The Risks and Repercussions of Non-Compliance

Not paying attention to your sales tax obligations is never wise. 

True, it’s a relatively new requirement to collect sales and use tax from remote customers, but it’s one the taxman has always taken seriously from businesses – and that seriousness is only intensifying. 

It’s also mostly up to you to determine your sales tax obligation, and the rules for complying change frequently. A recent TaxConnex survey found that four out of five respondents were not confident about how their company handled its sales tax obligations.

Determining your responsibilities 

Your sales tax obligation starts with nexus. Nexus is the connection a business has with a taxing jurisdiction.  This can be physical nexus, such as having offices or reps in a state or tax jurisdiction. It can also be through economic nexus, meaning you sell a sufficient dollar amount or have a sufficient number of transactions (or both) in a state or jurisdiction over a set period. 

Economic nexus rules – which did not replace any of the physical presence rules previously in place – change frequently. (See our economic nexus guide to see rules by state.) Generally, keep your eyes open for when your business exceeds $100,000 in revenue in a state – that’s a good indicator that you should look more closely to determine if you have economic nexus there. 

Once you’ve determined where you have nexus, you will need to understand if your products and/or services are subject to sales tax in these states and jurisdictions.  

In general, all tangible personal property (TPP) is subject to sales tax unless the state specifically excludes it. 

Services are not tangible and can be entirely different in terms of taxability. Generally, services are not subject to sales tax unless they are specifically referenced.  However, more and more states are taxing certain services including an increasing number that tax SaaS. 

Taxability is something you need to monitor on a per state basis. If you do business in two or three states and you are familiar with the taxability rules for those states, it’s easy to think the same rules apply in all states as you grow. That’s not always the case though.  

Estimate your exposure to understand your risk

After you’ve determined where you have nexus, and in which of those states you are selling a taxable item or service you now know where you have a sales tax obligation. But how far back have you had that obligation? Understanding when you first should have started collecting sales tax and calculating how much sales tax would have been owed to the state or jurisdiction over that time period helps you estimate your risk and potential exposure. This amount, plus penalty and interest is what would be expected of you in the case of an audit.  

Repercussions of not complying

There’s no statute of limitations for unfiled returns, meaning that unpaid tax liabilities for non-filing years can be audited indefinitely. Depending on the timeframe, it’s probable that it will be too late—or too impractical— to go back and collect from past customers. Penalties associated can start at 25% of tax liabilities. And even non-filing of zero taxable sales can result in penalties. 

Then there’s the business cost. The risk of non-compliance is that it can compromise your company’s financial statement, which would be a tough problem for small and new enterprises. Unresolved obligations can complicate business operations such as mergers or acquisitions and obtaining funding. Many business owners have been gut-punched in due diligence with an out-of-the-blue sales and use tax deficiency. The expense of rectifying this situation falls on you. 

All of this can add up quick and lead to a hefty payment needed to rectify what could cause big problems to a business of any size if you’re not prepared.  

Remediating 

If back taxes are not disclosed but instead discovered through an audit, you’ll be at a disadvantage and will end up being assessed penalties, plus interest plus all historical tax due. Your best bet is to be proactive. 

If you charged and collected sales tax, you must be intent on remitting that tax to the state or, if you don’t plan on registering with the state, refunding it to your customers. Intent is important. 

One remediation option that can be a good fit for many businesses is a Voluntary Disclosure Agreement (VDA). If you determine on your own (without a notice from a tax authority or an audit) that you have historical risk concerning sales tax obligations and exposure, one of the primary options for mitigation is a VDA. Almost all states provide some version of these agreements, which offer companies the chance to come forward and disclose that they have sales tax exposure and some past obligations in exchange for avoiding penalties. 

There are two main qualifications for your business to be accepted into a VDA program. You cannot have already registered in the state, and you cannot have already been contacted by the state for an audit or for questions about your sales/use tax exposure. 

VDAs can be most beneficial when you have previous non-compliance and exposure dating back five or more years (due to a “limited look-back period”). There are other options available if a VDA doesn’t make sense for you. It’s best to work with an expert to learn the best course of action for your business.  

(Learn more about VDAs on our recent “Hot Topic” webinar.) 

If you need help understanding your sales tax obligations and whether you should be collecting sales tax, get in touch. TaxConnex has experts to help answer these questions and to help you establish an ongoing process to ensure you remain compliant – even with the frequently changing rules of sales and use tax. They can also help mitigate your risk or work with you through an audit! 

For more on your non-compliance risks and repercussions and risks, here’s our webinar specifically on the topic.