We launched Cohen & Company’s 2023 Summer CPE Webinar Series with a discussion on sales and use tax, an area that is top of mind for many of our clients these days. It’s at the forefront of conversations as states increasingly turn to sales tax as a more significant revenue source — seeing state sales tax revenues are up over $20 million since 2018. This increase was largely due to the 2018 Wayfair decision, which allowed states to not only levy sales tax on online transactions, but also on more businesses that were not physically within their borders. Despite these gains, states are bracing for a leveling off of sales tax revenue in the remainder of 2023 and further softening throughout 2024, in anticipation of an economic downturn.
As such, businesses need to be even more proactive in managing their sales tax obligations as states ramp up revenue generation and collection efforts. Companies must be vigilant in positioning and preparing themselves, specifically in four key areas: nexus studies, compliance, tax recovery (refund reviews) and audit defense.
First: A Few Key Wayfair Reminders
Before looking at the ways to best position your business, let’s take a brief look at the Wayfair case of 2018, which had a sweeping effect on the U.S. and the way businesses will be taxed for the foreseeable future. Below are some important items to keep in mind:
- Wayfair impacts all businesses that sell tangible personal property into other states.
- Physical presence nexus still exists; it’s just not required after Wayfair.
- All states that impose a sales tax now have implemented an economic threshold; generally sales into a state of $100,000 triggers economic nexus and a legal requirement to collect and remit sales taxes. Note that if you have property, employees or agents in a state but fall under its economic threshold, you likely still will have a filing requirement.
- Marketplace facilitators are required to collect sales tax on behalf of their sellers
- Wayfair was intended for sales tax; however, it’s now affecting other state and local taxes, as states are starting to apply Wayfair-like standards to determine nexus related to income, franchise, gross receipts and CAT taxes.
- State tax audits have increased since the Wayfair case, making audit defense crucial for businesses.
The bottom line is even though you may not have a physical connection with a particular state, you may still have a state and local tax filing requirement based on that state’s Wayfair economic thresholds and regulations.
1. Nexus Studies – A Foundational Element
Understanding your tax obligations, or nexus, in the states in which you conduct business is critical. A nexus study will serve as the foundation for three tools/practices that will help you remain compliant: risk assessments, Voluntary Disclosure Agreements (VDAs) and registrations/closure protocols.
Especially because of Wayfair, you could have nexus in states where no physical presence exists. It’s important to:
- Determine your nexus footprint and quantify the level of potential risk in each state (via your nexus study).
- Identify your options and work with your tax adviser to determine the best approach forward.
- Once you have a plan in place, follow through on it to come into compliance with taxing authorities and set your company on the right track.
Voluntary Disclosure Agreements (VDAs)
If your nexus study shows you have significant liability, a VDA may be the best approach toward compliance. A VDA:
- Limits the lookback period taxing authorities can review your records (36 or 48 months in most states).
- Often allows penalties to be waived.
- Gives you, the taxpayer, the lead in providing information, instead of the state auditing.
Additionally, most states allow your tax provider to apply anonymously, meaning we don’t disclose the name of the company until you have an agreement in hand. Some states also allow payment plans. At the completion of the VDA, you will be registered and will collect/remit sales tax going forward.
Note for Ohio sales tax: While many states have one combined account for sales and use tax, Ohio has a separate account for each. It can be confusing, and many businesses may miss setting up their Ohio use tax account filing, instead only focusing on sales tax. If you are headquartered in Ohio and do not file an Ohio Consumer Use Tax return, we strongly recommend evaluating your VDA eligibility.
A nexus study will also tell you if you are required to register in any additional states currently or perhaps may need to register in the near future. Assuming there is no need for a VDA needed, you will register with each applicable jurisdiction by opening an account and obtaining a sales tax permit. Similarly, if your business has sales tax accounts in jurisdictions where no future activity will occur, you may want to close those accounts and file final returns.
2. Compliance – Manage and Minimize
Having efficient filing processes and procedures is key to managing and minimizing your sales tax obligations and risk. That includes filing accurate, timely returns in the right jurisdictions and managing any tax notices. Automating your state tax function, properly managing your exemption certificates and creating taxability matrices are important tools to help accomplish your goals.
Automating your sales tax function can help your business minimize risk by limiting manual efforts, i.e., human error, and maximize your value. We often assist clients in evaluating the most practical options for their business and recommend the below:
- Solicit demos from different software providers to ensure you find the best fit for your business and budget.
- Once you select a platform, your tax engine will be the most helpful if it’s extensively tested and set up by experts who are familiar with the system and intimately familiar with your particular sales tax issues.
- Once a system is in use, conduct periodic monitoring, maintenance and evaluation of its effectiveness and output.
Exemption Certificate Management
Do you have a solid process in place for capturing and managing your sales tax exemption certificates? If you didn’t collect sales tax from customers, you need the completed certificate on file – especially if you are ever audited. In fact, not having these on file could make you more at risk for an audit, particularly if you are entering a VDA.
Work with your tax advisers to:
- Review and optimize your business processes and procedures for obtaining exemption certificates.
- Help ensure your certificates are accurate and complete.
Product Taxability Matrices
A taxability matrix is a tool your tax advisers can create to help you identify how your products/services are taxed by each jurisdiction. Particularly as you grow, this is a great roadmap that will help you connect the dots and remain in compliance. Specifically, a taxability matrix will:
- Help you better understand your business product offerings.
- Review revenue streams/product offerings.
- Analyze business revenues and taxability for each applicable taxing jurisdiction.
- Enable training/education opportunities.
Another critical part of compliance is evaluating and responding to any notice you receive. Never ignore a notice from a state taxing authority — it will only snowball into bigger issues. You either owe money, didn’t file a return or have been selected for an audit. Regardless of the reason, at the end of the day ignoring the notice will lead to costlier headaches down the road. At the same time, you need to be on the lookout for scam, or fake, notices from taxing authorities. Some bad actors are sending notices asking taxpayers to scan a QR code, send money they “owe,” etc. If something seems off — don’t ignore it — look up the taxing authority’s phone number yourself and call them directly.
3. Tax Recovery
Tax recovery, also known as tax refund reviews, is a process that allows your tax advisers to look for instances where you may have overpaid tax in a prior year. While states look for underpayments, a refund review allows you to proactively look for overpayments and any potential refund planning opportunities.
Who Is Tax Recovery for?
This process is applicable to many industries and entity types:
- Financial institutions
- Food and beverage companies
- Multistate companies
- Businesses headquartered in Ohio
- Entities with significant A/P purchases
- High-growth companies
How Does Tax Recovery Work?
- Your tax advisers will review your purchase information for potential refund opportunities and exposure items.
- Together, you will discuss potential refund opportunities/exposure items and cost/benefit of filing for a refund. You can file a refund claim for the past three or four years, depending on the state.
- Once you and your tax adviser agree, your adviser will drive the refund process with state taxing authorities.
4. Audit Defense
As state revenues are projected to decline, a surefire way for states to increase their revenue is to ramp up state tax audit activity. The best defense is always a strong offense. The systems and processes already mentioned in this article will help you be prepared and catch issues before an audit even arises. File all returns correctly, timely and as error-free as possible.
If you are selected for an audit, incorporate your tax advisers into the process early. They can help manage communication with the auditor, work with them on information to be reviewed and a sample agreement, leverage their sales tax knowledge to minimize audit liabilities and potentially assist you in reducing penalties owed. Post audit, your tax advisers can help you address significant issues, necessary changes and even provide training and education.
Protecting What’s Yours
Sales and use tax will continue to serve as revenue drivers for states in the near future. Be proactive in your planning, timely and aware of the ways you can position your company to be compliant and minimize risk. Nexus studies, vigilant compliance, refund reviews and audit defense are all critical areas to discuss with your tax advisers — before you receive a notice from a taxing authority.
Contact Nick Longo at email@example.com, Mike Fink at firstname.lastname@example.org, Scott Zielaskiewicz at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.