solutions. Yet, the need to comply with state and local sales tax reporting and collection cannot be overlooked; no one wants to be audited, let alone having to endure a sales tax audit from the state's taxing authority.
Although sales tax is often a pass-through tax, many bookkeepers and accounting professionals who work with business owners should know enough about the rules to catch any unknown issues before they pop up in an audit. To minimize exposure and eliminate unnecessary audit flags, accurate and timely compliance is a must.
More than likely, businesses are filing returns and attempting to pay what they owe, but how do they keep up with changing state-by-state requirements if they can't even carve out the time to devote to the back office? We must first understand these requirements, and second, provide solutions to enable businesses to file on-time, every time, while maintaining the highest possible level of accuracy.
Compliance Throughout the States
Sales tax typically represents more than one third of a state's revenue; in many states, the percentage is much higher. Based on 2007 rates from the Federation of Tax Administrators, Washington, Nevada, Florida, and Texas generate more than 50 percent of their income from sales tax. Other states, such as Minnesota, Illinois, and California, fall on the lower end of the scale.
Is your client's business on the state's radar? Maybe ... maybe not. Regardless, many unsuspecting companies may endure the audit because mistakes were made that could have been prevented.
Let's look at the example of a large equipment manufacturer that did not properly comply. The company loaded and configured a sales tax software solution in the mid-'90s. The person currently responsible for sales taxes followed the procedures described and those partially documented by his predecessor. After an accounting firm came in and performed a sales and use tax review, it was discovered that a number of states were turned "off" in the tax system. In addition, customers were set up as exempt in the wrong state based on nonexistent or invalid exemption certificates, and credits weren't being handled properly.
The CFO called a meeting, questioning his team about these issues. The sales tax manager and tax director looked around the table and said, "Well, that's the way we've always done that ...." The sales tax manager then added, "I just assumed all those sales were exempt when no tax was calculated."
In short, customers were not charged the tax because the tax calculation was turned off in many of the states. In other states, credits to customers included tax, but were never accounted for in the tax system. The lack of focus on sales tax led this company to nearly $2 million in exposure from this "pass through" tax and over $250K in lost refund opportunities.
Specific State Concerns
An understanding of sales tax compliance would not be complete without looking at several factors.
First, companies must understand "nexus." Based on the due process and commerce clauses of the U.S. Constitution, nexus is the minimum connection needed between the vendor and state so that subjecting the vendor to the state's laws is neither unfair to the vendor nor likely to harm interstate commerce.
The nexus standard for sales tax is a much lower barrier than for income tax. New York, for example, recently tried to require Internet retailers to collect tax by using referral programs with participants residing in New York as the link (TSB-M-08(3)S). Among other activities, if a company has a "warm" body â sales people visiting the state, service personnel or even contractors â it will have nexus.
Next, consider whether each state is an "origin" or "destination" state. According to Commerce Clearing House, nine states have origin-based taxation. Any transactions originating and terminating in the state are sourced to the origin jurisdiction, so local rates at the origination point (retail location or shipâfrom) of the sale apply. Transactions crossing state boundaries are usually sourced to the "destination" regardless of the state's sourcing rule.
Many states have adopted the Streamlined Sales and Use Tax Agreement (SSUTA), but some larger states have not. These include California, Illinois, New York, Pennsylvania, and Texas. Since March 2000, this voluntary effort by state governments to simplify and harmonize sales and use tax collection and administration was designed to encourage efforts at the federal level to allow states to require remote sellers to collect sales tax. SSUTA rules made sweeping changes in the way sales tax will be computed, administered and collected.
Getting the Most out of Technology
Imagine your small business client trying to figure out nexus, state regulations, and other sales tax minutia â instead of spending more time on the business itself. Just like most other any tasks, technology is a great assistant. Here, there are two basic components associated with sales and use tax: calculation, and returns and remittance.
Thousands of rates exist for more than 10,000 sales and use tax impositions. Maintaining these rates and numerous, often monthly changes, are nearly impossible for companies doing business in multiple states. In addition, the rules for taxability and calculation vary from state to state, and in some states, in local areas. Determining the tax base, rounding rules, and the tax treatment of specific goods and services is very complex. Automated solutions that maintain the data for all the rates and rules are a necessity for businesses that operate in a multistate environment.
Companies doing business in multiple states with limited resources have no choice but to find an automated returns solution. A listing of basic sales and use tax state and local returns for the United States can exceed 450 forms! It is not unusual for a company with multi-state nexus to file hundreds or even thousands of returns each year.
Some companies, however, may be calculating sales tax and preparing reports through manual or hybrid solutions. In a "manual" environment, businesses load state, county, city, and local tax rates into accounting software, and then manually update the tax tables for rate changes every time they occur in each jurisdiction in which the business ﬁles.
In a "hybrid" situation, the business subscribes to a rate table update service that populates the tax rates in the company's accounting software for all jurisdictions in which the business ﬁles. Determining whether an item is taxed and customer exemption status are performed manually.
Manual and hybrid solutions are cumbersome and mistakes frequently occur. Some fully automated solutions, on the other hand, leverage the significant advantages of the Internet-based Software-as-a-Service (SaaS) model.
SaaS is suited to handling constant rate and jurisdiction changes because all changes are tracked by a central service accessed through the Internet. You or your client must ensure unique company settings â nexus, product taxability and exemptions â are updated within the system with Web-based tools connected to the company's accounting software at the appropriate points. As a result, the client receives effortless consistency and accuracy with every sales tax calculation.
Automated solutions should be SSUTA-certified in order to ensure the highest possible level of compliance. Currently, four certified service providers exist in the marketplace: SpeedTax, ADP Taxware, Avalara, and Exactor.
With a SaaS sales tax solution, your client's accounting application continues to function as the repository for the general ledger, as well as balance information, invoices, payments and customer lists. The sales tax solution is activated by automated triggers built into transaction processing that seamlessly interface with your client's accounting package.
SpeedTax MANAGER for QuickBooks
The SpeedTax solution for QuickBooks Pro, Premier and Enterprise Editions automatically calculates sales tax for each transaction across more than 12,000 U.S. sales tax jurisdictions. It calculates, reports, files and remits sales taxes online, helping small- to medium-size businesses simplify their sales tax functions.
Because SpeedTax is an online service, the SpeedTax Service Engine provides jurisdiction and rate determinations through a rules-based engine that is always updated with geographic data, state rules, and all applicable variables unique to a customer's business.
Offered as a one-click solution layered on to QuickBooks, SpeedTax MANAGER:
- Automatically prepares signature-ready tax forms. The approval process is streamlined with built-in controls to save time and eliminate human error. Submitting documentation and remittance to the proper taxing authorities is handled automatically, and tools are built in to ensure tax-filing deadlines are anticipated, allowing for on-time, consistent, predictable preparation with a minimum of effort.
- Offers executive dashboard, management and detail reports down to the transaction level, tracking tools and a comprehensive audit trail.
- Manages taxability, nexus, sourcing rules, exemptions, exceptions, shipping locations, SSUTA volunteer status and other settings that are unique to each business.
- Provides a link with each customer's financial or e-commerce application to deliver sales tax calculations directly into invoicing or customer set-up processes. This helps businesses avoid rate look-ups and any potential manual error.
How to Help Your Clients
SpeedTax has a short survey on its Web site that assesses a business's risk, provides education and a greater understanding of streamlined, protective measures. Also available is the company's Learning Center with postings on current news, as well as a White Paper, Why it's Smart to Put Sales Tax on Your Radar.
As an accounting professional, you should fully educate yourself on sales tax. In addition, start asking clients more questions. Chances are, your clients would beneﬁt from implementing precautionary steps to reduce risk of penalty and audit. However, their limited knowledge of sales tax and its potential risk prevents them from even raising these concerns with you.
Next, educate your clients and explore the options to improve their practices. Finally, learn more about certiﬁed solutions. The benefits associated with Software-as-a-Service compared to traditional software will enable compliance and peace of mind.
About the author
Diana DiBello is director of Product Development for SpeedTax, a provider of sales tax compliance software solutions. She previously was a senior manager in the state and local tax services group for Grant Thornton. Contact her at [email protected].