There are more than 13,000 sales and use tax jurisdictions in the U.S.—all of which have different definitions and levels of enforcement. The complexity of sales tax rules can be found in numerous examples, like how orange juice is taxed more than 300 different ways in the U.S., or how streaming fitness classes can be taxed more than 160 different ways—and that’s just across 20 states.
Because sales tax has so many dependencies—product type, taxability definitions, location, and more—it’s clear why it takes ample time and resources to get managing sales tax right.
In recent years, the acceleration of e-commerce and prevalence of omnichannel selling has only exacerbated tax obligations for businesses. Today, many businesses must manage tax requirements across state and local jurisdictions triggered by a mix of online and in-person sales transactions. And, despite an increasing volume of business taking place online, many continue to manage sales tax just as they did prior to the digital age: Manually. As commerce has inched closer to real-time and tax obligations have soared, the burden of managing tax manually has also increased.
Avalara commissioned NetReflector/Potentiate to survey hundreds of small and midsize U.S. businesses across the manufacturing, retail, and software industries to understand the cost of manual sales tax compliance. Key findings from the survey include:
Larger Businesses Face the Greatest Cost Burden
Because sales tax hinges on so many factors, it’s understandable that the larger the business, the larger the tax burden is likely to be. Larger businesses often come with more products, transactions, and locations, which all add up to expensive and expansive tax compliance obligations.
When comparing emerging small businesses (ESBs—those with three or fewer total employees) and small and midsize businesses (SMBs—those with two to five employees working on sales tax), it’s clear that the larger the business, the costlier tax management is. On average, the survey found that SMBs spend 163 hours and more than $17,000 each month on sales tax compliance. By comparison, ESBs spend 131 hours and nearly $12,000 on sales tax compliance each month.
When you look closely at the specific sales tax requirements, it’s also clear that larger businesses must dedicate more time at every step of the process—from identifying obligations and calculations, to exemption certificate management and tax returns. For SMBs, tax returns cost an added 8.7 hours of management more than ESBs.
Retailers Shell Out the Most on Tax Compliance
The pandemic and shifts in consumer behavior have prompted the rapid acceleration of e-commerce. More goods and services are being purchased digitally, creating new sales opportunities, and triggering new tax obligations for businesses.
The survey looked at businesses across three key industries: manufacturing, retail, and software. Interestingly enough, retailers spend the most of any industry on sales tax compliance, at $24,000 per month. That’s likely because retailers have expansive product catalogs and a greater likelihood of selling to customers across numerous jurisdictions.
While retailers spend the most on sales tax compliance in general, manufacturers are at greater risk of being hit with penalties associated with tax audits. A total of 18% of manufacturers reported an audit, compared to 10% and 4% of retailers and software companies, respectively. Among the main reasons for audit penalties are sales tax rate or rule errors, missing exemption certificates, and late filings.
Many SMBs Have Audit Liability in Non-Registered States
Before a business can begin collecting and reporting sales tax with a jurisdiction, it must first register to collect. That need is determined by nexus—either a physical presence in a jurisdiction or economic nexus created by remote sales into certain states. The thresholds for economic nexus vary by state but generally range from $100,000 to $500,000 in revenue, and some also have a transaction threshold.
According to the survey, 80% of SMBs sold between $50,000 and $3 million in states where they weren’t registered. Mean revenue for those businesses was $678,000, meaning that many SMBs could have triggered economic nexus, along with a requirement to register, in states where they weren’t compliant. Without proper registration, businesses that have exceeded thresholds put themselves at significant risk of audit and financial repercussions.
Businesses are Becoming More Interested in Technology
Of the businesses surveyed, more than a quarter noted that the pandemic has made them more likely to purchase new technology solutions in the next year. Aside from the pressures of the pandemic, it’s likely that the sheer complexity and cost of managing tax obligations have driven the interest in tax-specific technology.
Ben Scrivens, president and CEO of Fright-Rags, adopted technology for these exact reasons. Earlier this year, he noted that he pays Avalara just over $1,600 a year for tax technology services, which he said is “totally worth it, because they’re dealing with the brunt of everything. Hiring a person to do that would cost more than $1,600 a year.”
While technology comes with its own set of costs and complexity, the survey points out that there are several factors in play to manually manage tax. Paying employees and external service providers, and for some likely audit penalties, make the potential cost of manual compliance daunting.
At the end of the day, sales tax compliance is a regulatory requirement with which businesses of all sizes must comply. Managing sales tax provides no value to a business or its bottom line, but mismanaging it can have serious repercussions.
Aside from the risks of managing sales tax incorrectly, there’s also an ongoing risk of spending valuable time and money in the everyday management of sales tax, as this survey illustrated. Because sales tax presents a confusing labyrinth of rates, rules, and requirements in most of the U.S., managing it manually will inevitably lead to mistakes, risk, and added costs.
You can read more about the survey findings here.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Liz Armbruester is Senior Vice President of global compliance operations of Avalara where she oversees the company’s global returns business.
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