Steps to Becoming Compliant: Sales and Use Tax

Jan 13, 2023

The majority of U.S. states require businesses to collect and remit sales and use taxes, regardless of whether the business is physically located in the state or not. Tackling sales tax upfront is critical to reducing potential tax liabilities of the company and taking advantage of passing the tax burden on to customers. Becoming compliant, while daunting upfront, is not as difficult as it may seem before starting. In fact, the process can be broken down into 6 simple steps:

  • Step 1: Determine the Company’s Nexus and Filing Obligations
  • Step 2: Analyze Your Product/Service Taxability
  • Step 3: Evaluate Potential Tax Exposure
  • Step 4: Reduce and Disclose Historical Tax Liabilities
  • Step 5: Choose and Implement a Sales Tax System
  • Step 6: Maintain Compliance

Determine the Company’s Nexus and Filing Obligations

Determining which states your company has nexus is an important first step. All states that impose sales tax have economic presence nexus statutes, with sales thresholds ranging from $100,000 – $500,000 on an annual basis. There are also a few states that have transaction thresholds, though it has been on the decline in recent years. Foreign businesses selling into the U.S. are also subject to each state’s economic nexus statutes and are required to collect and maintain compliance with the sales and use tax requirements.

Analyze Your Product/Service Taxability

Furthermore, states and local jurisdictions have their own legislation describing which products and services are subject to sales and use tax, making it imperative for companies to determine which of their products or services are subject to the tax in states where they have nexus.  As such, make sure to spend the requisite time to fully understand whether the product or service you are providing is taxable or nontaxable in the states you’re selling to.

Evaluate Potential Tax Exposure

After identifying in which states a company has nexus and which products/services are subject to tax in those states, it is then time to determine outstanding tax exposure for prior periods. This involves estimating by both product/service and jurisdiction the tax exposures for sales and use tax using historical data.

Reduce and Disclose Historical Tax Liabilities

Once estimates are determined, the company should then make efforts to reduce and disclose taxes. There are two common courses of action:

  • Sales and Use Tax Mitigation: One means of reducing tax liability is to obtain customer documentation regarding favorable adjustments. In this case, companies should collect tax exemption certificates, proof of use tax payments, etc. from customers to decrease the total amount owed by the company.
  • Voluntary Disclosure (amnesty programs): One way to significantly reduce historical tax liabilities and therefore penalties and interest, is for companies to decide to voluntarily disclose liabilities to the taxing authority, or in certain cases, participate in an established amnesty program.

Choose and Implement a Sales Tax System

Since taxing jurisdictions have control over the rate charged, one simple way to reduce risk is to implement tax automation software that can streamline calculations and help companies maintain compliance. Implementing an automated system can also serve to improve efficiency and reduce costs.

Maintain Compliance

Sales and use tax compliance is an ongoing effort. Even after determining nexus and resolving any historical liabilities, companies still need to remain up-to-date and informed of the changing laws and rates in each jurisdiction where they have nexus. Investment in advanced technology can greatly reduce the burden of remaining compliant and allow companies to shift resources to value-added activities.

To learn more about how sales and use tax can impact your organization and for assistance with sales and use tax related issues, please contact Tim Reynolds @ tim@dhw.net or 828.322.2070.