November 29, 2022

Sales Tax Is Constantly Evolving: What Retailers Need to Know

Sales Tax Is Constantly Evolving: What Retailers Need to Know Year-End Tax Guide

Sales tax is deceptively simple. A company sells something, collects tax, files a return, and sends money to the state. However, the products we use in our day-to-day lives have changed significantly in recent years and that means laws regarding sales tax have changed as well.

In 2018, the United States Supreme Court’s decision in South Dakota v. Wayfair, Inc. opened the door for states to adjust their nexus rules. As a result, states implemented sales and transactions thresholds for nexus. The most common and lowest threshold is $100,000 or 200 transactions. This ruling was a major change for companies that sell taxable goods, but we still see clients and prospects that have not addressed their additional sales tax requirements.

Over the years, states have changed their views on the taxability of products. Many states, such as Maryland, have expanded their definition of taxable products to include most digital products. States such as Pennsylvania, Minnesota, and Washington have determined that non-fungible tokens (NFTs) are taxable in their state. While these states did not previously issue guidance on NFTs, they did have guidance on digital products. States have historically utilized similar items to determine the taxability of products, so even if a state has not explicitly deemed NFTs taxable, it may still expect retailers to collect sales tax based on digital product laws already on the books.

This creates a grey area for retailers, but to be safe you should err on the side of collection to reduce your risk. This may mean collecting sales tax when your competition is not. It is important to stay in contact with your advisor to understand the current taxability of products and potential exposure. In the coming years, we expect states to continue to expand their list of taxable items.

Sales tax sourcing can also be difficult in the digital age. For example, software as a service (SaaS) companies often have a difficult time determining where their customers are located. When software was sold on CDs, it was easy to track where they were shipped. Today, a company may have a contract with an entity that allows employees located in multiple states to use the software. If this information is not easily obtained the SaaS company may need to use less than optimal sourcing, such as the customer’s billing address.

NFTs also have sourcing issues. Since many NFT transactions happen via cryptocurrency, the seller may not have enough information to identify the location of their customer. Washington provides the best guidance in this circumstance: it requires a taxpayer that has no information on its customer to utilize origin-based sourcing, which is very different from the standard destination-based sourcing. Taxpayers can plan around this issue if they include their advisors as they establish their business. However, if they don’t plan ahead, the origin sourcing approach means that all NFTs could end up being taxable, even if customers don’t live in states where NFTs are taxable.

Sales tax is important because it is collected by retailers, and thus a liability to retailers if uncollected. Not collecting sales tax is akin to giving customers an unwritten discount. If a retailer that has created nexus (and thus is required to collect from consumers) fails to collect, the retailer assumes the customer’s liability.

State tax issues generally arise during an audit or due diligence. When a retailer is audited by the state due to non-filing, there is no statute of limitations. During due diligence examinations, state tax exposures are common and can lead to escrow and/or a decrease in purchase price. Taxpayers looking to sell their business in the near future should invest in cleaning up their sales tax issues now, before it becomes more complicated during the due diligence process.

At a minimum, taxpayers should understand the exposure to their business as it relates to state sales tax. State taxes are complicated and laws vary by state. With constant changes, it is important to engage the right advisors. Don’t assume income tax compliance teams are looking into a company’s sales tax issues. Make sure you have relationships with state and local tax teams and schedule calls about sales tax and specific engagements to address any issues.

2022 Marcum Year-End Tax Guide