Navigating sales and use tax: Mitigating risks and managing compliance

Many business owners and management teams underestimate the importance of sales and use tax compliance.

It’s not uncommon for them to assume because they’re providing services or dealing with exempt customers, they’re off the hook from any obligation. However, these assumptions can lead to costly oversights, which tend to remain hidden until a potential acquisition or audit exposes deficiencies in sales and use tax compliance.

Take, for instance, the misclassification of services as nontaxable. This oversight can occur due to the misconception services historically have been, and continue to be, immune from sales taxation. Businesses who provide software as a service (SaaS) are particularly susceptible, as they might wrongly assume all states view their product as a nontaxable service.

Weaknesses in policies for collecting exemption certificates also can lead to costly repercussions, with taxpayers who neglect to acquire and maintain valid exemption certificates bearing the burden of paying sales tax themselves. Additionally, industries like manufacturing, construction, and real estate may overlook proper self-assessment of use tax, operating under the assumption all their purchases are automatically exempt, which can result in significant financial setbacks.

Awareness plays a pivotal role in effectively navigating the complexities of sales and use tax, empowering businesses to make informed decisions and optimize their financial strategies. By taking an informed approach, business leaders can avoid significant repercussions during an acquisition, such as special indemnity clauses, additional funds held in escrow, or in severe cases, even the termination of the deal.

Utilizing a nexus study

One powerful tool in managing sales and use tax obligations and mitigating risks is a nexus study.

A nexus study is a thorough analysis conducted by experienced tax professionals to determine the extent of a business’ connection, or nexus, with a specific state or jurisdiction for tax purposes. This study involves examining various factors such as physical presence, economic activities, sales volume, and employee presence within the state in question. By meticulously analyzing these factors in relation to the state’s tax laws and regulations, tax experts can assess whether the business meets the threshold for registration in that jurisdiction.

Such a study provides clarity on your sales and use tax obligations across different states or jurisdictions. By identifying where your business has nexus, you can ensure compliance with state tax requirements and avoid potential penalties or liabilities.

Additionally, a nexus study helps quantify and assess the risks associated with sales and use tax compliance. By pinpointing areas of potential exposure, such as inadequate collection of exemption certificates or misclassification of taxable products or services, businesses can proactively address these issues and implement strategies to minimize risks during transactions or audits.

A nexus study also offers valuable insights for strategic decision-making, especially for businesses considering expansion or restructuring. By understanding the tax implications of operating in different states, businesses can make informed decisions about their growth strategies and allocate resources more effectively.

By understanding common pitfalls and taking proactive steps to address them, businesses can mitigate risks, ensure compliance, and pave the way for smooth transactions and audits. Remember, when it comes to sales and use tax, awareness and action are key.

• Michael Szewc is senior state and local tax manager for Mowery & Schoenfeld, LLC, a Lincolnshire-based public accounting firm.