Tax compliance issues can complicate your business as you expand into new locations. Not understanding your state and local tax (SALT) obligations in each jurisdiction may raise your tax bill considerably and/or open you up to potential tax exposure, including penalties and interest. These seven questions will help you identify SALT reporting and compliance gaps and determine where you may need to address outstanding issues.
1. How do you source sales among the states (are you using your customer’s billing address)
Many states use market-based sourcing, but due to statutory variations, the proper application of these provisions may differ by state. Businesses often use billing address to source revenue, but this is not consistent with state market-based sourcing requirements because a billing address often does not accurately represent where the customer receives the benefit of the services. Sourcing sales for income tax purposes is complicated, and the slightest nuance in the statutory language can make a material difference in your company’s tax liability. Failure to apply these provisions correctly may result in overpayment or underpayment of income tax in various states.
2. Are you using the same apportionment methodology to source sales in all states?
States vary widely in terms of revenue sourcing requirements. Some states apply market-based sourcing, while others source revenue based on the location(s) of the costs incurred to generate such revenue. Businesses must evaluate their sourcing methodology separately in each state because it’s likely the methodology varies across state lines. Reviewing your revenue sourcing methodologies may help your business mitigate tax exposure or even generate tax refunds.
3. Are you apportioning 100% of your sales, and if so, should you be?
State and local revenue sourcing laws vary by state, and it is not uncommon for the interplay between state tax laws (especially state sourcing methodologies) to result in the taxation of less than 100% of your income among the states. Careful review and application of these provisions may create material benefit for your business.
4. Are you making sales outside the state in which your company is located?
Even if you do not have a location or employees in a particular state, you may still have an income tax filing obligation. Physical presence is no longer required for a state to impose income tax on businesses. Simply deriving revenue from the state may be enough. It is important to carefully review each state’s revenue sourcing requirements to accurately determine whether your business has economic nexus in a state, which triggers incremental state income tax filing obligations you may not be aware of. Failure to file income tax returns in such states may create material income tax exposures that will continue to accrue in perpetuity since there is no statute of limitations on the state’s ability to assess income tax if the business never files an income tax return.
5. Do you have sales over $100,000 and/or more than 200 sales transactions in any state?
The state and local sales tax thresholds vary by state, as does the measure for triggering these thresholds. However, since the U.S. Supreme Court’s seminal 2018 South Dakota v. Wayfair decision, every state that has a sales tax has enacted an economic nexus provision. Many use a combination like the sales and transaction thresholds noted above, which were modeled after the South Dakota statute at issue in the Wayfair case. If your business meets these thresholds, you should evaluate the taxability of your product to determine whether you have a sales tax collection and remittance responsibility in one or more states.
6. Is your product taxable in the state or locality in which you do business?
The taxability of products and services varies by state. This may create situations where your business falls within a specific category of taxable services in one state and a completely different non-taxable category in another state. Separately, the state may have provisions that exempt some of your sales and/or tax them only at the local level.
7. If your product is taxable, are you compliant with the state and local sales tax requirements?
If your business meets a state’s nexus threshold and you fail to collect and remit sales tax on your taxable sales, you could end up paying the tax bill for your customers. Typically, the seller passes the sales tax to its customers. However, sellers that do not collect the tax from customers are on the hook for the uncollected sales tax plus penalties and interest.