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When entrepreneurs start small businesses, sales tax is rarely the first thing on their minds. As a small business grows, sales tax compliance often remains an afterthought. The truth is, sales tax is one of the most complicated tax obligations for businesses in the U.S., and one of the hardest areas of tax compliance to stay on top of.
Why does sales tax create so many headaches, and how can small businesses avoid pitfalls that jeopardize profits? It all starts with a series of commonly-repeated myths about sales tax.
Myths cause mistakes
The fastest way to get sales tax wrong is to believe something you sell isn’t taxable when it, in fact, is. A common culprit: online sales.
Until sales on the internet began, consumer purchases were generally made at a physical location or via mail. In a 1992 case, Quill Corp. v. North Dakota, the Supreme Court ruled that remote sellers, like mail-order companies, were only obligated to collect sales tax in states where they had a substantial physical presence (often called “nexus”).
Consumers were still supposed to pay use tax on their purchases, but almost none did, creating a pernicious myth: “internet sales are tax-free.” As states lost revenue to internet sales, they took matters into their own hands, broadening the definition of nexus to include remote employees and sales contractors, drop shipping programs, affiliate advertising links, trade show attendance and more.
This means that many businesses are obligated to collect tax on internet sales in more states than just those where they have a physical address. This isn’t a theoretical problem: growing companies have faced major penalties (sometimes in the millions) over not paying taxes to a state where they have nexus.
Another common myth is that only products are taxable, not services. This used to be true, but as services take over for manufacturing as the heart of the economy, states have started charging sales taxes on many services, as well.
These two most common myths about sales tax are also the ones that can put businesses in the greatest jeopardy. Completely failing to pay sales taxes for months or years can result in enough fines and penalties to squash growth and halt plans for further expansion.
The prosperity problem
When businesses enter fast-growing phases, entrepreneurs can feel like they’re on top of the world: there’s always a new customer and always more prospects.
When it comes to sales tax, though, prosperity can create problems. With 70,000 taxing jurisdictions in 45 states making thousands of rule changes every year, keeping up with every new rule and rate first becomes daunting and then impossible as a company continues to grow.
Each state has its own forms to file and different taxability rules (one example out of thousands: in Chicago, bottled water is taxable, but flavored or sparkling water is tax-exempt), as well as unique filing dates and prepayment requirements.
With so many confusing laws and regulations, the more a company grows, the more likely it is that some aspect of sales tax compliance isn’t being addressed. When that happens, all it takes is one sales tax audit to bring profits crashing down. Often, businesses don’t even realize they’ve fallen out of compliance until they’re looking at a long list of missed payments and penalties.
Seeking sales tax solutions
In a growing small business, keeping up with sales tax regulations rapidly becomes an impossible task to perform in-house. It can be tempting to just stick your head in the sand and ignore complexity, but the moment an auditor walks in your door, it’s all over.
Fortunately, small businesses don’t have to give up on achieving compliance and minimizing audit risk. In sales tax — just like payroll, another highly-regulated business task where manual methods come up short — smart automation technologies are taking over. Automated sales tax compliance solutions calculate rates, manage important documents, and streamline filing and remitting to various jurisdictions.
Outsourcing and automating sales tax makes good business sense: since you can never make money with sales tax, taking risks or doing it yourself can’t possibly pay off. Automated solutions take those risks away, replacing them with fixed costs that can be anticipated and budgeted.
While sales tax is a complex issue for small businesses, it doesn’t have to be a thorn in your side. By leveraging today’s automated sales tax technologies, companies can stay compliant without the hassle, so they are free to grow.