How to Fix a (Sales Tax) Broken Heart
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss the complexities and challenges of managing sales tax, particularly highlighting the emotional and financial troubles businesses face due to inadequate services from tax software providers. They delve into the risks associated with over-reliance on automation and the importance of accurate tax collection and remittance, emphasizing the need for clear communication and realistic expectations.
Here’s a glimpse of what you’ll learn:
What are the most common sales tax pitfalls?
What should someone do if they’ve never paid sales tax?
What should someone do if they’re not registered in the correct number of states?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More your go-to resource for all things state tax related. Now here is your host, Michael Fleming.
Michael Fleming: Hello everyone. Mike Fleming here, founder of Sales Tax and More in today's co-host of the Sales Tax and More Podcast where we talk about everybody's favorite topic, which is of course sales tax. And in the spirit of Valentine's Day, we're gonna talk about how to fix a sales tax broken heart.
But first, let me introduce you to my co-host who's breaking hearts all the time. Ellie Moffat.
Ellie Moffat: Hi everyone, great to be here. I'm only breaking the hearts of the general public [00:01:00] who have to learn about sales tax issues. It's not fun for anyone, but it is necessary and you can avoid a lot of pain. But before we get started, let's do a quick introduction for Sales Tax and More. We are a full service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs.
So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense exemption certificate management, and like our name states more. So if you have questions about our services or you'd like to work with us, please reach out. We would love to hear from you and we would love to work with you as well.
And Mike, that being said what are the most common sales tax pitfalls falls?
Michael Fleming: Oh, it's breaking my heart. Trying to figure out, narrow this down to just one or two. There's so many pitfalls that are very common and we see all the time, but I think perhaps [00:02:00] if I have to narrow it down, there are two that I want to talk about.
The first one has to do with nexus. And unfortunately some companies just don't understand where they have this link or connection with the state where the state's gonna require them to do something like collect or pay a sales tax or a vendor's use tax. They don't understand where they have this connection.
And that's all nexus is. It's a connection with the state. So when we're talking about nexus. There's physical nexus and there's economic nexus. So a lot of companies don't understand this new nexus, which is the economic nexus. Now it's new since 2018, so that's relatively new, but it's almost eight years old now, and a lot of companies just still did not realize about 50 to 60% are not compliant.
They're not compliant because they think that the [00:03:00] US Supreme Court's gonna step back in and change it. I just don't think that's gonna happen. They may fine tune it, but they're not going to change it. It's here to stay. Or they think Congress is gonna step in. Congress passed a law in 1959, the Interstate Income Act of 1959, and that's a nexus law that was passed by Congress. When they passed it, they said, nexus is so complex and so confusing. This is just temporary. Once we get our arms around the concept of nexus, once we empower panels and do studies and we're gonna come out with a permanent solution. That was in 1959. This is 1926 that was what, 67 years ago. We still had this antiquated solution on the books. So if you are waiting for Congress maybe your great-great-grandchildren will get some sort of help from them. But in some instances, we've had to do nothing Congress for a lot longer [00:04:00] than you would realize on some topics, especially nexus being one of them. So I don't know why people are waiting when they know about economic nexus.
But some people just don't know about it. Here we are almost eight years into it, and our salespeople are stumbling across companies all of the time, and even their advisors, like their CPAs that don't understand that their clients could be subject to this economic nexus. So that's number one, understanding where you might have a responsibility for economic nexus.
And then the second part of nexus is physical nexus. And it's how third parties, if we have an office somewhere, most of us are gonna realize that creates nexus. But third parties, this is the biggest issue that has created more problems for more companies as long as I've been doing business. And the reason I think that is, is because when we're thinking about how we [00:05:00] create a link or connection with the state, we don't often think of what third parties are doing on our behalf.
That just doesn't make common sense to me. So I think that's why this is such a big issue. But if you have someone out there who's doing installations or implementations or credit repair or collections. If they're helping you to establish or maintain a market, then that can be nexus creating.
And it doesn't matter if you call them an independent contractor, a subcontractor, a manufacturer's rep. It doesn't matter what you call them. It could just be a company. You don't even have to put a label on it. If you hire a company to do something on your behalf and the state can deem that to be helping you establish or maintain a market, then that's gonna be nexus creating in most instances.
When it comes to physical presence, that's the biggest issue right there. Nexus is the number [00:06:00] one heartbreaker out there, not understanding what it is. And if a state finds you, they can go back to the point that your nexus began. It may be 20 years ago. In theory, they can go back that far and sometimes they try to do that.
In practice, more states limit the amount they go back. But even limiting it, it's seven, eight or 10 years. I don't know of any states that go back nine years, but lots of states go back seven or eight years and a couple go back 10 years. So that's where the real heartbreak comes in. Your business is going along, you think everything's good.
All of a sudden, states finds you and they want the last seven years of back tax, which could be a substantial amount to begin with. Then they want the added insult , the penalty and interest on it, and that could exceed 50, 60% of the actual tax that's owed. So that's a [00:07:00] heartbreaker. So that's number one.
Number two, let's talk about taxability. A taxability heartbreak. A lot of companies and a lot of accountants are under the assumption that services are not taxable, and unfortunately that's just not true. We go back to the 1950s. That was more true. But at this day and age, I mean our economy has changed.
It used to be manufacturing based. We're a service-based economy now, and the states have lost a lot of revenue because of this change from manufacturing to service. And the states are playing catch up and every year more and more states are taxing more and more services. So that's tripping up a lot of companies out there and I talk to some very smart people and they'll tell me our state doesn't tax any services, and then I have to go out and list the services that their state actually taxes. So every state that has a [00:08:00] sales tax, taxes, at least some services at this point. And like I said, more and more services are being taxed every year.
And again, where the heartache comes in is if you have not been collecting sales tax on your services for the last 7, 8, 10 years, the state's gonna find you, they're gonna want all of that back tax plus the penalty and interest. Those are the two biggest heartaches or heartbreakers out there that I see Ellie.
Ellie Moffat: Two biggest Heartbreakers out there. Let it be written. Those are just some of the things. If you have questions, you can always reach out to us and ask us more, and we offer consultations as well. But Mike, what should someone do if they've never paid sales tax?
Michael Fleming: Interesting question. This one? It depends. It depends on a couple of things. It depends on the state, number one. It depends on your exposure, number two. How big is it? Is it material? [00:09:00] And it depends on if you want me to tell you what the state says you should do or what companies actually do.
So a lot of depends in there. So there are certain states that are more aggressive than others. And if this is an aggressive state, and no matter what your exposure is, you should really do what the state wants you to do. And I'm gonna get to that in a minute. If it's a less aggressive state and the exposure is not high, then maybe you ignore it. Maybe you don't do anything because the cost of compliance is actually greater than the cost to comply with the state. Now, that doesn't mean you won't get in trouble if the state finds you. It just means that it would be cheaper for you to pay the state out of your own pocket than to do what the state wants you to do and you gotta pay to get registered, or time is money.
If you do it yourself or you hire someone like us, then you gotta file the returns or hire someone like us to file the returns for [00:10:00] you. So there's a cost to being compliant. Now, if your exposure is material. Then you gotta decide there's three basic ways to get registered. One is registering prospectively.
In other words, I'm just going to stop the bleeding. I'm not gonna continue to do it wrong. I'm just gonna start doing it right. That's not the way the state wants you to do it, but some companies either don't have the mindset to pay it or they don't have the ability to pay those back taxes, so they're just gonna start collecting going forward.
And in some states that's okay. In other states, they're gonna audit everyone who gets registered. States like Illinois, Minnesota, Arizona, Arkansas. You definitely don't want to try to just get registered going forward 'cause it's not a matter of if you're gonna be chosen for audit, it's when you're gonna be chosen for audit.
But if it's the other states, they usually take you at your word. And while you're not supposed to do it, we see a lot of companies doing it. So you've gotta make a decision. Do I [00:11:00] wanna do it the way the state wants me to do it? Or do I just wanna roll a dice and get registered, stop the bleeding?
That past exposure doesn't go away, but it gets small. The chance of being found gets smaller and smaller every year. And if you're going to do it the way that the state wants you to do it, there's what we call a historical registration. In other words, you use the date where your nexus actually began.
And when you register, the state's gonna say, thank you for registering now, please give me all of my back tax plus penalty and interest. Now, at that point, you can ask for the penalty be to be waived, and a lot of states are gonna work with you on that. Since you're stepping forward. Some states won't.
And virtually none of the states are gonna work with you on interest if you do a historical registration. The next way to do it is if you have a whole lot of exposure, going back a whole lot of years, is to register through a voluntary [00:12:00] disclosure agreement. And a voluntary disclosure agreement is gonna reward you for stepping forward voluntarily.
And instead of going back 7, 8, 10 years, however long your exposure is they'll say, as a reward, we're only gonna go back three or four years. So right away, anything older than that three years has fallen off. You don't have to pay any of that back tax. And in whatever that period is, whether it be three years or four years, they're gonna generally waive the penalty. And the penalties can be 25% or so.
So right away that's a big savings there. And in a handful plus one or two states. They'll waive the interest, like Texas will waive a hundred percent of the interest. The state of Oklahoma will waive 50% of the interest. So there, all in all, there's about seven states that will waive either all or some of the interest.
Sum up depends on the state. And it depends [00:13:00] on your exposure on how you wanna register going forward. The states are always going to say they want you to take care of that past exposure, but doesn't make a good business decision or not to go ahead and take care of that. It's all gonna depend on the materiality.
So I, I think that pretty much answers that question for you, Ellie. Does it not?
Ellie Moffat: Yeah, I think so. Are you ready for the next one, Mike?
Michael Fleming: Yeah, absolutely.
Ellie Moffat: All right. What should someone do if they're not registered in the correct number of states?
Michael Fleming: This sort of relates to the last question. The first thing you wanna do is determine what your potential exposure is.
And, if it's not that large, maybe you just register going forward. Maybe you just cross the nexus threshold and then the correct way is to just register going forward. Maybe it's only the last eight [00:14:00] months. And the exposure is not huge, but it's growing. Maybe you do a historical registration, which is use the actual date of the registration and pay the back tax and penalty and interest and ask the the state to waive the penalty.
Or maybe if you have a lot of exposure, then you go and do the voluntary disclosure agreement like I was talking about. So the first thing you need to do is get your arms around what your potential liability is. Now, if you need help doing that, we do have a service. We call it an exposure review with a VDA cost benefit analysis. And if you're thinking about doing VDAs, I think that this is very important. A VDA is a great tool and it can save you a lot of money, but just like any other tool out there, it's not a one size fits all tool. And for a long time, this is one of the reasons why I [00:15:00] say you shouldn't go to software companies for services.
We'll throw Avalara underneath the bus. They said that if you owed any state more than $500, you need to do a VDA. By the way, we charge you $3,500 for each VDA that we do. And we had people coming to us that were paying $120,000 for, 30 plus VDAs before they even paid a dime to the states.
You still gotta pay some money to the states, whether it be three years or four years of back taxes. Why in the world would anyone pay $3,500 to remit $500 worth of tax? That just doesn't make sense. I don't know how their salespeople got up in the morning and looked at themselves in the mirror, but that was their policy.
That's what they did. And, if people were smart enough to get a second opinion, we got a lot of clients that way because they said you're [00:16:00] taking a logical approach, Avalara's just trying to fleece us. And we would do this cost benefit analysis. And here's the rule of thumb, if you are not saving at least as much money as it costs to do the VDA.
Why in the world do the vda? So even we have a cost to doing our VDAs and ours is on a sliding scale. Theirs is 3,500 no matter what, or may actually be higher than that now. But ours, if you're doing one, it's gonna be more expensive than if you're doing 40. So that's the sliding scale there. There are economies of scale and the more you do the cheaper it will be.
But no matter what. You still have to be saving more money by doing the VDA than what we're gonna charge you. So no matter who's charging you it, that's the rule of thumb. You gotta be saving more money than it costs to do the VDA. If you're not saving that much money, then you get two other options.
Do I just [00:17:00] register historically and ask for the penalty waiver? And we can do that for you also. Or do I want to do nothing at all or do I just wanna register prospectively? So there's four options that you can do. And that's what we tell you, we give you what we believe should be done as well as letting you know approximately how much money is gonna be due. Because the other thing is, it's gonna cost you $120,000. People would tell 'em, and they wouldn't mention that each one of those VDA could be costing 'em 50, 60, 70, $80,000 because you got still gotta pay the back tax. So in this exposure review with a VDA cost benefit analysis, we also going to tell you if the state finds you, here's how much money you would pay.
And if you do a VDA, here's how much money you can expect to pay. So that you'll go into this with open eyes and [00:18:00] sometimes people will say, oh, wow, I'm gonna have to break this down. I'm gonna do our five states where we have the greatest exposure first, and I'll get to these other states later on because if these states found us, this could be crippling to our business, but I can't afford to do 'em all at the same time.
Some companies choose 10 states, some choose six states. Some do one at a time. So anyway, great tool. You gotta know when and how to employ it. And this VDA cost benefit analysis is gonna give you all of the information that you need in order to make an informed decision on how you want to move forward.
And we'll give you the guidance in how to do it. And if you wish, then we can actually implement that plan for you.
Ellie Moffat: All right. Thank you so much Mike. I hope that this podcast helps everyone avoid a broken heart. And if you have sales tax needs , we have a lot of solutions and services. [00:19:00] We would love to work with you.
We'd love to hear from you. You can reach out to me directly at E-M-O-F-F-A-T
at salestaxandmore.com. Or visit our website, salestaxandmore.com. And we have an entire series of free webinars and resources on our website that are great to check out as well. Thank you so much.
Michael Fleming: Yeah. And Ellie, even if it doesn't break anyone's heart, it can break your business, which is heartbreaking.
So you work so hard to be successful. You don't want something overlooked like this. To potentially put you outta business order to weaken you to the point where it's a problem. Again, we hope that this has been beneficial and we hope to see you on the next installment of the Sales Tax and More Podcast. Bye-bye.