The coronavirus pandemic has left state governments with high expenditures and shrinking tax revenue. New York State alone has reported a $13.3 billion shortfall, and states are expected to run a $105 billion deficit in 2020.
Many states are providing sales and use tax relief to businesses affected by the pandemic. However, once the worst passes, or towards the tail end, state governments are going to have to make up for all of the money they’ve lost. To do so, states will look for ways to increase revenue with taxes.
We think states will use sales tax as a primary remedy to their revenue problems. The reason is simple: South Dakota v. Wayfair gives states the power to expand sales tax liability and adjust regulations in unprecedented ways.
If your business has a presence in multiple states, then this could have a significant impact on your operations. Here are three things we think you need to prepare for.
Since Wayfair introduced the concept of economic nexus, sellers are liable for the collection of sales and use tax if they meet or exceed a state’s economic threshold. Companies reach this threshold if they make more than a certain amount of sales or transactions per year in the state.
The thing is, these thresholds are pretty arbitrary. The states have the power to set them wherever they’d like. The first year after the conclusion of the Wayfair case saw states set thresholds and retroactive legislation that bolstered their revenue.
Now that most states are in dire financial situations, they could easily lower thresholds. If a state lowers their threshold, it would make more businesses liable to collect and remit sales tax in that state. As a result, state revenue from sales tax would go up and many businesses would have more liability.
If states start lowering their economic nexus thresholds, you could develop new sales tax liability you’ve never had before.
A state sales tax audit occurs when a state agency inspects the books and records of a company. Specifically, they’ll evaluate the correctness of sales tax paid on invoices and use tax accrued on invoices. The auditor’s goal is to find underpaid sales tax and to make an assessment of liability, penalties and interest that the company has to pay. This increases revenue for their state. And, as we mentioned, this is a big pain point for most states right now.
States get to decide who they audit and how frequently and aggressively they do it. Texas audits, for example, have a reputation for being among the toughest in the country.
States in need of revenue can easily increase their auditing frequency without any need for new legislation. If multiple states where you do business double down on auditing, your probability of getting audited goes way up.
And while an auditor’s goal is to make sure everyone pays their fair share of sales tax, pressure from departments of revenue could make them more aggressive with their assessments.
In summary, audits can be very costly for businesses, and there’s a chance they’ll become more frequent. If there’s a chance you have exposure, it’s better to get compliant now than pay for it later.
Getting compliant is often easier said than done, but it’s possible with the right resources and knowledge in your corner.
One quick way to minimize your potential audit exposure is to get your exemption certificates in order. They’re low hanging fruit for auditors, and carry huge penalties and exposures if found missing.
The good news is this could be an easy win to reduce your exposure. Just start collecting exemption certificates if your business activities require them. This will limit your exposure in the event of an audit.
Determining whether the sales of a product is taxed is relatively straightforward. A state either charges sales tax for the item, or it’s exempt. The taxation of services, though, is much more complex.
Typically, states can only tax services if they specifically enumerate that category of service in their laws. Most states tax only a few services. On the other hand a few tax almost all services, like Hawaii, New Mexico, and South Dakota. Connecticut and Texas tax many services.
State looking to increase sales tax revenue could expand the definition of what services are taxable.
If you provide services that are currently not taxed by states you provide those services in, you should be prepared for that to change. You could develop new tax liability in the near future.
It’s impossible to predict the future of sales tax, especially as the world’s never been more uncertain. But these are the things we things we think will happen.
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