The Definitive Guide to Sales and Use Tax: A Sales and Use Tax Compliance Primer

7/28/2019 The Definitive Guide to Sales and Use Tax: A Sales and Use Tax Compliance Primer

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p. 1/28 The Defnitive Guide to Sales and Use Tax. Avalara 2013

THE DEFINITIVEGUIDE TO SALES

AND USE TAX

A Sales and Use Tax Compliance Primer


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TABLE OF CONTENTS

INTRODUCTION .............................3

The Sales and

Use Tax Landscape ...................... 4

Sales and Use Tax

Complexities ................................ 9

Complying with Sales

and Use Tax ..................................14

Sales Tax Practices by State .....18

Alabama ..............................................18Alaska ...................................................18Arkansas .............................................. 18Arizona .................................................18Caliornia ............................................. 18Colorado ..............................................18Connecticut ........................................19District o Columbia ........................ 19

Florida...................................................19Georgia ................................................. 19Hawaii ..................................................19Idaho .....................................................19Illinois ...................................................19Indiana ................................................20Iowa ......................................................20Kansas ................................................. 20Kentucky ............................................. 20Louisiana............................................20Maine ...................................................20Maryland ............................................20

Massachusetts ................................. 20Michigan ............................................20Minnesota .......................................... 21Mississippi .......................................... 21Missouri ............................................... 21Nebraska ............................................. 21Nevada ................................................. 21New Mexico ...................................... 21

New Jersey .......................................... 21New York.............................................. 21North Carolina ..................................22North Dakota ....................................22Ohio .......................................................22Oklahoma ...........................................22Pennsylvania .....................................22Rhode Island ......................................22

South Carolina ..................................22South Dakota ....................................23Tennessee ............................................23Texas ......................................................23Utah .......................................................23Vermont ...............................................23Washington ........................................23Wisconsin ............................................23Virginia ................................................ 24West Virginia ....................................24

Glossary ........................................25

ADDITIONAL RESOURCES ......... 28


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INTRODUCTION

For years, tax-ree online shopping has brought customers to the web in droves, allwhile raising the ire o brick-and-mortar retailers claiming an unair price advantage tosellers oering prices ree o sales tax. At the center o these debates lies the small tomedium business, attempting to navigate changing sales tax requirements, and acingincreased scrutiny under these new rules.

Sales tax compliance is becoming a sticky wicket, as state and local governments revisetax laws to increase revenue, and Congress considers granting states the authority tomake remote sellers charge sales tax.

This Defnitive Guide lays out sales and use tax basics as well as commonly misun-derstood elements o sales tax compliance, to provide you a one-stop reerence or allthings sales and use tax related. The last two sections include a state-by-state sum-mary o sales tax rules and regulations, and a glossary o terms.

How this guide may help you

I you collect sales tax rom customers in one or more taxing jurisdictions, this guide isor you. Covering everything rom sales tax challenges to use tax statutes, this paperprovides a detailed primer on sales and use tax compliance.

This guide is divided into six main sections:

1. Overview o the sales and use tax landscape.

Who owes it? Who collects it?2. Discussion o the complexities in sales and use tax laws.

Who is exempt?

3. Inormation about complying with sales and use tax.What steps can a company take?

4. General sales tax rules by state.

5. Glossary o relevant terms.

6. Additional resources.

What this guide will not provide

Although we hope youll fnd it helpul, this guide is not presenting legal or tax advice.And it is defnitely no substitute or expert advice. For that, please consult your taxadvisor.


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THE SALES ANDUSE TAX LANDSCAPE

Sales tax defned

Sales tax is a transactional tax that is imposed on the privilege o transacting businessin a particular state and/or local jurisdiction, based on the product or service beingsold. As a general rule, the sale o tangible personal property (TPP) is taxable unlessspecifcally exempted by statute, or through the receipt o a valid exemption certifcate.By contrast, services are generally exempt unless specifcally identifed as taxable bystatute. Exceptions are the two true gross receipt states, Hawaii and New Mexico. Inthese two states, the tax is imposed on the seller, with ew exceptions.

45 states, including the District o Columbia, impose some orm o sales and use tax.These transactional taxes are called by various names including Sales Tax, Transaction

Privilege Tax, Gross Receipts Tax, General Excise Tax, Retailers Occupation Tax, GrossRetail Tax, and/or Consumer Sales Tax. The fve states that do not impose general salesand use taxes are Alaska, Delaware, Montana, New Hampshire and Oregon, althoughAlaska does not impose a state sales tax, many local jurisdictions there impose a localsales tax.

A recent Census Bureau report1 indicates that sales tax comprises 31% o taxes that states col-lect, second only to income tax. Nationwide, sales taxes collected in 2011 totaled approximately$234 billion, an increase o 5.4% rom 2010.

Sales tax versus use tax. How are they dierent?

States that impose a sales tax impose a corresponding use tax based on the storage,

consumption or use o the tangible personal property or taxable service. A use taxcomes in one o two orms, either a sellers use (collected by the seller) or consumersuse (sel-assessed and reported by the purchaser). When the seller does not collect asales tax, a consumers use tax is due. Generally speaking, whether a taxable transac-tion is subject to sales tax or use tax depends on whether the seller has nexus in theship-to state. The ollowing are examples o transactions that result in a tax:

The ollowing are examples o transactions that result in a tax (though i the Market-place Fairness Act o 2013 passes, remote seller requirements could change):

Did you know?

Many states have passed lawsrequiring remote sellers (sellersbased in one state selling intoanother) to collect sales tax i theyreceive a certain number o reerralsrom in-state afliates. Congressrecently introduced the MarketplaceFairness Act o 2013. I enacted,this law would authorize states to

require almost all remote sellersto collect sales tax as long as thestates meet certain simplifcationrequirements. This will please statesthat have worked at lightning speedto implement remote seller salestax rules.


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AB

A

B

A

B

EXAMPLE 1:Transaction resulting in sales tax

EXAMPLE 3:Transaction resulting in consumer use tax

EXAMPLE 2:

Transaction resulting in sellers use tax

B Seller ships rom WA.

Shipped to the customer in WA.Thereore, the seller charges sales tax.

Shipped to the customer in WA.Thereore, the seller has sellersuse tax obligation.

Shipped to the customer in WA.Thereore, the customer hasconsumer use tax obligation.

B Seller ships rom Utah, butdoes not have nexus in WA.

B Seller ships rom Utah, buthas nexus in WA.

A Items purchased in WA.




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Common misperceptions about sales tax

1. Outside the state where Im located, I dont have to worry about sales tax.

Defnitions o nexus between states are oten so incongruous and conusing,many businesses remain in the dark about their collection obligations outsideo jurisdictions in which theyre physically located. By ailing to comprehend thenuances o sales tax requirements, merchants can unknowingly increase theirrisk o audit. As rules requiring out-o-state companies to collect sales tax areconsidered at both the state and ederal level, the path to compliance gets evensteeper.

2. I only need to know and collect one tax rate in additional states where I haveoperations.

The reality is that sales and use tax is a moving target. Recent legislation andproposals at the ederal level are indicative o more sales tax obligations acrossmore business and services types. This moving target could make it even harderor companies to accurately collect and remit taxes to avoid audits and penal-ties.

3. This company has been doing it this way for years so there is no need to

change.

With the high number o annual sales and use tax related changes, it is nowonder businesses have a difcult time keeping up. Tracking rates, managing

exemption certifcates, and fling returns manually tap limited company re-sources in an era o slim margins and higher audit rates. Sellers risk potential taxexposure and uture liability under an audit i they dont collect tax correctly.

Nexus: Why it may not be enough to determine tax liability

Nexus means a connection or tie. It is a legal term that denotes a businesss presencein a state or local jurisdiction or tax collection purposes. Nexus exists i a business con-nection with a state is substantial enough to allow the state to require tax collection.This connection could include a physical location (store, ofce or warehouse), companyproperty, sales personnel or representatives, or any other business activity that extendsbeyond the use o a common carrier or the U.S. Postal Service.

The Supreme Court decision, Quill vs. North Dakota, guides the current signifcantphysical presence defnition o nexus. Although states are not allowed to enact nexuslegislation in conlict with ederal regulations, they are allowed to defne nexus untilsuch time as ederal legislation passes.

Somebody has to pay

As a general rule, once nexus exists, the seller inherits a legal obligation to collect taxon all taxable transactions and remit any tax due to the applicable taxing authorities

Did you know?

Companies that sell products inmany states are fnding that thebest way to manage sales and usetax is to implement solutions thatautomate as much o the process aspossible, rom calculation to returnsfling. Many o these productsintegrate seamlessly within existingaccounting and ecommerce systems.


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(e.g., Department o Revenue, Tax Commission, State Board o Equalization or Depart-ment o Taxation). I the seller has no nexus in a taxable state, the ull responsibility oremitting any tax becomes the responsibility o the purchaser (i.e., consumers use tax).

States are broadening defnitions o nexus in an eort to capture more tax on sales.Caliornia and Illinois, or example, have determined that online afliates create aphysical presence, and thereore nexus. I your neighbor publishes a blog with afliatelinks to Amazon products, he is considered an Amazon seller. This activity creates nexusin his state or Amazon. To avoid creating nexus, Amazon, Overstock and the like oughtstates and even broke afliate relationships in order to avoid collecting sales tax.

Sel-assessment o tax

When sales tax is not due, the purchaser has the obligation to sel-assess the tax.Sel-assessing the tax means reporting to the appropriate taxing jurisdiction any tax-able purchases made during a certain reporting period and remitting the associatedtax. Many states have added a line on personal income tax returns or the purpose oreporting tax-ree purchases.

I a seller has nexus in a state, they will not be released rom the liability o collectingthe sales or sellers use tax, even though the purchaser may have sel-assessed the taxon the purchase. The burden o proo alls on the seller and they have the responsibil-ity o proving that the state received the appropriate revenue. With ew exceptions, thepurchaser is not released rom the ultimate liability o the tax i the seller ails to collectand remit the tax due to the state. Both the seller and the purchaser can and will be

assessed the tax due, i an auditor discover improperly fled or under-reported taxes.

Sel-administered and Home Rule jurisdictions

Home Rule states are those that allow local jurisdictions to impose their own sales anduse taxes. The ollowing are Home Rule states:

Alaska Alabama Arizona Colorado Idaho Louisiana

Taxing jurisdictions (city, county, et. al.) within these states can sel-administer taxesand impose their own taxability rules. Sales tax administration costs in these jurisdic-tions are so high, some businesses have chosen to take their chances with an audit,rather than comply with these rules.


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Sourcing

The term sourcing describes the location used to calculate tax rates, boundaries, andjurisdictions. Destination-based sourcing associates the rate charged with the deliverylocation o the product or service. Origin-based sourcing reers to the location o thebusiness that provides the taxable item. In the case o brick-and-mortar stores, thesales tax rate is based on the store location.

For retailers shipping across taxing jurisdictions, whether online or via catalog, sourc-ing rules come into play more requently. Such companies must be aware o tax rulesand apply these rules or both calculating and remitting the correct tax. Only a hand-ul o states have origin-based sourcing rules, where products that are shipped to the

customer are taxed based on the location o the business itsel.

The ollowing are states that tax sales at their origin:

Arizona Caliornia Illinois Mississippi Missouri New Mexico Pennsylvania Texas

Utah Virginia


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SALES AND USE TAXCOMPLEXITIES

Determining accurate taxability encompasses layer upon layer o complexity. From de-termining and tracking jurisdictions, rates, and transaction types to surviving an audit,its a burdensome, increasingly costly chore that promises to get more difcult.

Determining the taxability o products and services

Each state, and in some cases local jurisdictions (see Home Rule defnition) establishtheir own unique taxability rules or purposes o generating sales and use tax revenue.Shortalls in state revenues are motivating legislators to fnd ways to pass laws thatwill expand their existing taxable base.

Lacking tax expertise and without a sophisticated tax decision-making system,

companies can fnd it difcult to properly calculate rates or all taxable transactions.Sellers need to know whats taxable in each applicable taxing jurisdiction to preventtax exposure and uture liability under audit. Moreover, they need to know whats nottaxable, to avoid over-charging tax and potentially becoming named as a deendant ina class-action lawsuit. The more a company can automate tax collection and paymentsystematically, the more it can reduce tax exposure.

Multiple taxing jurisdictions and tax rates

There are over 11,000 taxing jurisdictions in the U.S., with localities increasing tax rateson a regular basis. Without an automated sales/use tax system in place it is almostimpossible or a company to administer sales/use tax collection and reporting respon-sibilities in a multi-state environment.

Application o state-by-state exemptions

Many states oer special exemptions or manuacturing, industrial, arming, promo-tional materials, pollution control, capital improvements, warehousing, call centers,ood, and various services.

Most o these exemptions have limitations and restrictions that are difcult to inter-pret correctly. One example is the manuacturing exemption. Some o the limitationsinclude only machinery and equipment that expands a companys capacities or opera-tion and exclude replacement due to wear and tear. Other states limit the exemptionto the actual process in which an item changes rom one orm to another. Throughoutthe U.S., there are dozens o variations o qualiying exemptions.. As a result, companieserroneously overpay thousands o dollars in sales and use tax.

Bundled transactions

Bundled transactions are packaged sales that include both taxable and non-taxableitems or services that are sold as a single unit. This type o transaction creates difcultywith system and law interpretation.

Did you know?

While searching or the perectpumpkin or Halloween in Iowa, besure the pumpkin patch knows thatyoure going to use the pumpkinor making pies rather than ordecoration; it will save you 7% salestax.


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Digital Goods

Digital goods are typically things like podcasts, music, video fles, or e-books that aredelivered electronically, but states oten defne these goods only vaguely, i at all.

Sellers o digital goods ace an uphill battle when determining i and when to chargesales tax. A number o states have determined that businesses selling digital goodssuch as MP3s, e-books, and movies should charge sales tax. Other states allow thesesales to remain sales tax-ree (though technically consumers still need to pay consumeuse tax).

Even i you get a handle on which states tax digital goods, you still need to know what

counts as a digital good in those states. In other words, how do states defne digitalgoods? The 22 states (such as Indiana, Kentucky, and New Jersey) that have signed onto the national eort to streamline sales tax laws defne digital goods as electronicallydelivered movies, e-books, and music.

States not currently part o the streamline agreement oten use a dierent approach.Connecticut includes ring tones and sotware under the digital goods category. Illinoiscounts newspapers, magazines, books and music downloaded electronically as digitalgoods. Other states such as Caliornia, Colorado, and Arkansas, dont defne digitalgoods whatsoever.

Drop shipmentsthe Bermuda Triangle

Third-party drop shipments are the Bermuda Triangle o sales and use tax. Thesetransactions involve at least three separate parties and two separate sales. It gets morecomplicated when each party is in a dierent state. The ollowing diagram shows atypical third-party drop shipment transaction.

SALES INVOICE

PAYMENT

COMPANY 2:

Located in State B Registered in State B NO NEXUS in States A

or C

COMPANY 1: Located in State A Registered in State A NEXUS in State C

SALES INVOICE

PAYMENTPROPERTY

COMPANY 3:

Located in State C

In this example, and in most drop-shipment transactions, taxabilityrelies on documentation. That is, willState C accept a resale certifcate romCompany 2 in State B? Because Com-pany 2 does not have nexus in State Cit is unable to provide a State C resalecertifcate, relieving Company 1 o its

collection responsibility.

The Institute or Proessionals in Taxation (IPT) publishes a Third-Party DropShipment Survey annually. Companieswith drop shipment concerns canpurchase this survey on IPTs website,www.ipt.org.


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Exemption certifcate documentation

Generally, all purchases o tangible personal property are presumed to be taxable.Unless there is a specifc statutory exemption or a receipt o a properly prepared and executed exemption certifcate, the sale is subject to tax. Exemption certifcate documen-tation can come in many orms and applies to all purchases. Each state establishes itsown laws related to exemption documentation. In most cases, the seller is required toobtain exemption certifcate documentation on or beore the date o sale, in order to bereleased rom the liability o the tax. Some states have all-in-one exemption certif-cates that cover all available reasons or exemption treatment, and others have specifcexemption documentation or each available reason. The most widely used exemptioncertifcate is the MTC (Multi-state Tax Commission) orm.

Example o exemption certifcate records include:

Resale certifcates. List o exempt customers. Direct pay permits. MTC orm. Manuacturing/Industrial exemption certifcates. Records o capital improvement. Border state exemption certifcates. Temporary storage records.

Which groups are always exempt?

In all cases, a sale to the ederal government (or one o its agencies) is exempt romstate taxation. Other exempt customers include state and local governments andagencies, charitable or non-proft organization such as churches, hospitals, or schools,and relie organizations, resellers, oreign diplomats, and Native Americans.

Audits

Each taxing state and local jurisdiction has an audit division responsible or ensuringthat the governing jurisdiction receives the tax revenue that is due.

Who is likely to be audited?

Each licensed businesses is a potential audit candidate. In addition, all unlicensed sell-

ers that have nexus in a state or local jurisdiction can be audit candidates. Even thoughits difcult to audit unlicensed out-o-state sellers, the possibility or audit exists, andany tax defciency, penalty and interest associated with non-compliance can be su-fcient to cripple i not bankrupt a business.


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What do auditors review?

Auditors review both sales and purchase transactions during a given reporting period,based on the statute o limitations (usually between 3 and 4 years). In most cases, anauditor will use a sampling methodology (block, random, or statistical) to review salesand non-capitalized purchases. They will generally review 100% o all fxed asset pur-chases. Because the auditors time is limited, an audit usually ocuses on areas that wilgenerate the greatest amount o error, tax defciency, and recovered tax revenue.

The scope o the audit is usually determined by initial selective sampling. I a taxpayerdoes not maintain sufcient records, or i reports and records are not easily audited, theauditor has the authority to conduct the audit in any way they deem necessary.

Who must provide proo? How are disagreements resolved?

Once the auditor identifes a defciency, the burden o proo that the assessed tax is notdue shits to the taxpayer. I the taxpayer does not agree with the assessment issued,there are certain appeal rights that range rom an inormal hearing to the U.S. SupremeCourt. Most disagreements are resolved in an inormal hearing phase. All audit assess-ments are legally binding bills that are enorceable.

Internet Tax Freedom Act

In October 1998, then-President Clinton signed into law the Internet Tax Freedom Act(ITFA). The Act imposed a three-year moratorium on any taxes on Internet access andmultiple and discriminatory taxes on electronic commerce. The act provided an excep-

tion or state and local jurisdictions that were already taxing access charges.

With a name like the Internet Tax Freedom Act, you can imagine the conusion thatensued. ITFA does not give consumers reedom rom taxes on purchases made online.I a seller has nexus (through a store, sales sta, inventory, and so on) and is alreadycollecting tax in a particular state, the seller must continue to collect sales and use taxon all taxable sales regardless o the channel o sales. The act was designed to preventa taxing jurisdiction rom imposing tax collection duties on a seller i the only channelo sale is through the Internet.

The Streamlined Sales Tax Project

The Streamlined Sales Tax Project (SSTP), www.streamlinedsalestax.org, is an eort

among state governments and private industry to create uniormity in administeringsales and use tax compliance and reporting. The goal is to simpliy sales and use taxcollection and administration or retailers and governing jurisdictions, thus improvingcompliance and encouraging remote sellers to collect tax. Through the eorts o SSTP,costs and administrative burdens on retailers that collect tax in multiple states can besignifcantly reduced. SSTP levels the playing feld so that physical stores and remotesellers ollow the same rules. The original agreement was adopted in November 2002.


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The key simplifcation measures include:

Uniorm defnitions within tax law Rate simplifcation State level tax administration Uniorm sourcing rules Simplifed exemption administration Uniorm audit procedures State unding o systems

States partner with private suppliers o services, like Avalara, to certiy the accuracy otheir sotware. By using a Certifed Service Provider (CSP), businesses are immune romaudit liability or the sales processed through the CSP sotware. In addition, states willpay the cost o service or any business that voluntarily becomes a taxpayer in an SSTstate. Avalara is one o six CSPs.

The Streamlined Sales and Use Tax Agreement (SSUTA) distinguishes between sellersthat are obligated to register voluntarily and those that are not. I a seller voluntarilyregisters to become a taxpayer through the SSTP they will not be charged a registra-tion ee, they may be able to fle returns less requently, and they can complete theirregistration online and not be required to provide additional inormation required onon-volunteer taxpayers. All sellers that register through the SST system are eligible oramnesty regardless o their voluntary status.

Did you know?

When you think o Utah, adultentertainment typically doesntcome to mind. In an eort to closethe budget gap, Utah enacted a 10%sales tax on certain adult services.

Beore getting inked in Arkansas,make sure you budget or the 6% tax

on tattoo and body piercing services.


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COMPLYING WITH SALESAND USE TAX

Compliance is comprised o our main areas:

1. Registration and collection.

2. Return preparation and fling.

3. Exemption certifcate management.

4. Audit management.

All companies, regardless o their size, will be required to address items 1 3 at somepoint during the business liecycle. Once nexus has been decided and registration with

the jurisdiction is complete, the company must collect taxes. This includes assigningtaxability and tax to products or services, and instituting a collection process. Point-o-sale retailers have a airly simple tax collection task: programming cash registers to ap-ply and capture the tax on the correct items at the time o sale. Wholesalers and manu-acturers have ew issues with tax collection, but have a larger concern with managingexemption certifcates. Companies that sell directly to end users in multiple states andthat have nexus in multiple states have the greatest challenge related to taxation.

Preparing and fling returns

Prepayments

The preparation and fling o returns is one o the most time-sensitive aspects o the tax

management process. Companies should meticulously maintain a calendar o criticaldue dates to fle and pay returns in a timely manner.

To improve cash low, many states have imposed prepayment requirements on largertaxpayers. Some states, like Illinois, inorm taxpayers what their monthly prepaymentshould be, whereas others, such as Florida, provide multiple ways to calculate theprepayment amount:

60% o average tax liability or prior calendar year. 60% o tax due or the same month prior year. 60% o current month liability.

Who Is Required to Make Prepayments?

Taxpayers that remit large amounts o tax to a jurisdiction may be required to makeprepayments.

There are three types o prepayments:

1. Prepayments included with current return the ollowing states require companies to include any prepayments with their current return:

Alabama Florida


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Georgia Kansas North Carolina Ohio

2. Prepayments made separately from returns the ollowing states requireprepayments to be made separately rom returns:

Illinois Minnesota Missouri New York Oklahoma Pennsylvania Texas

3. Prepayments considered deposits against total sales tax obligations theollowing states consider prepayments deposits against total taxes owed:

Caliornia Iowa New York New Jersey

As you can see, types o prepayments vary by state. Once a taxpayer meets the mini-mum threshold amount owed, states will typically notiy the taxpayer o their prepay-ment requirement via mail. However, taxpayers are required to monitor their activityin each state and not rely on the state to inorm them when a prepayment requirementhas been met.

How are prepayments calculated?

Just as the threshold or making prepayments varies by state, so do prepayment calcu-lations.

Many states oer multiple calculation methods, including those listed below:

Florida60% o the current month liability, or 60% o tax due or the same monthprior year.

Minnesota90% o June liability. New York90% o actual liability or the frst 22 days o the month, or 75% o 1/3 o

liability or the same quarter prior year. Pennsylvania50% o the gross tax reported or the same month, prior year.

When are prepayments due and how are they paid?Some prepayments are made on the monthly sales tax return along with tax due orthe month, while others are made separate rom the returns themselves. For instance,taxpayers required to make prepayments in Georgia and Florida will report tax due orthe month and both make the prepayment and claim credit or the prior month pre-payment. Illinois requires taxpayers meeting the prepayment threshold to make ourseparate prepayments each month: 7th, 15th, 22nd and 29th.


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Timely fling

To compensate companies or collecting and reporting tax, many jurisdictions allowor a timely fling discount. Unortunately, ew states apply this calculation universally.For example, Florida allows a timely fling discount o 2.5% on the frst $1,200 o taxreported, not to exceed $30. Illinois calculates the timely fling discount at 1.75% o salestax due.

Filing o returns and tax payments must be completed using the method the juris-diction mandates. As technology has improved, many states have begun requiringtaxpayers to fle returns and pay taxes electronically. Some states accept credit cards or

payment o tax. A companys tax department must monitor tax payments and knowwhen they have met electronic fling, electronic payment, and prepayment thresholds.Although states send notices to taxpayers inorming them o changes in fling and pay-ment requirements, companies are required to make the mandated changes regardlesso whether they have received notifcation.

Tax preparation and fling do not end when a return is mailed or payment is made.Jurisdictions send notices when they believe a return has not been fled incorrectly, late,or not at all. The taxpayer is responsible or reviewing and responding to notices in atimely ashion. Notices that remain unresolved can result in tax levies on the companybank account, or tax liens placed on the company and/or their corporate ofcers.

Managing exemption certifcates

Every sale should be considered taxable until proven exempt. One o the most impor-tant tasks or a companys tax department is obtaining a properly prepared exemptioncertifcate. The tax department should review exemption certifcates or accuracy andcompleteness as soon as they are received.

The onus is on the seller to: Veriy validity o certifcates. Generate reports summarizing status and location o certifcates.

Whether or not a licensed seller collects the tax, they bear the liability o the tax. Oth-erwise clean audits can end up with negative fndings, should the seller not be able todocument and justiy granting a customer an exemption.

Without a system to automatically monitor and manage exemption certifcates, manycompanies needlessly expose themselves to signifcant audit risk.


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Managing an audit

Entire books have been written about tax audits and how to coordinate and controlthem. A companys tax department is likely to be most concerned with the ollowingour aspects:

1. Schedulingevery audit should be scheduled in advance with the auditor.

2. Record presentationearly in the audit process, agree with the auditor on whichrecords and documents will be reviewed, how the data or the audit will betested and projected, and any other special needs the auditor may have.

3. Review o fndingsreview and discuss with the auditor items the auditor identifes

4. Appeals and remediesreview and monitor a timeline o dates and deadlines topreserve protest and appeal rights.

Internal audits

Typically, independent departments responsible or ensuring compliance with fnancialand accounting policies perorm internal audits. Because the sales tax unction is typi-cally a pass-through (dollars collected equal dollars remitted), the sales tax depart-ment is oten on the periphery o an internal audit analysis. Within the tax departmentthere should be a continuous sel-audit to ensure that data is being captured and

processed correctly, and tax procedures, including remittance, are being ollowed in alldepartments, including Accounts Payable, Purchasing, Marketing, and Sales.

Part o the audit unction should include reviewing and reconciling sales tax generalledger accounts regularly, especially when the return preparation and fling is out-sourced. By reviewing and reconciling the general ledger, it should be quite easy toidentiy when taxes have been paid incorrectly.

Small to mid-sized companies typically do not have sta with sales tax expertise,which can put them at risk or noncompliance. Regardless o company size, reconcilingthe sales tax general ledger accounts will help ensure proper payment o taxes col-lected.

Tax planning

A companys tax department should actively participate in business decisions such aswhere to establish new operations. All too oten, the tax implications o such decisionsare discovered ater the act, with a direct impact on profts.

Legislative review

Legislation constantly changes. A tax department should review pending laws andtheir potential impact on the company, products, and services it sells.

Did you know?

I you buy a Coca Cola in a glass orcup in Chicago youll pay a 9% tax,but i you buy it in a bottle or canyou only pay 3%.

I you like blueberries and wantto buy them in the great state oMaine, youll pay an additional

0.75% per pound tax. The tax is usedtoward advertising and research orblueberries.


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SALES TAX PRACTICESBY STATE

This list is not exhaustive, and is subject to change. We encourage you to research thecurrent standards and exceptions or states in which you do business.

Alabama

Many cities and counties in Ala-bama administer their own laws,tax rates, collection and audits, orthey contract out to third partiessuch as Revenue Discovery Systems

and Sales Tax Auditing and Collec-tion Services.

Taxability rules (or example,whether ood sales are taxed) maydier between state and local

jurisdictions. Services are generally non-taxable. Manuacturing and arming ma-

chinery/equipment exemptions areavailable but may be subject tolimitations and restrictions.

Location-based reporting is re-quired at the local level. Prepayment requirements may

exist. Separate returns are required or

sales, sellers use, consumers useand rental tax.

Alaska

Alaska has no state sales tax butthere are numerous local jurisdic-tions that do impose sales tax.

Each local jurisdiction establishesits own taxability rules.

Arkansas

Tax is imposed on the sellers grossreceipts.

Manuacturing and arming ma-chinery/equipment exemptions areavailable but may be subject to

limitations and restrictions. Timely fling discount is only avail-

able or sales tax reported.

Arizona

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, and dining.

Many cities in Arizona sel-adminis-ter their own laws (Home Rule), taxrates, collection and audits.

Food is exempt rom state salestax.

Many services are subject to salesand use tax.

Manuacturing and arming ma-chinery/equipment exemptions are

available but may be subject tolimitations and restrictions.

Location-based reporting is re-quired at the local level.

Annual prepayment requirementsmay exist.

Caliornia

Partial exemption rules exist orcertain types o transactions (e.g.,agricultural and manuacturing).

Services are generally non-taxable. Bundled transaction rules mayexist.

A git exemption may exist. Special sotware taxability rules

may exist (electronic transer vs.tangible personal property).


Many organizations that are usu-ally exempt (e.g., state and local

government, certain charitable/non-proft organizations) are sub-

ject to sales and use tax. Location-based reporting may be

required. Modifed origin sourcing rules may

be in eect. Prepayment requirements may

exist.

Colorado

The taxable event takes place atthe ship-to location or place oconsumption.

Many local jurisdictions in Coloradosel-administer their own laws, taxrates, collection and audits. Tax-

ability rules (or example, whetherood sales are taxed) may dierbetween the state and local juris-dictions.


Manuacturing and arming ma-chinery/equipment exemptions areavailable but may be subject tolimitations and restrictions.


Many cities impose a PropertyImprovement Fund (PIF) surchargethat is reported separately romsales tax. These unds are typicallyapplied in retail mall locations.

Certain ees, like the PIF, must beincluded in the taxable base.

Location-based reporting is re-quired at both the state and locallevels.


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Connecticut

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, or dining.



Bundled (taxable and non-taxableitems sold together as a singleunit) transaction exemption rulesapply.

Certain ood items are taxed; oth-ers are not.

Clothes are exempt rom statesales tax with limitations/restric-tions.

Non-prescription medicine is gen-erally treated as non-taxable.

District o Columbia





Florida

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, or dining.



limitations and restrictions. Bundled (taxable and non-taxable

items sold together as a singleunit) transaction exemption rulesapply.


Location-based reporting is re-quired.

Prepayment requirements mayexist.

Georgia

The taxable event takes place atthe ship-to location or place oconsumption.

Taxability rules (or example,whether ood sales are taxed) maydier between the state and local

jurisdictions. Some services are subject to sales

and use tax.


Qualifed agriculture producersreceive a sales tax exemption onagricultural equipment and pro-duction inputs.




Hawaii

Hawaii is a gross receipt state, andtax is always imposed on the grossreceipts o the seller.

Special tax rates may apply or cer-tain types o transactions such as

lodging, tourism, or eating estab-lishments.

Any tax collected rom customersis included in the taxable base (es-sentially a tax on a tax).

Transportation services are gener-ally not subject to tax but mostother services are taxable.

In additional to monthly, quarterly,and semi-annual returns, Hawaiirequires an annual recap return to

be fled.

Idaho

Special tax rates may apply tocertain types o transactions suchas lodging, tourism, or dining.


Illinois

Reduced tax rates apply to oodand medical supplies.

Most services are non-taxable. Manuacturing and arming ma-


Bundled (taxable and non-taxableitems sold together as a singleunit) transaction exemption rules

apply. Sales shipped to Illinois rom out-

side o the state are taxed at thesellers use tax rate, regardless owhether or not the company has aphysical location in Illinois.




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Indiana

Services are generally exempt romsales and use tax.



apply. Certain ood items are taxed; oth-ers are not.

Iowa

Some services are subject to salesand use tax.




Kansas

The taxable event takes placeeither at the ship-rom location orwhere the order is placed.




Kentucky

Services are generally exempt romsales and use tax.



apply. Certain ood items are taxed; oth-ers are not.

Louisiana

All Parishes (including cities) inLouisiana administer their ownlaws, tax rates, collection andaudits.

Taxability rules (or example,whether ood is taxed) may dierbetween the state and parishes.

Services are generally non-taxable. Farming machinery/equipment

exemptions are available but maybe subject to limitations.



Limited exemptions exist or resale

certifcates (credit structure).

Maine

Services are generally non-taxable. Manuacturing and arming ma-


Bundled (taxable and non-taxableitems sold together as a single

unit) transaction exemption rulesapply.


Maryland


Manuacturing and arming ma-chinery/equipment exemptions are

available but may be subject tolimitations and restrictions. Bundled (taxable and non-taxable




Massachusetts

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, or eatingestablishments.




Clothes are exempt rom sales taxbut limitations or restrictions apply

Michigan

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, and eatingestablishments.


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apply.

Minnesota

Special tax rates may apply orcertain types o transactions suchas lodging, tourism, and eatingestablishments.

There are a ew cities (Duluth, orexample) that administer theirown sales tax laws, collection andaudits.




Clothes are exempt rom statesales tax but limitation and restric-tions apply.

Non-prescription medicine is gen-

erally treated as non-taxable. Prepayment requirements may

exist.

Mississippi

Special tax rates may apply or cer-tain types o transactions such aslodging, tourism, or eating estab-lishments.

Some services are subject to sales

and use tax. Manuacturing and arming ma-


Missouri

Reduced tax rates apply to ood. Services are generally non-taxable. Manuacturing and arming ma-



Nebraska

Many services are subject to sales and

use tax.

Farming machinery/equipmentexemptions are available but may be

subject to limitations and restrictions.

Food is exempt from state sales tax.

Bundled (taxable and non-taxable

items sold together as a single unit)

transaction exemption rules apply.

Nevada





New Mexico

Tax is imposed on the sellers grossreceipts.

New Jersey


Some services are subject to sales



Bundled (taxable and non-taxableitems sold together as a single unittransaction exemption rules apply.

Certain ood items are taxed; othersare not..

Clothes are exempt rom state salestax but limitations and restrictionsapply.

Non-prescription medicine is generally treated as non-taxable.

Capital improvement exemptionsare available.

Returns must be fled electronically

New York




Certain ood items are taxed; othersare not.


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Clothes are exempt rom statesales tax but limitations and re-strictions apply.


Capital improvement exemptionsare available.


North Carolina


Taxability rules (or example,whether ood is taxed) may dierbetween the state and local juris-dictions.

Manuacturing and arming ma-chinery/equipment may qualiy ora reduced tax rate treatment.

Manuacturing machinery tax isrequired to be fled on a separate

orm rom sales and use tax Food is exempt rom state sales

tax. Prepayment requirements may

exist.

North Dakota





Bundled (taxable and non-taxableitems sold together as a single unit)transaction exemption rules apply.

Ohio




limitations and restrictions. Food is exempt rom state salestax.

Exemptions exist or warehouse/distribution center machinery andequipment.

Call center (direct sales) equipmentexemptions are available.


Oklahoma




Pennsylvania






Clothes are exempt rom statesales tax but limitation and restric-tions apply.


Prepayment requirements mayapply.

Returns must be fled electronically

Rhode Island



chinery/equipment exemptions areavailable but may be subject to

limitations and restrictions. Bundled (taxable and non-taxable



Clothes are exempt but limitationsand restrictions apply.


South Carolina


Manuacturing and arming ma-chinery/equipment may qualiy ora reduced tax rate treatment.

There is a reduced tax rate on ood


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or those 85 years o age and over. Location-based reporting is re-

quired.

South Dakota

Services are generally subject tosales and use tax.

Farming machinery/equipmentexemptions are available butmay be subject to limitations and

restrictions.

Tennessee

There are reduced tax rates onood.

A multi-tier tax rate (single-articletax) is imposed based on maximumdollar amounts in local jurisdic-tions:

First $1,600 taxed at the standardrate

$1,601 - $3,200 taxed at a uniormrate o 2.75% $3,201 and above exempt rom

local tax Some services are subject to sales



Bundled (taxable and non-taxableitems sold together as a single

unit) transaction exemption rulesapply.


Texas

Modifed origin rules apply tosourcing.

Special tax rates may apply or cer-

tain types o transactions such aslodging, tourism, or eating estab-lishments.



Modifed bundled (taxable andnon-taxable items sold together as

a single unit) transaction exemp-tion rules apply.



Prepayments are optional; how-ever, taxpayers that make prepay-ments that meet specifc rules areallowed additional discounts o1.25%.


Utah



Vermont Special tax rates may apply or cer-

tain types o transactions such aslodging, tourism, or eating estab-lishments.


chinery/equipment exemptions areavailable but may be subject to

limitations and restrictions. Food is exempt rom state sales

tax. Bundled (taxable and non-taxable

items sold together as a single unittransaction exemption rules apply.

Clothes are exempt rom state salestax but limitations and restrictionsapply.

Non-prescription medicine is generally treated as non-taxable.

Washington


Manuacturing machinery/equip-ment exemptions are available butmay be subject to limitations andrestrictions.


Wisconsin




Certain ood items are taxed; othersare not.

Bundled (taxable and non-taxableitems sold together as a single unittransaction exemption rules apply.

Wyoming



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Farming machinery/equipmentexemptions are available butmay be subject to limitations andrestrictions.

Virginia

There is a reduced tax rate or ood. Services are generally non-taxable. Manuacturing and arming ma-




West Virginia





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GLOSSARY

ACH Credit: An electronic transer o undswhereby the taxpayer initiates a transac-tion and pushes unds to the tax jurisdic-tions bank. Payment is not deposited inthe jurisdictions bank account imme-diately but may be required to processovernight.

ACH Debit: An electronic transer o undswhereby the taxpayer provides bank-ing inormation to the jurisdiction andthe tax jurisdiction pulls unds rom thetaxpayer.

Amnesty: A special program oeredby a taxing authority to allow taxpay-ers that have tax defciencies to reporttaxes due without incurring penalties. Insome cases, interest charges are abated

either in ull or in part. As a general rule,amnesty periods are short and maintainstrict requirements or participation.

Block Sampling: A sampling methodol-ogy used by a state auditor to estimatethe level o non-compliance without hav-ing to review every transaction duringthe entire audit period. Typically, a blockcan be a period o time such as a week ora month, or it could be related to specifcaccount numbers or vendors. Based on ablock sample, an auditor can extrapolate

error rates.

Consumer Use Tax: Tax due rom aconsumer on the purchase o a taxableproduct or service in which a sales taxwas not imposed. There are a numbero reasons why a vendor may not chargesales or sellers use tax on an invoice: (1)not licensed to collect, (2) no nexus in theship-to state, (3) exempt by statute, (4)

receipt o an exemption certifcate, or (5)purchase order indicates non-taxable. Inmost cases, i a seller cant provide justif-cation or not collecting the tax rom thecustomer, the state will assess the selleror the tax due.

EFT (Electronic Funds Transer): Manystates require the electronic transero sales and use tax revenues, eitherbecause a certain taxpayer reaches aminimum threshold as a tax-collectingagent or as a convenience to the state.

Error Rate: A calculated percentage oerror. Error rate calculations are generallyassociated with sales and use tax auditsin which the auditor projects the percent-age o error based on a sample. An error

rate is generally calculated by dividingthe total errors ound in a sample by thetotal sales in the sample period.

Exempt Customer: A buyer that isexempt rom the imposition o sales anduse tax. Examples include ederal gov-ernment, state and local governments,resellers, charitable organizations, andothers. With the exception o the ederalgovernment, entities that qualiy asexempt vary rom state to state.

Exemption Certifcate: A paper cer-tifcate that provides verifcation that acustomer is exempt rom taxation. Thereare several types o exemption certif-cates available such as resale certifcates,exempt organization certifcates, directpay permits, oreign diplomat exemp-tion certifcates, and Native Americanmembership cards. Generally speaking, inorder or a transaction to be exempt rom

sales and use tax, the exempt customermust provide a copy o the exemptioncertifcate to the seller prior to, or at thetime o, the sale. In most cases, the ex-emption certifcate must contain relevantinormation such as the purchasersname, address, exemption number, andeective date, and must include an au-thorized signature.

Home Rule Jurisdiction: A taxing juris-diction that imposes taxability rules di-erently rom the state. Only sel-admin-istered jurisdictions can be consideredHome Rule. Not all sel-administered

jurisdictions are Home Rule (such asthose in Alabama and Idaho).

Institute or Proessionals in Taxation

(IPT): A proessional tax organiza-tion based in Washington, D.C. Mem-bers range rom individuals and smallbusinesses to ortune 500 enterprises.Established in 1976, the IPT is an educa-tional association that seeks to establishstandards and uniormity in tax adminis-tration requirements.

Item Taxability: The taxable status oa particular item or product that is sold.The statutes o each applicable taxing

jurisdiction determine the taxability o

products and services.

Multi-State Sales and Use Tax Exemp-tion Certifcate: An exemption certifcatethat can be used or multiple statesunder a single document. The advantageo using this document is that a companydoesnt have to prepare separate exemp-tion certifcate documentation or everyapplicable state. This document has


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restrictions and limitations. Not all statesrecognize it as valid, and most acceptingstates limit its use or purposes o resaleonly.

Nexus: A legal term that denotes a con-nection between a business and a stateor locality or tax collection purposes.Based on the Supreme Court Ruling inthe Quill vs. North Dakota, nexus existsi a business connection with a state issubstantial enough to allow the stateto impose tax collection responsibility.This connection may include a physi-cal location (store, ofce or warehouse),company property, sales personnel orrepresentatives, or any other businessactivity that extends beyond the use o acommon carrier or the U.S. Postal Service.

Non-Taxable: Generally indicates that aparticular product or service is not subjectto tax as determined by statute, regula-tion, private letter ruling or court case.

Occasional Sales: Many states have anoccasional sales provision speciyingtransactions that are occasional innature are exempt rom sales tax. Anexample o such a transaction is a liq-uidation sale o urniture by a computerhardware manuacturer. The company isnot normally in the business o sellingurniture, but has used urniture to selleach time it upgrades ofce urniture.

Prepayment o Sales Tax: Prepaymentsare reerred to in a number o ways:

Estimated Tax, PrompTax (NY), Acceler-ated Payments, quarter-monthly Pay-ments. Prepayments are sales tax paidin advance as required by state or locallaws. As a general rule, prepaymentsare required when a taxpayer reaches acertain annual threshold o taxes paidor a given period o time. Examples oprepayment thresholds:

Caliorniaaverage tax liabilityexceeding $17,000 per month.

Minnesotafscal year (July June)tax liability exceeding $120,000.

New Yorktax liability or June 1 May 31 exceeds $500,00.

Pennsylvaniaactual tax liability inthe third quarter o the precedingcalendar year in excess o $25,000.

Texasoptional.

Private Letter Ruling: A legal opinionthat is provided by a taxing authority

based on a request rom a taxpayer. Suchrulings are useul and highly recom-mended i the taxpayer is unclear aboutthe taxability o an item, or i the statestatutes and regulations dont adequate-ly address the item in question. Generallyspeaking, Private Letter Rulings are bind-ing and will support a taxpayers positionunder audit.

Real Property: Land or building. Alsoincluded in the defnition o real propertyis tangible personal property (e.g., carpet)

that becomes a component part o abuilding or structure. The taxation o realproperty transactions diers rom state-to-state. Since real property transactionsgenerally involve the incorporation otangible personal property, the taxationissue primarily centers on who is deemedto be the consumer with respect to thetangible personal property.

Regulation: Administrative policies andinterpretations established by taxingauthorities relative to the statutes (laws)that state and local lawmakers havepassed.

Reserve Account: An account that allowsa company to reserve unds or potentialsale and use tax liabilities that may beassessed during uture sales and use taxaudits. Reserve accounts are advanta-geous when errors or defciencies arediscovered during an audit cycle, or when

there are known systemic problems thatare preventing a taxpayer rom ullycomplying with the law on a month-to-month basis.

Retailer: The party that sells a product oservice to the fnal consumer. The retailerbears the responsibility or the collectionand remittance o any sales and use taxthat is due. Taxing authorities will holdretailers accountable or any defcienciesthat are ound during an audit, and willassess the retailer including penalties ornon-compliance.

Sales Tax: A transactional tax that isimposed on the sale o tangible personalproperty and certain types o services.Generally speaking, a sales tax transac-tion occurs when the buyer and sellerare located in the same state and theproducts or services are consumed inthe same state where they were sold.45 states and the District o Columbia

impose a general sales tax. The fvestates that have no sales tax are Alaska,Delaware, Montana, New Hampshireand Oregon. Local jurisdictions within astate may impose a local sales tax. Mostlocal sales taxes are administered andcollected by the state, and thereater al-located to local jurisdictions.

Sales Tax Holidays: During these desig-nated periods o time, a state temporarilysuspends the imposition o sales and/or use tax. This can include a limited

list o normally taxable items (e.g., oodand clothing) or all normally taxableitems. The suspension period usually lastbetween 1 and 7 days.

Sales Tax Liability Account: Generalledger account. This is the liability ac-count that is used to account or the salestax or sellers use tax that is charged tocustomers.


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Sel-Assessment: Sel-assessment isrequired because in most cases thepurchaser is ultimately responsible orthe tax on the transaction. I a sellerdoesnt impose tax, it is usually becausethey are not licensed to collect tax in theship-to state (they dont have nexus),the ship-to state does not impose a salestax, or the seller views the transaction asnon-taxable.

Sel-Administered: A local tax jurisdic-tion that has chosen to administer salestax collection itsel.

Sellers Use Tax: A transactional taxsimilar to a sales tax that is imposed onthe sale o tangible personal propertyand certain types o services. Generallyspeaking, a sellers use tax is due when asales tax isnt imposed because the sellerand buyer are located in dierent states,and the consumption o the sold prod-ucts or services takes place in the state in

which the buyer is located.

Services: Services come in many ormsand varieties (or example, consultingor other proessional services, repair otangible personal property (TPP) repair oreal property, and installation o tangiblepersonal property.). The taxability o ser-vices depends on a variety o actors suchas type o service being perormed, statein which the service is being perormedor allocated, whether the service is beingperormed in conjunction with the sale

o TPP.

State Policy Statements or Bulletins:Ofcial policy provided by a taxing au-thority to help taxpayers understand thestates position on a certain tax issue. Inmany cases, these bulletins are gener-ated because o a recent court case rulingor a change in state law.

Statutes: Laws that have been passed bystate and local lawmakers.

Statute o Limitations: A period o timein which a state has to assess additionaltax, penalties and interest or non-compliance. For most states, the statuteis three years rom the time the tax wasdue or when the return was fled, which-ever comes frst. A taxing authority orassessment purposes can void a statuteo limitation period i raud or evasion isdetermined.

Statute o Limitations Waiver: A bindingagreement that extends the statute olimitations period. An auditor will otenrequest a waiver rom a company so thatthey dont oreit time during the earlyportion o an audit period. The need torequest a waiver rom a taxpayer is gen-erally a result o time delays in obtainingnecessary data rom taxpayers, or deal-ing with unexpected problems.

Tangible Personal Property (TPP):Property that is tangible in nature andnot considered real property. Under nor-mal sales and use tax law, all tangiblepersonal property is subject to tax, unlessproven otherwise through state statute,regulation, private letter ruling, courtcase, or other.

Tax Commission: An agency o a stategovernment similar to a Departmento Revenue that has the administrative

responsibility o collecting and auditingo sales and use tax revenues.

Third-Party Drop Ship: A transactionwhere the purchaser is not the fnalconsumer. An example o this would bewhere X (seller) who is located in Cali-ornia sells to Y (buyer) who is located inNevada, but ships the purchased productto Z (third-party) who is located in Utah.The sales and use tax implication o this

type o transaction is related to whobears the responsibility or the collectiono tax under this type o sale.

True Object Test: A test aimed at de-termining the real intent or purposeo the purchase o a product or service.This is useul in deciding whether or nota particular product or service is taxable.A true object test might be employedwhen you have a ood item that is pack-aged in a colorul tin container.

Wholesaler: A party that sells to aretailer. The sale to a wholesaler andthe sale rom the wholesaler are usuallyexempt rom tax, providing a properlyprepared resale certifcate is obtained inlieu o the tax.

Wire Transer: An electronic transer ounds rom the taxpayers bank to the tax

jurisdiction. Wire transers deposit undsimmediately into the jurisdictions bank

account.


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ADDITIONAL RESOURCESAccess state-specifc tax inormation and rates here:http://www.taxrates.com/.

I its inormation on sales and use tax you need, we have it here:http://www.avalara.com/resources

Avalara simplifes tax collection with a web-based solution.Learn more: http://www.avalara.com/cloudsalestax

END NOTES

1State Government Tax Collections Summary Report: 2011, U.S. Census Bureau

2Defned by Supreme Court Decision: Quill vs. North Dakota, May 1992.

3Caliornia and Texas are considered modifed-origin states, where state, county,and city taxes are based on the origin o the sale, while district taxes are based on thedestination o the sale.

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Documents

The Definitive Guide to Sales and Use Tax: A Sales and Use Tax Compliance Primer