If your company conducts business outside of your home state, whether through selling products or offering services, it will be liable for sales and use tax. However, navigating the compliance obligations for such multi-state taxes can be incredibly challenging. After all, depending on which states you work in and what you sell, there may be different requirements about the type of tax you pay, who you pay it to, and when it’s due.
In this blog, we’ll cover all the essential aspects of sales and use taxes, to help your business navigate the terrain with ease.
Sales Tax vs. Use Tax
To begin with, it’s important to understand the differences between sales and use tax. Although they’re pretty similar, there are a few key differences that will affect your tax obligations. As such, they should therefore be a key part of your tax strategy.
What is sales tax?
Sales tax is a government-imposed consumption tax against the sale of goods and services. It’s usually levied at the point of sale, is collected by the seller, and then passed on to the government.
Sales tax rates vary by state, and some states have exempt products and services, while others may not levy this tax at all. To be liable for sales tax in a specific state, your business must have a presence there, whether physical or economic. This is known as your nexus.
What is use tax?
Use tax is a conditional sales tax levied against goods or services. Specifically, it is levied against products or services (including digital ones) that your business buys from a state with no sales tax, but intends to use, store, or distribute in a state where a sales tax applies. The rate is generally the same as a state’s sales tax rate. However, the responsibility to calculate and pay this tax lies with the user.
How they compare
Because they’re similar, many businesses view these taxes as the same thing. After all, they both generate income for a specific state, are charged at the same rate, and each has exemptions. However, remember that sales tax is levied against tangible property, while use tax applies when that property is used.
The main difference between sales and use tax comes down to how they’re calculated and who pays them. The former is levied by the seller and given to the government, while the latter is calculated and paid by the end user.
The Basics of Nexus
As mentioned above, sales and use tax obligations depend on your business’ nexus within a state. But what does this mean? In a nutshell, it’s a form of contact between a taxpayer and a state.
However, this can be in one of two ways – physical or economic. Although that wasn’t always the case. Before 2018, a physical presence in a specific state was all that was necessary to determine a sales and use tax nexus. That year, the Supreme Court issued a decision to include an economic nexus standard for sales and use tax.
Physical presence nexus
Under this kind of nexus, if your company, employees, or stock and warehouses are located in a state, you will be subject to nexus there. Note that this also includes remote staff living in a state in which your business would otherwise have no physical presence. Similarly, it can be triggered if your business has an affiliate or partner in a state that directs traffic to your webpage in exchange for a share of profits.
Economic nexus
This depends on your business’ economic activity within a state. This includes sales from a physical location in a state, or those sold online and then shipped to another state. If you meet the state economic threshold, your business must collect taxes from customers in that state.
Generally, states will follow a baseline established by the Supreme Court’s 2018 decision, of $100,000 in gross receipts or 200 transactions in-state. But the exact thresholds can vary between states. For example, $100,000 in sales is enough to trigger nexus in Florida, while nexus in New York requires $500,000 in sales and 100 transactions.
When in doubt, it’s best to consult a tax pro to ensure you’re compliant with each state’s threshold.
Sales Tax Compliance
If your business has a physical or economic nexus within a state, the IRS requires you to register for sales tax permits in that state. This includes where you source your stock. Some states have ‘origin-based sales tax sourcing’ or ‘destination-based sales tax sourcing’.
If your home state is origin-based (like Tennessee), you’ll need to charge customers sales tax according to the rate of your state, no matter where it’s going. Alternatively, if your state is destination-based, you charge sales tax rates for the state to which the product is being shipped.
Keep in mind, though, that there are several factors that affect sales taxes in different states. These include a state’s base rate, on which all calculations for sales tax are set. This means that how you calculate the tax in each state can be very different. Some states also allow cities and counties to impose their own sales tax, on top of existing state rates.
Some products are also exempt from sales tax. Usually, there are three categories for sales tax exemptions. These include:
- The kind of product or service sold. If something is bought to be resold, it’s usually exempt in most states. Some states also exempt purchases that are defined as necessary for a customer to survive.
- How the purchase is used. Some products that support pivotal industries or benefit the community are exempt from sales tax. The exact circumstances surrounding these exemptions are regulated by the state.
- Purchaser exemptions. Some buyers may be exempt from paying sales taxes, even if the sale is made in a state that levies the tax. This can include NPOs and charitable organizations.
Collecting and remitting sales tax
If your business sells goods or services, the responsibility for remitting sales tax falls to you. This means that you must keep accurate records of all completed sales and taxes collected, and file regular reports with the agency that collects the tax. Not doing so leaves your business open to hefty fines and penalties, and even possible legal action.
To simplify compliance, some states are members of the Streamlined Sales Tax (SST) program, so your business can register to collect and report sales tax in these states through a single platform.
But how do you know whether you’re charging the correct sales tax rate? This depends on your customer’s location. Remember that tax jurisdictions only receive tax revenue when a sale is made to the end consumer.
Use Tax Compliance
The main purpose of use tax is to protect in-state retailers against unfair competition from out-of-state sellers who do not need to collect tax.
As discussed above, use tax is only applied in certain circumstances, and the user or buyer is responsible for calculating and paying it. As with sales tax, not paying use tax can lead to fines and penalties. However, because the responsibility falls to the purchaser, this is often more difficult to enforce.
Generally, your business will only need to comply with use tax obligations if you are the one making the purchase in a state without sales tax, and intending to use the product or service at home. This is particularly relevant for software and digital goods.
Also, note that each state has its own laws governing when to pay use tax, so if you must pay it, you need to liaise with a tax professional to ensure you’re truly compliant.
Strategies for Managing Sales and Use Tax Compliance
A significant challenge to navigating compliance is the risk of audits. Because of the complex nature of these taxes, audits are becoming more common.
Of course, this means it’s more important than ever to ensure that your business follows all the necessary regulations. And that requires keeping on top of the constantly changing tax laws, including the filing requirements.
Another essential component is to create a proactive tax strategy.
Best practices for sales and use tax compliance
As part of your strategy, make sure your finance team is aware of the nexus rules on a state-by-state basis. Remember that these rules change constantly, so missing an update could land you in hot water with the tax man.
You’ll also need to keep track of exactly what products and services are subject to sales and use taxes, as well as any exemptions. That way, you won’t have to worry about forgetting to collect or pay these taxes for any transaction.
It’s also a good idea to embrace technology and get software that can help you calculate sales and use tax. Most software options will also keep detailed reports and supporting documents for all your transactions, to make compliance so much easier.
Finally, don’t forget that you can always ask for help. With the assistance of a tax professional, you can ensure that your business stays up to date with its regulatory obligations and that you don’t give the IRS a reason to flag you.
Need help?
For assistance navigating sales and use taxes across states for your business, schedule a Discovery Call with one of our CPAs. With years of experience in multi-state taxes, we’re ready to guide you!
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