Small Business Guides
How to manage sales and use tax
9 min read
As a small business owner, your list of tasks can feel endless. And one job that often falls to the bottom of the list is tax. We spoke to Avalara, a tax automation software company, to find out how small businesses can manage sales and use tax.
Understand your tax obligations
If you’re selling taxable goods or services in a state where you have a presence, you almost always have tax obligations. This means you are legally required to collect, file and remit sales and use tax.
We worked with the team at Avalara on this guide. It will help you understand what it means to collect sales and use tax, explains the risks of not doing it, and includes a simple plan to achieve sales tax compliance.
1. Understand the risks of not paying sales tax
When you begin collecting sales tax, you’re dealing with the state and local government. As a small business owner, you’re acting as an agent of the state. You’re obliged to transfer tax revenue from your buyers to the state and local tax authorities. Failure to do so opens up the door for audits, penalties and interest payments. Here are the risks:
- Late payment penalties
If you miss your filing or payment deadline you may end up owing money to local tax authorities. This may apply even if you have collected no sales tax during the filing period. Remember to check the rules in your state as these rules vary between states.
Once you’ve registered with a state to collect sales and use tax, you’ll be given a filing frequency – usually monthly, quarterly, or annually. You must file your tax return(s) on the correct due date(s).
Set up alerts on your computer or phone to remind yourself of due dates. Failing to file a return draws the attention of state tax authorities. If you’re trying to avoid being audited then don’t forget to file.
Outstanding sales tax liability isn’t a free loan. State and local tax authorities may charge interest on outstanding tax revenue. Depending on how much sales and use tax you owe, this can add up fast. And if you haven’t collected any sales tax you may end up with two bills. Firstly, you’re responsible for paying your buyers’ tax (out of your pocket). Secondly, you’re responsible for any fines and interest on the late payments.
- Collection fees
If a state auditor confirms you have outstanding sales tax liability and they’ve told you about it, they may call in a collection agency. Collection agencies aren’t cheap and the costs will be charged to you. It also may affect your personal credit rating.
- Criminal charges
Evading your responsibility to collect sales tax may result in civil penalties such as fines, penalties and interest charges. However, collecting state taxes and not remitting (paying) them to local tax jurisdictions may result in jail time.
2. Find out when you need to start collecting tax
A common question from small business owners is, “When do I need to start collecting sales tax?” The answer is complicated.
By law, you need to begin collecting sales tax on your first taxable sale. State and local tax authorities don’t offer a grace period when this tax can be ignored. You need to think about the risk of not collecting sales tax versus the overall cost of filing and paying.
Deciding when to get started with sales and use tax is your responsibility. It makes sense to ask a certified tax professional for expert advice on when and how to get started collecting sales and use tax.
3. Taxes are complicated – make sure you use genuine experts
Sales and use tax management can be complicated. Many people think they are so-called 'experts' because they are also wrestling with compliance. Your peers and colleagues may be very knowledgeable, but how can you be sure when you’ve found an expert?
You need to strike a balance between online research and professional advice. Use government websites to start with. And always consult an accounting professional. This is especially important for questions that go beyond basic tax compliance.
When you’re ready to consult a tax professional, you can use this tool to find a certified advisor.
4. Learn about nexus
Once you’ve decided to start collecting sales tax, you need to know which states require you to collect it. This depends on an important legal concept called nexus (or “physical presence”).
Nexus is broadly defined as “a physical connection to a state or local taxing jurisdiction.” But nexus is not just about having a "physical presence". The actual meaning is more complicated.
Nexus is commonly defined by things like your office location, your warehouse location or where your employees are. But there are other ways to define nexus. These are important because your nexus can affect your tax jurisdiction – and therefore your tax obligations.
Five things can determine nexus:
- Your home state
Your business will always have nexus in its home state. Your home state is more than just the state in which the business is located. In fact, home state is defined as “the state where your company exists, either in physical form or by virtual existence based on business registration, DBA name registration, or banking activity.”
This makes the home state the most common “nexus trigger” and applicable to nearly every business. So use meeting your home state tax obligations as an opportunity to develop a sales and use tax management process. Develop a plan, get the right tools and become efficient with your tax filing. That way, when you’re ready to begin filing in other states, the task will be easier. You’ll have a template to follow.
- States you visit
If you travel to other states for business – for example conferences, meetings, sales calls – this can trigger nexus. Manage your travel carefully so you don’t trigger nexus without realising. If you do and fail to collect sales tax, it can cause problems.
- Your fulfillment services
If you have a fulfillment service with stock in warehouses in several states you may trigger nexus in those states. This is common for Amazon sellers using the Fulfillment by Amazon (FBA) program. If that includes you, carefully monitor where your stock is at all times.
Always check the warehouses where your goods are being stored. If they are moved quickly (as they often are) it can change your nexus profile.
- Your remote employees
Services like Skype, Slack and Google Hangouts make it easy for you to work with remote staff. They can also trigger nexus across the country. If possible, hire remote employees within your home state. If remote employees outside your state trigger nexus, it can complicate your tax collection requirements.
- How you use affiliate marketing
Many small businesses harness the marketing power of the internet using affiliate marketing. It usually works best for businesses with an internet presence like a blog or online store. Adverts for your business are placed on your affiliates’ websites. This drives relevant traffic (and hopefully sales) to your website. The affiliate marketer gets a small cut of the revenue in exchange for their advertising efforts.
Amazon Associates and Google AdSense are the most common affiliate marketing programs. Click-through nexus applies if your business works with an affiliate marketer in another state. In this case, your relationship with the affiliate marketer can trigger nexus.
5. Follow these steps to ensure tax compliance
Feeling overwhelmed? Don’t panic. Here are the basic steps to manage sales and use tax properly:
Determine if what you sell is a sales tax object. A sales tax object may be a good, a service, a digital object or a combination of each. Understanding the taxability of objects is critical. Under-collection can result in audit assessments and over-collection can result in potential lawsuits (or annoyed customers). It’s important to remember that every state may view the same object differently.
The next step toward establishing sales and use tax compliance involves registering your business in the states in which you have nexus. Depending on the size of your business, this may involve a brief review of your operations or a professional nexus study.
The type of registration can vary depending on the facts and circumstances of your business. Completing registration accurately is important for compliance. It lasts forever, so take your time, do the necessary research and get it right.
Registration gets your business an official sales tax licence. All states require a business to register at least one to two weeks before selling taxable goods in their state.
- Collection and filing
Once you’ve registered for a business licence in the states in which you have nexus, the next step is to begin collecting sales tax. Every major online selling platform offers this functionality built-in. You can set it up from within your software.
Once you’ve started collecting sales tax, you’ll need to file a return based on your filing frequency (assigned during registration). Filing a tax return involves breaking down the tax you have collected by jurisdiction – state, county, city. Then you submit this information to your state and local taxing authorities.
After you’ve filed your return, you’re responsible for remitting (paying) the sales tax dollars collected. Be sure to review state filing procedures as some states require filing and remittance to happen at the same time.
Make sure you know what your payment options are ahead of time. Most states offer modern fund transfer via EFT or wire transfer. If you’re planning to write a cheque, use a credit card or pay with cash, be sure to check with your tax authority first.
Managing sales and use tax is complicated
Sales and use tax compliance is a very real concern for any small business serious about growth and long-term success. Failure to collect, file, and remit this tax in states where you have nexus is a risky path. Late payment penalties, collection fees and interest payments can put your business at risk. Remember, knowledge is power. Take the time to learn how to achieve and sustain sales and use tax compliance. It’s time well spent.