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Sales Tax Exposure Revisited

Monika Miles

In our practice, we see many new clients who have sales tax exposure issues. And we, of course, are happy to help them identify and then mitigate that exposure. As we discussed in our blog last month, “Sales Tax Non-Compliance: What’s Your Exposure“, sales tax exposure can add up quickly. Sales tax is a gross tax and if not properly collected from the buyers at the time of the sale, it can come back to haunt the seller later.

In this month’s blog, we add a little more detail to the example we started last month, just to show how these liabilities can really add up—and how we can assist in remedying them.

When a client comes to us with multi-state tax issues, we start by asking the questions:

  • Does the company have nexus in the state in which it sells its products? If yes, since when?
  • Is the product taxable?
  • Are there any exemptions?
  • What is the potential retroactive exposure?

Here’s a detailed example of how that plays out:

Last month, we examined the activities of ABC Company. Recall that the company is growing and based in Florida. In 2010, the company hired Jane. She lives in New Jersey (NJ) and is responsible for making sales in the Northeast, namely Massachusetts (MA), New York (NY) and Pennsylvania (PA). Her presence in NJ creates nexus, or a taxable presence, in the state, and it likely does in the other states as well.

Since 2010, Jane has created $200,000/year worth of sales in MA, NY, and PA. The company sells software that is downloaded electronically.

What is ABC’s potential sales tax exposure?

For ABC Company, Jane has created nexus in NJ just by living and working on there on ABC’s behalf, and so, if the company has any sales in NJ, those sales are subject to sales tax. She also travels to the other three states on a regular basis (about 8-10 times a year). By traveling to these other states regularly and engaging in sales activities, she has created nexus in the other states as well. Therefore, if she sells taxable products in those states, ABC Company will be liable for collecting and remitting the sales tax in MA, NY and PA.

The next step is to determine if the products that are sold are taxable in the states in question. In this case, all three states, MA, NY and PA, tax electronically downloaded software.

Calculations for determining the sales tax liability: *

PA: 6 years X $200,000 (sales) = $1,200,000; $1,200,000 X 8% (approximate rate) = $96,000

The tax liability is approximately $96,000.

NY: 6 years X $200,000 (sales) = $1,200,000; $1,200,000 X 8.875% (approximate rate) = $106,500

The tax liability is approximately $106,500.

MA: 6 years X $200,000 (sales) = $1,200,000; $1,200,000 X 6.25% (approximate rate) = $75,000

The tax liability is approximately $75,000.

Total tax liability for all three states: $96,000 + $106,500 + $75,000 = $277,500

Wow, that’s a significant liability! But wait, there’s more. On top of the amount of tax owed, the states will also tack on varying penalties and statutory interest. For purposes of our example, let’s assume a 25% penalty and a 5% annual interest rate. (Both are fairly representative of actual rates charged.)

Calculations for determining the tax penalty and the interest: *

PA: $96,000 X 25% = $24,000; $96,000 X 5% = $4,800

Total amount owed to PA: $96,000 (tax) + $24,000 (penalty) + $4,800 (interest) = $124,800

NY: $106,500 X 25% = $26,625; $106,500 X 5% = $5,325

Total amount owed to NY: $106,500 (tax) + $26,625 (penalty) + $5,325 (interest) = $138,450

MA: $75,000 X 25% = $18,750; $75,000 X 5% = $3,750

Total amount owed to MA: $75,000 (tax) + $18,750 (penalty) + $3,750 (interest) = $97,500

Total amount owed for taxes, penalties and interest for these 3 states: $124,800 + $138,450 + $97,500 = $360,750

How can a company reduce its liability?

If a company chooses to voluntarily disclose to a state (or states) that it potentially owes sales tax, most states will allow companies to enter into voluntary disclosure agreements (VDAs), which will limit the lookback period (often to 3 or 4 years) and generally waive penalties.

Sample calculations under a 4 year VDA *

PA: 4 years X $200,000 = $800,000 (sales)

$800,000 X 8% (approximate rate) = $64,000; $64,000 X 5% (interest rate) = $3,200

PA tax liability: $64,000 + $3,200 = $67,200

NY: 4 years X $200,000 = $800,000 (sales)

$800,000 X 8.875% (approximate tax rate) = $71,000; $71,000 X 5% (interest rate) = $3,550

NY tax liability: $71,000 + $3,550 = $74,550

MA: 4 years X $200,000 = $800,000 (sales)

$800,000 X 6.25% (approximate tax rate) = $50,000; $50,000 X 5% (interest rate) = $2,500

MA tax liability: $50,000 + $2,500 = $52,500

Total tax liability: $67,200 + $74,550 + $52,500 = $194,250

Let’s compare the numbers. If the company does not file a VDA and the state finds them, they will owe approximately $360,750. However, if the company chooses to file a VDA with each state, ABC Company will pay approximately $194,250. The company will save $166,500. That’s a pretty large incentive to come forward voluntarily! Obviously our numbers are nice, round estimates, but the point is, it’s generally beneficial for a company to engage in a “clean-up” project once exposure has been determined.

*Note that all calculations are estimates and approximations for purposes of this example.

Monika Miles

Monika founded Miles Consulting Group which focuses on multi-state tax consulting, helping clients navigate state tax issues such as sales tax and income tax in interstate commerce, including e-commerce.

Prior to forming the firm, Monika worked for 12 years combined in Big 4 Public Accounting and private industry. Monika has provided such services as federal and state income/franchise tax compliance and consulting, sales/use tax consulting, audit support, and credits and incentives reviews. She has served clients in a variety of industries including manufacturing, technology, telecommunications, construction, utility, retail and financial institutions.

Monika graduated from the University of Texas at El Paso (UTEP) with a BBA in Accounting/Finance and has a Masters in Taxation from San Jose State University.