A constantly changing tax landscape — from the Marketplace Fairness Act and various uniformity projects, to Wayfair and the digital economy — continues to alter the course of business as usual when it comes to staying compliant with state and local taxes. The current environment has also led to increased tax audits and more burden on business owners. Our sales and use tax team’s recent webinar offered an inside look at what businesses need to know.
Changes following the landmark 2018 Wayfair decision have been significant in terms of state and even local tax implications. Six years out from the decision, all states that impose a sales tax have now implemented an economic nexus threshold that requires more businesses to pay tax in various states, with local jurisdictions following suit. Marketplace facilitators are required to collect sales tax on behalf of sellers, shifting the tax burden from the seller to the facilitator themselves; and now taxes beyond sales tax, such as income/franchise tax, are being impacted.
However, Wayfair is still applied with little uniformity — with varying effective dates; economic and transaction thresholds; sourcing, filing frequencies and taxability; and marketplace facilitator laws. While state revenues from sales tax have increased drastically, from $3.2 billion prior to Wayfair to $23.1 billion in 2021, business owners are the ones facing additional burdens. To maintain compliance with this complex and evolving landscape, they are having to add technology, automation software and outside resources. Taxpayers are also enduring a significant uptick in state audits being performed to capture additional state revenues.
On the positive side, states are beginning to gradually remove nexus transaction thresholds, which use number of transactions to dictate a business’ state tax obligations. This is good news for many small businesses, which often find that meeting the transaction threshold doesn’t necessarily mean they are yielding enough revenue to cover the related cost of the additional compliance.
We are clearly seeing the broadening of the sales tax base across the country. One of the catalysts involves a recent political “win” in the form of cutting individual income tax rates or repealing those taxes altogether. At least 20 states have cut individual and/or corporate income tax rates since the start of 2021, resulting in state revenues in some instances dropping by hundreds of millions of dollars. As a result, states are looking for new revenue streams — aiming to broaden the sales tax base, with services and digital goods specifically in their crosshairs.
Why is taxing services so enticing for states? From their perspective, there are three primary reasons:
In terms of taxing digital products, the key driver is that the digital economy has led to a large revenue base erosion for states and municipalities. Current tax law focuses on tangible personal property, in which digital goods and services are often not captured. States are strategically attempting to recapture that lost revenue in the form of expanding the sales tax base and implementing gross receipts taxes.
The problem to date is that there is no uniform approach to how digital products are classified for tax purposes. One point of contention the sales tax world is watching closely is the taxation of digital advertising services, with the first case of its kind currently being challenged in Maryland. The case revolves around taxing ads on digital interfaces, such as software, websites or apps, including banner advertising, search engine advertising, interstitial advertising and comparable advertising services. If Maryland succeeds, we can expect to see similar taxes throughout the U.S.
Understanding sales and use tax audits is increasingly important thanks to the impact of Wayfair, as states have become more aggressive in their audit practices since the decision. Ohio and New York have been particularly active in conducting audits, but California, Illinois and others also remain aggressive.
Like it or not, states have the right to audit taxes they administer. If selected for a state tax audit, you’ll be notified by letter or phone detailing items such as the audit period (likely three to four years) and type of tax being audited. Know that there are many intricacies to an audit. Some things are negotiable, such as the start date, while others are not. Filing your returns accurately three to four years before you are ever audited is the best way to be ready, e.g., don’t take shortcuts during annual compliance. Doing things right will put you in the best position for an audit.
Once you are under audit, communicate with your tax team and auditors. Be ready to pull information requested, and review anything before you hand it over. Know your business. Don’t ignore auditor requests or deadlines, and document everything.
But it’s also important to remember that just as an auditor will review your business for missed payments, you can review it proactively with your advisers for missed overpayments — which means missed refund opportunities. Some of the most commonly missed overpayment items come from businesses with call centers, warehousing, manufacturing and companies using software throughout multiple locations.
Sales and use tax will continue to be an avenue through which states will increase their revenues. Proactively and thoroughly looking at your business and the myriad of state and local taxation requirements — and potential opportunities — is the best approach to this dynamic environment.
Contact Nick Longo, Mike Fink, Scott Zielaskiewicz or a member of your service team to discuss this topic further.
Cohen & Co 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 with your professional advisers.