In our multi-state tax consulting practice in Silicon Valley, we often see that sales tax is an afterthought in companies’ finance departments. Many companies have net operating losses (NOLs) for income tax purposes, and they often don’t consider the ramifications of sales tax.
Further, many of our clients sell intangible products – like software, SaaS platforms or digitally downloaded information – and those items don’t SEEM to be taxable. Plus, in California most of those items do qualify for sales tax exemptions; but that’s not the case in all states.
As such, with an already long “to do” list, CFOs and corporate controllers may not put sales tax concerns on the front burner. In another blog post, we explained why it’s not a good idea for a company’s corporate controller to take on the burden of sales tax. In some organizations, however, these responsibilities fall to the CFO. This post explains why this likely isn’t the best option, either.
The CFO And Sales Tax Issues
As CFO, you’re expected to think strategically about all things finance. Admittedly, sales tax compliance doesn’t seem very strategic, but ignoring the filing responsibilities in multiple states can end up being a strategic blunder.
Consider this: Your software- or SaaS platform-based company generates $10 million in revenue per year and sends salespeople out to various states throughout the year. Let’s assume that just 35% of your sales are generated in states that tax SaaS platforms (like New York, Arizona and Texas). You could have a potential understated sales tax liability of $300,000 for just one year. Your financial statement liabilities are potentially materially understated, you have audit exposure in multiple states, and if you don’t come forward in those states before they find you, the company will also be subject to a variety of penalties!
We deal with issues like that example all the time. As we meet with CFOs and controllers, it’s clear that there is a distinction between “financial” people and “tax” people; we find that even very competent internal finance teams don’t generally fully address all the potential state tax issues that may be present at their companies. It’s important to stress that sales taxes are gross taxes, and Net Operating Losses (NOLs) won’t offset them. As with the many other things on the “to do” list, it is key to address sales tax issues early – before the liability grows to a material level.
CPA Firms And Sales Tax Issues
Unfortunately, many businesses mistakenly believe the outside CPA firm they hired to complete their tax returns is handling sales tax issues as well. However, we find that many smaller CPA firms don’t specialize in sales tax consulting, which includes nexus, taxability across state lines, potential exposure analysis, etc. Your outside CPA firm may have the income tax issues handled, but they likely haven’t looked deeply enough at how sales tax affects your company. Often, they assume that the client has already addressed the sales tax issue. Or, worse, they don’t really have the expertise so they don’t bring it up as an issue.
Economic Nexus And Sales Tax Issues
Following the Supreme Court’s Wayfair decision last year, state sales tax issues became even more complicated. Most states have adopted economic nexus provisions which make it much easier for retailers to establish nexus and be liable for collecting and remitting sales tax their states. As we’ve reported before, almost all the states (except for a small handful) have passed economic nexus legislation. The states vary on their thresholds ($100,000 of sales OR 200 transactions are common thresholds, with states like CA and TX at $500,000 of sales), and effective dates.
For example, let’s say you are a SaaS company. You send employees to other states as part of a traveling salesforce, plus you rent server space in a couple of nearby states and house servers in another state across the country. You have established physical presence nexus in a few different ways – but that’s hopefully nothing new! Now, layer in that you may have exceeded an economic nexus threshold in several other states, without ever setting foot into them. Now you have a registration, reporting and collection responsibility. Many companies think that because SaaS is a service, state sales tax doesn’t apply. However, it’s more confusing than that because some states see it as taxable software. SaaS doesn’t easily fall into existing tax definitions, leaving room for interpretation – which not all states interpret the same way.
Interpreting all the new Wayfair legislation is confusing beyond SaaS companies, too. Because of the various ways states define their thresholds or varying taxability of products or services, we often see a lot of confusion in a variety of fields including medical products (i.e.; what’s a non-taxable prosthetic device or a drug in one state may be categorized as taxable in another), software (custom versus customized, versus off the shelf), and even some retail (food items, some clothing, etc.).
Sales tax compliance has become much more complicated, as companies are needing to register, collect and remit, and file sales tax returns in many more states. Keeping up with each state’s changing thresholds and taxable items, and how they apply to your business, is much more than many CFOs, CPAs or finance departments have the capacity to handle on their own. Even CPA firms, especially local firms and even some regional ones, don’t often specialize in sales tax; we often see clients getting incomplete advice in this area.
Money Events And Sales Tax Issues
We often see the CFO become interested in sales tax during “money events” – when they need a loan or other outside financing (and audited financial statements to secure that financing), or during a merger/acquisition (M&A) transaction. Both of these events would bring potential sales tax liabilities to the forefront.
For example, a full financial statement audit will bring to light whether the company has examined its potential multi-state sales tax exposure and accrued for any such liability. During an M&A deal, the acquiring company will engage in due diligence to see if the target company has outstanding liabilities, including sales tax. Ideally, a company would engage in such an analysis before the M&A deal, but we often find that it’s the first time the sales tax exposure analysis has been considered. And again, with the issues around the Wayfair decision, more companies are finding they have exposure that must be addressed.
If your busy CFO or overworked finance department is trying to manage sales tax with limited training or comprehension of the issues, it’s likely they may not be aware of a huge potential liability in your company’s future, and this could be detrimental for any impending “money events.” We’ve seen deals fall apart because of the sales tax exposure. You don’t want to need to explain a huge sales tax liability right before trying to secure a loan or closing a merger.
Your Accounting Group And Sales Tax Issues
So, what can you do to mitigate the potential sales tax issues that might be bubbling up at your company? Have your accounting team ask some questions.
- Do they know, operationally, what company employees and third-party contractors are doing on the company’s behalf across the United States? The accounting group is sometimes the last to know what the sales group is doing. If you currently have (or retroactively have had) salespeople traveling, trainers training or people installing in other states – look out! You may have a sales tax issue.
- Are sales into any state at $100,000 or more? If so, economic nexus likely kicks in and the company may need to take steps to become compliant.
- Are they aware of the various products the company sells and the potential sales tax consequences of those sales in states beyond your home state? Things are that are exempt in one state may not be exempt in another.
- How do they keep up with states’ changing sales tax provisions? Do they have a clear understanding of how different state tax departments define products vs. services, especially in the digital landscape?
Next Steps For Your Business
Be proactive in dealing with your state sales tax issues!
Have a question about sales and use tax? Contact Monika Miles.