BY JOE KRISTAN, CPA, Partner, Eide Bailly
Sales tax audits are the worst.
It’s not just the way some auditors seem to use Calvinball rules to determine what is taxable, or how much you should collect from your customers. The worst part is you can end up paying 6%, 8%—10% in some places—of some of your gross receipts to a state, even if your margin might have been close to zero. Oh, and interest and penalties, too. And best of luck in getting your customers to send you checks to cover the sales taxes you should have collected from them.
It’s bad enough to keep up with sales tax audits in just one state. Now, thanks to the U.S. Supreme Court, you might have to collect sales tax from your customers in 45 states. Yes, but some states don’t collect sales tax.
Life was simpler back in the heyday of the mail-order catalog. In 1992, the Supreme Court Quill decision said businesses didn’t have to collect sales tax from buyers in a state unless the business had a “physical presence” in the state. While most out of state buyers were supposed to pay “use tax” in their home state to make up for the sales tax catalog merchants didn’t collect, few did.
As internet sales replaced catalog sales, states began to poke holes in the “physical presence” rule—for example, by saying “cookies” left on a shopper’s computer drive created “physical presence.”
The states won their long battle last year when the Supreme Court Wayfair decision overturned Quill and ended the “physical presence” requirement. The Supreme Court upheld a South Dakota law requiring sellers to collect sales tax if they met one of two tests in a year:
- Over 200 transactions in South Dakota
- Over $100,000 in sales in South Dakota
In response, over 20 states (including Iowa) have changed their rules to mimic the South Dakota law upheld in Wayfair, with others expected to follow.
Not Just Amazon
You might be thinking that this means nothing to your business. After all, your business isn’t Amazon. You make most of your sales the old-fashioned way, with phone orders from reliable old customers.
That’s a mistake.
Nothing about the new rules requires any Internet involvement. If you have $100,000 in sales in a Wayfair state, you need to start collecting there—whether the order comes in online or by Pony Express.
What to do?
States are always looking for revenue. They are aggressively using their new powers under Wayfair to go after out-of-state sellers; after all, they are potential taxpayers who don’t vote. That’s why businesses should take steps to make sure they don’t get stuck with a big sales tax liability.
A good way to start is to review your sales by state to see where you exceed the Wayfair sales limits. While not all states use those exact rules, many do. Also, the more you sell in a state, the more likely you are to trigger sales tax collection requirements some other way. The Wayfair decision didn’t replace the old rules to determine whether you have “nexus” in a state, requiring you to collect sales taxes; it just added new ones.
The old ways to get nexus can include:
- Physical presence in a state, including employees, real estate, or tangible personal property.
- Independent contractors working for the business in the state.
- Affiliates located in the state working with the business to promote its sales.
- Storage of tangible personal property in the state.
- Distribution of tangible personal property.
- The business engaging in trade shows within the state.
- The business engaging in drop shipment activities in the state.
It doesn’t take much.
Don’t assume it’s not taxable.
Every state has different rules for what items are subject to sales tax. Just because Iowa doesn’t want to charge sales tax on something doesn’t mean Minnesota feels the same way.
Also, don’t take “sales for resale” for granted. You might “know” that your buyer only buys for resale, but a state tax auditor might not care what you know if you don’t have paperwork from your customer (a reseller certificate) to back it up.
Help is out there.
Sales tax rules are complicated, and the stakes are high. If you aren’t sure you have your sales tax compliance under control, contact your tax advisor or an Eide Bailly professional.
| Joe Kristan