How Do I Catch Up If I Haven’t Been Collecting/Reporting Sales Taxes?
October 08, 2021
By Julia Bennetsen
As a technology or life sciences company grows, it’s likely that its nexus footprint does too. This is often seen among fast-growing companies within those industries. It’s not uncommon for these high-growth companies to stumble when it comes to collecting and reporting their sales tax.
Sales tax nexus is critical to determining whether an out-of-state vendor has an obligation to collect sales tax on sales into a particular state. Sales tax nexus occurs when a business has some kind of minimal connection to a state. Until this connection is established, the taxing jurisdiction cannot impose its sales tax collection requirement onto a taxpayer.
Traditionally, nexus was created when sellers had physical presence in a state, including:
- Owning or renting real property in a state, including brick and mortar stores, offices, warehouses, and/or showrooms;
- Having employees in a state, including remote employees, sales representatives, repair persons, and/or even trade show attendees; and
- Owning or renting tangible personal property in a state, including inventory, furniture and fixtures or other assets or equipment.
However, in 2018, the Supreme Court held that states can mandate a tax collection obligation on out-of-state-businesses that have certain levels of economic activity within the state, even without physical presence in a state. 1 The ruling, commonly referred to as the Wayfair decision, allowed South Dakota to impose “economic nexus on businesses with more than 200 transactions or $100,000 of in-state sales, requiring them to collect and remit sales taxes on transactions in the state.”
Since Wayfair, all states with a sales tax have enacted some type of economic nexus provision. These provisions vary in implementation date, as well as their thresholds. Typically, the thresholds are $100,000 and/or 200 transactions, although some states have gotten rid of the transaction threshold while other states may only look at taxable transactions. Accordingly, when taxpayers exceed these thresholds in a particular state, they may have a filing responsibility in that state.
If a taxpayer determines that they should have been filing in a particular state, their next step should be to calculate their potential estimated liability and determine the best way to address uncollected and/or unremitted sales tax. Depending on the level of exposure, some taxpayers may choose to do nothing. However, there are several reasons why you as a taxpayer should remediate your outstanding sales tax:
- If you are audited, you are paying your customers’ taxes out of your own pocket;
- You may have due diligence issues should you sell your company or seek additional funding;
- You are personally responsible for ensuring the sales tax you collect is sent to the state; and/or
- You may be subjected to large interest and penalties.
For those taxpayers who do want to remediate their prior exposure, there are several ways to do so. You may:
- Register and file prospectively;
- File all outstanding back tax returns; or
- Request participation in one of two formal state programs:
- An amnesty, or
- Voluntary disclosure agreements.
Each of these is discussed in greater detail below.
REGISTER AND FILE PROSPECTIVELY
If you are working at a technology or life sciences company, agility and the ability to move quickly are generally keys to success. However, moving too quickly can be costly when it comes to sales tax. All taxpayers want to avoid paying tax to the state out of their own pockets that they could have collected from their clients. They also do not want the administrative burden of trying to look back and determine how much sales tax they should have collected. As a result, many taxpayers may decide to register and start collecting and remitting sales tax immediately. The major considerations in making this choice are the amounts of risk and prior exposure that exist. Depending on these variables, many companies choose to pay any prior amounts due on their initial returns so as to ensure they have paid all taxes due. While it may initially seem like the easiest, less costly choice, it may not be. When you register for sales tax, the application typically asks for the date you started doing business in the state. It may be tempting to use a current date. However, if you had previously been doing business in the state, the state may audit you and assess you for those earlier years as well as impose interest and penalties. If you enter an earlier date, the state may come back and ask for those back sales tax returns. Under either scenario, you could end up owing more tax than you expected.
REGISTER AND FILE BACK RETURNS
Doing some research can pay off when it comes to sales tax. Some taxpayers choose to file all of their back returns and remit the related interest and penalties, typically with the assistance of their accountant. The benefit to this approach is that the liabilities are all paid and the taxpayer is up-to-date. However, you will be required to pay interest on the older liabilities as well as penalties. While interest is typically not waived, you may be able to waive all or part of penalties – you should work with your accountant to request a penalty waiver.
There are a few considerations to this approach—so it pays to consider the different variables at play. Since Wayfair was only decided in 2018, many states have only enacted their economic nexus provisions in the last few years, with Missouri’s provisions not effective until 2023. Therefore, a state’s implementation date may limit how far back you need to actually file. There may also be ways to remediate the total tax due, which is discussed in further detail below.
FORMAL STATE PROGRAMS
The rules for companies seem to be constantly changing to keep up with technological advances. They also vary widely state-to-state. It’s hard to keep up. States acknowledge these challenges and typically offer two programs to remediate unfiled taxes: amnesty or voluntary disclosure agreements (VDAs).
Amnesties are programs occasionally offered by taxing authorities for a limited time (typically 60-90 days) to allow both registered and unregistered taxpayers to pay all past tax liabilities without incurring penalties (interest may also be waived or reduced). They are typically offered to all taxpayers, including those under audit, to encourage taxpayers to pay their taxes and liabilities promptly and become fully compliant.
In order to participate in an amnesty, taxpayers must comply within strict timelines and deadlines. They need to request permission to participate, typically by completing an application, file all outstanding tax returns and pay all outstanding tax due.
Note that this program is only available when a state expressly offers it, and additional penalties may be imposed on taxpayers who choose not to participate and later determine they had tax liabilities during the amnesty period. Further, VDA programs may be suspended during Amnesty periods.
- Voluntary Disclosure Agreement (VDA)
A VDA is formalized program whereby a state typically allows a taxpayer to approach the state anonymously through a representative (typically either a CPA or attorney). The taxpayer, through their representative, offers to register for sales tax, pay all past due taxes for a certain number of years, and begin filing on a prospective basis. In exchange, the state typically limits the number of years for which they are required to file and waives most or all penalties (and occasionally interest) for those years under the agreement. A majority of states have ongoing VDA programs and each has their own voluntary disclosure program, with varying lookback periods.
Most states will enter into VDAs with unregistered taxpayers as long as the taxpayer:
- Is not under audit or investigation, has not already received a nexus questionnaire, or has not been contacted by the state in any form for the particular tax for which they are applying;
- Has no past compliance issues;
- Is willing to begin filing; and
- Is financially able to pay past liabilities, although some states do allow payment programs.
Taxpayers typically find these programs desirable because they receive a limited look-back period, have certainty by quantifying tax due amount for prior years, and typically receive a penalty waiver.
In order to participate in a VDA, taxpayers must request permission to participate, and if they are accepted, they must review and sign an agreement issued by the taxing authority, register, file the agreed upon tax returns or schedules, pay the tax and interest (if applicable), and immediately begin filing prospectively.
Note that if you choose to enter a sales/use tax VDA, you should consider whether you may also have income, franchise, or other tax obligations. If you do, and you only participate for sales tax purposes, the state may cross-reference their records and you may be at an increased risk of audit for those undisclosed taxes.
- Amnesty versus VDA
At first glance, both programs may appear very similar, inasmuch as they are both formalized programs that require permission to participate and they both typically offer full or partial penalty waivers, but that is where the similarities end. There are a few key differences in these programs:
VDAs are often imposed statutorily and are therefore ordinarily available when a taxpayer is ready to come forward. Most states that impose sales tax offer VDA programs year-round. Typically, you may choose when to participate in these programs.
Amnesties are infrequently offered and have a very limited time frame for participation. Individual states offer them at different times, if at all. If you need to remediate your sales tax in a particular state, you may not have time to wait and see when, or even if, that state will be offering an amnesty program.
- Look-back periods
Taxpayers that participate in VDAs typically have limited look-back periods. While the states tend to vary, typically the period is three to four years. If you have been doing business in a particular state for a long time, this may significantly reduce your liability when you are trying to determine the amount of tax you will owe if you choose to participate.
Taxpayers that participate in amnesties typically do not have limited look-back periods. They are generally required to file for ALL back years, which can result in a much longer look-back period. If you have been in business for a long time, it may also be administratively burdensome trying to find all of your old records on which to calculate your liability. This will likely result in a much larger amount of overall tax due then you would have otherwise owed had you participated in a VDA.
- Nonparticipation penalties
Taxpayers that choose not to participate in amnesties may be subject to possible repercussions for not participating. These may include nonparticipation penalties and/or the inability to waive penalties in the case of an audit that covers a period where an amnesty was in effect.
REMEDIATING TOTAL TAX DUE
Now that you have chosen a strategy to pay your back taxes and get up-to-date in your sales and use tax filings, you need to calculate your liability. While it may seem as simple as multiplying your taxable sales by the state’s tax rate, as noted above, there are several ways that you may be able to reduce the amount of tax you will need to remit.
- Ask your clients for resale certificates, direct pay permits, or any other applicable exemptions. Many pharmaceutical companies’ sales are purchased by their buyers for their use in manufacturing or for resale, and therefore may be exempt.
- Ask whether your client paid use tax on their purchases from you. If they have, you should try to get proof from them of the tax paid.
- Bill your client the unpaid sales tax. Note: Depending on your relationship with the client, as well as other factors, this may or may not be an approach you want to take.
- Ask if your client was audited and if your sales were taxed as part of the audit. If they have, you should try to get proof from them of the tax paid.
If your sales are exempt or your client already paid the sales tax on some of your sales transactions, you should not have to remit sales tax on those same transactions a second time.
If you determine that you should have been filing in a particular state, you should first calculate your potential liability and then determine the best way to address your uncollected and/or unremitted sales tax. There is no one-size-fits-all solution for every taxpayer. You, along with your tax advisor, should work together to determine the best solution based on your facts and circumstances.