The pandemic has been and will be remembered as one of the most impactful global events of our era. An unprecedented challenge was thrust upon the medical, government, and business community that will clearly change many of the behaviors of our society in the long run.
When state enforced lockdowns and the advice of medical professionals globally forced the ceasing of business as usual for industries across the country, businesses both large and small were left with one choice: adapt or die.
In an inspiring display of free market forces, most businesses chose to adapt and did so quickly. By the end of March 2020, a stunning number of businesses had employees working from home, restaurants were full curbside and delivery, retailers and customers were shifting to e-commerce in ways they were not previously, and everyone had ZOOM on their electronic devices.
When your back is to the wall, you act decisively in order to do what you must to survive, weighing options and making the right decisions when they are needed most. However, do you know what many businesses are not considering when making decisions on the precipice? – Sales tax.
Why care? Because businesses are held legally liable for uncollected sales tax or tax calculation errors. Combined sales and use tax rates can be as high as over 9.5%. Is your business prepared to take a hit of 9.5% of gross sales plus penalties and interest?
Sweeping changes to operations, especially ones that must be done swiftly without tremendous planning, are going to trigger implications in the tax that, according to the Tax Foundation, provides the second largest source of state and local tax revenue. Most businesses, and much more individuals, do not have solid processes to constantly monitor changes in operations for such consequences. Allow me to highlight my top 3 implications:
Mistake #1 – Remote Employees are expanding your sales tax obligations
The first critical step in determining if your business must be concerned with state sales tax is evaluating what is referred to by tax professionals as “nexus”. Nexus is the connection between a taxing jurisdiction and the taxpayer. The US Supreme Court has interpreted certain clauses of the US Constitution to limit a taxing authority’s influence only to those businesses that have “sufficient nexus” with them. What I refer to as “traditional nexus” is any nexus that was in constitutional favor prior to July of 2018 (more on that later). Traditional nexus is predominantly dictated by physical presence of people or property in the jurisdiction of the taxing authority, whether under the direct or indirect use by the taxpayer. The most common instance of implications in traditional nexus during the pandemic is in the shift to work from home.
Let’s say your business sells the infamously highly taxable “widgets” via the Internet across the US, with one physical headquarters location in Pennsylvania. Since your business only has employees or property in PA, and you are only in the business of selling online with generally less than $100,000 in sales or similar level of business into each state (again, more on this in Part 2), WidgetsRus only has nexus in PA. In this hypothetical example, no other state has the level of connection with you necessary to impose a tax burden on you or require you to become a collecting agent of the state. However, when the pandemic began to reach consequential levels in March, you made the executive decision to allow all employees who could perform their work remotely to work from home for the remainder of the year. Some employees live in neighboring Ohio and West Virginia, and some choose to travel to friends and family in other states to avoid coronavirus hotspots.
You made the right call as a business owner for your operations and employees. Now, however, you have members of your organization physically in states where you weren’t previously. In many states, regardless of their specific functions, their presence alone creates sufficient nexus. Perhaps these employees have company owned assets with them, or even worse, inventory. This only makes the case for nexus stronger. Now, these states have valid reasons to require you to determine the taxability of your products, register for the appropriate tax account, collect the required tax or applicable (and validated) exemption certificate, and remit that tax to the state. Whether or not you chose to collect that tax is not a big concern for them at this point because you are now on the legal hook. Whether you collect it or not, you will have to pay it.
Some states who are allowing leeway during the state of emergency are: Connecticut, Kentucky (on a case-by-case basis), Maine, Massachusetts, Minnesota, New Jersey, Oklahoma, Pennsylvania, Rhode Island, and South Carolina.
States who have confirmed remote workers due to COVID-19 will continue to create nexus are: Colorado, Indiana, Michigan, Ohio, Virginia, and the District of Columbia.
Lastly, it would not be a state and local tax topic if there wasn’t at least one “in between” category. Vermont has not issued a direct answer, but they did state to Thompson Reuters: “We have no intention of changing our audit program or focusing audit inquiries to identify workers working temporarily from home during the COVID-19 emergency.”
The remaining states with a sales tax have not issued guidance one way or the other. It should be assumed for the sake of registrations and voluntary disclosure agreements that while they may choose to decide internally not to actively pursue such businesses, they have not made such decisions public and the legal obligations still apply. The remaining states with a sales tax have not issued guidance one way or the other. It should be assumed for the sake of registrations and voluntary disclosure agreements that while they may choose to decide internally not to actively pursue such businesses, they have not made such decisions public and the legal obligations still apply.
Keep in mind, earlier I spoke of “traditional nexus” and not just “physical presence nexus”, because there is more to this than just your employees, property, or inventory. Over the years with physical presence nexus as the general law of the land and other forms of nexus being limited by SCOTUS, states got creative in how they could stretch those parameters to apply to derivatives of such presence.
If WidgetsRus has a sister company, and part of the response to the pandemic was to utilize that sister company in another state to perform certain actions, that agency relationship could create nexus outside of NY. Perhaps WidgetsRus chose to take advantage of certain vendors located in other states to perform actions for them as they closed their offices? An agency relationship has formed, and that can create nexus too.
As I said earlier, none of these scenarios were poor decisions by the business, and with adequately managed tax processes, sales tax should not tip the scale in how these decisions are made. However, businesses should be prepared to take appropriate action to ensure they are not liable for uncollected tax.
Mistake #2 – If your remote employees didn’t create nexus, your remote sales boost / pivot did
Did traditional nexus exhaust you? If not, then allow me to introduce “economic nexus”. Earlier, I mentioned July of 2018 and $100,000 in sales. This is where that comes into play.
In July of 2018 the era of physical presence being the chief law of the land came to an end when the landmark SCOTUS decision in South Dakota v. Wayfair, Inc. set the precedent that economic nexus, even in the absence of physical presence, could be considered sufficient. It did not replace the physical presence standard, but became a new standard in addition to it, vastly expanding the reach of state taxing authorities. South Dakota’s law considered sufficient economic nexus to be $100,000 in sales and/or 200 separate transactions.
Immediately states with a sales tax began adopting economic nexus laws, and now all but 2 states and the District of Columbia with a statewide sales tax have such laws in effect today (however, note that the two hold out states, Missouri and Florida, have taken legislative action this year that is expected to take an unopposed journey to becoming state law). Most states you encounter have played it safe by adopting South Dakota’s exact threshold parameters, while others have taken playing it safe a step further by instituting higher thresholds, requiring both thresholds to be met, or eliminating the transaction parameters altogether. Few states have instituted more aggressive thresholds, and the Kansas Department of Revenue has been widely criticized for enacting rules without any small business safe harbor thresholds at all, even though no official economic nexus laws have been passed. Despite condemnation by the Kansas Attorney General himself, the Kansas DOR has stated they intend to enforce tax collection on all taxable sales into Kansas until intervened by courts or legislature.
E-commerce has increased tremendously in the last few months as people have turned to remote sellers; not just for convenience but for the safety of the transactions as they maximize social distancing. If your business has reached a certain level of economic activity delivered into most US states and the District of Columbia, then you have likely triggered sales tax obligations. This will not have the same potential for flexibility as nexus triggered by remote employees. States will impose tax collection and remittance responsibilities on you regardless of the pandemic circumstances.
Another factor that concerns me regarding economic nexus this year is timing. It has now been two and a half years since the Wayfair decision. States have been slower to engage in sweeping enforcement than we expected, but I believe that honeymoon to be over. States are suffering from unprecedented drops in revenue due to tax deferments and economic stagnation in this time of crisis, which has also brought on increased public service costs. States will need to make up that revenue and then some, and I believe they will do it through broader enforcement of economic nexus, ramping up audits, and encouraging legislators to expand the tax base (particularly through taxations of digital goods and services). Do not let your business end up as one of those on the chopping block, take this warning seriously!
It is very simple to get a high-level understanding of your potential for economic nexus. Go to Allyn’s website and use our State by State Wayfair & Economic Nexus Reference Map. It gives details on each state’s thresholds, critical details on such thresholds, enforcement dates, and more. You can even download the chart, as have many of our clients, competitors, and more, to use as reference. Ultimately, I recommend getting with a sales tax expert if you have substantial remote sales to analyze. There are nuances that will both increase and decrease your risk of nexus that an expert can take advantage of or help you avoid. They will also know the right course of action such as proactive registration or the preparation of a voluntary disclosure agreement. A reliable consultant will ensure their services create value for your business through increased compliance, tax savings, or audit risk minimized.
Mistake #3 – If you aren’t collecting and verifying exemption certificates, then you will pay tax on your exempt sales
The general rule is all tangible personal property is subject to sales tax unless specifically exempt, and all services are non-taxable unless specifically listed as taxable under state and local law. As always in state tax, exceptions and differences apply, but note if your customer claims they are exempt from tax due to their industry, status, or activities, documentation proving this must generally be provided to you. This documentation is known as an “exemption certificate”, the most commonly encountered of which is the “resale certificate”. All taxable sales under state law will maintain their status as taxable unless you can provide an auditor with one of these certificates.
It is not just about collecting certificates; more businesses of scale do that than not – it’s about validating certificates to ensure at the time of audit they will hold water and as well as reliably storing them for retrieval when requested years later. This is typically where we as sales tax professionals see the most dramatic differences in audit results between processes outsourced to professionals and those managed in-house. Now, it is not uncommon for auditors to allow taxpayers to collect current exemption certificates at a time of audit to apply to sales going back years prior, which means that lacking a process does not always equate to liabilities under audit. However, trying to conduct exemption certificate management (ECM) retroactively is stressful, harder to encourage participation from customers, and in unfortunate cases not an option at all.
Take a recent situation we saw as an example. We had a client come to us to assist with a sales tax audit who was completely managing certificates in house. When evaluating their ECM, we found a significant certificate gap from a “former” customer of theirs who they had exempted from thousands of dollars in tax.
There were two issues with the certificate. First, the certificate was made out to the client’s former name and state tax account number. Years prior, they had gone through an organizational change, and while most certificates were updated, this old one was not corrected.
Second, the client’s customer had been purchased by another entity and fully absorbed, therefore they no longer existed. It would be impossible to collect a certificate from that customer – there was no one to contact!
This certificate was issued to a different company, before the current client existed, by a customer that is no longer in business. It is impossible to replace this certificate in a way that covers the audited transactions and requires a bread crumb trail to line this exemption up the said transactions. It certainly does not meet the legal requirements of a valid exemption certificate. Negotiations with the auditor is the only method of relief now, and beyond that, attempts through the court system.
It is the unfortunate reality of difficult economic times that your customers may go out of business or otherwise cease to operate as the entity they formerly were. If you aren’t being proactive at the time of sale, you are setting yourself up for significant tax cost. As I said earlier in this article, does your business have the margins to take an up to 9.5% hit on your “exempt” sales?
Tips for the Taxpayer
Mistake #1 and #2
Start immediately on a thorough nexus review for all nexus types across the states. Your earliest point of nexus is the day your tax liabilities began, and though this article has been specific to COVID-19 actions, nexus can go all the way back to the inception of your business with certain triggers.
Conduct a survey of your employees to find out where they have been remotely working through the pandemic and when they started in those locations. Ensure your employees know to keep you notified of such moves, and in certain cases you may want to restrict employees from working remote in certain problem states.
Part of that review will be analyzing economic nexus by assessing sales and transactions per state. This, like traditional nexus, can go back prior to COVID-19 but will not likely go past the 2018 Wayfair decision.
All the above have nuances and exceptions. Consult with a state tax expert, it will be the most effective and economical decision in the long run.
Immediately add to your accounts receivable process the collection of exemption certificates from all customers to which you make taxable sales or potentially taxable sales and they are claiming exemption. This should include states where you both are and are not registered (worst case scenario you are overprepared, and the additional administrative burden is relatively low if implemented correctly).
Evaluate the gaps you have currently by validating all current certificates and requesting new ones where insufficient or missing entirely. Begin charging tax on taxable sales where you are unsuccessful in obtaining a valid certificate from the customer and you are registered with the state to collect tax. Assess the possible need to charge tax on prior transactions you do not have a valid certificate for.
There are four standard approaches to ECM: 1) In-house manual management (not recommended), 2) outsource to a tax consultant for manual management (not recommended) 3) In-house management using ECM technology solutions (minimum recommended) 4) Outsource to a tax consultant who leverages ECM technology (recommended). When outsourcing, evaluate – is the vendor a tax expert who leverages tax technology, or, a technology firm first and tax services company second? Focus matters. Remember collection is rarely the main issue, validation is.
Have a question? Contact Jordan Perri, Allyn International.
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