Managing taxes can feel like a recurring nightmare for business owners and entrepreneurs. The sheer complexity of the United State’s tax landscape can be overwhelming, which can make navigating tax intricacies a daunting task.
In this article, we’ll cover:
- The common challenges businesses face when striving to make accurate indirect tax calculations
- The role sales tax changes and product taxability play within indirect tax
- Why accurate indirect tax calculations are critical to overall business success
- How to avoid indirect tax errors
What Is Indirect Tax?
First things first, indirect tax refers to the amount collected by a retailer or manufacturer that is paid to the government as a result of a sale or consumption. Sales tax is an example of indirect tax.
It is important to note that the tax is passed onto the consumer by the seller as part of the purchase price for the good or service provided. Ultimately, this means that the consumer is paying the tax by paying more for the product and the seller is remitting it to the tax authorities.
Common Challenges of Maintaining Accurate Indirect Tax Calculations
Making accurate indirect tax calculations is no easy feat. Businesses often face the following common challenges when trying to maintain accuracy:
- Frequent Changes in Tax Laws and Rates: Tax codes are rarely static; they evolve with time and with changes in government policies. Adapting to these changes and staying compliant can be an uphill battle.
- Varying Product Taxability by State/Jurisdictions: Product taxability can differ significantly from one state to another rather one jurisdiction to another. Businesses operating in multiple locations must account for these variations, adding complexity to the process.
- Penalties and Fines: Non-compliance with tax laws can result in severe penalties and fines. These financial repercussions can be detrimental for businesses, particularly when they're already grappling with managing their finances.
- Resource Constraints: Businesses may lack the resources to hire in-house tax experts, leading to a greater reliance on external accountants or tax consultants, which can be costly. This is especially true for smaller businesses with limited resources.
Get in touch to learn how we take these challenges completely off your plate at Zamp.
What Role Do Sales Tax Changes Play?
In the United States, taxes are levied at the federal, state and local levels, each with its own set of ever-changing laws, rules, regulations, and rates. We’ve seen more than 600 sales tax rules and rate changes in the US in 2022 alone.
Any mistake in capturing these changes and indirect tax calculation can result in heavy penalties, cash-flows (out of pocket payment), a negative company reputation, and additional costs to rectify issues. It’s no surprise that one of the most common assessment error categories is “under collection of tax” during indirect tax audits.
Understanding Product Taxability
Understanding product taxability is particularly challenging for many businesses as most tangible property is subject to sales tax, yet some fall under “exempt” or “sometimes taxable” categories.
Exemptions are not a one-size-fits-all, and can vary by state. For example, digital goods are:
- Taxable in Alabama, Arizona, Arkansas
- Exempt in California, Florida, Georgia
- Exempt with non-permanent access and taxable if the access is permanent in Idaho, Indiana, and Louisiana
Exemptions are also based on the product itself, who’s buying it, when it’s purchased, and the product’s use. Check out the examples below for more information.
Product-based exemptions are based on the specific product itself. For example, meat sticks and meat jerky are considered taxable snacks only in Maine, whereas they follow food and food ingredient taxability everywhere else in the US.
Another example is sales tax on clothing. Clothing in New York, Massachusetts, and Rhode Island is only exempt if it’s priced under $110, $175, and $250, respectively.
Entity-based exemptions are dependent on who is purchasing an item. For example, computers are taxable TPP (tangible personal property)in all states, but if a state/federal government entity purchases it with a valid exemption certificate, the purchase is exempt.
Stationery is also taxable TPP, but if an educational entity purchases it with a valid exemption certificate, it is exempt.
Time-based exemptions are contingent upon when an item is purchased. If a lunch box is considered general taxable TPP, but purchased during a Sales Tax Holiday, it can be non-taxable.
Use-based exemptions are made when they are intended to be used for a specific exempt purpose. For instance, hand tools such as shovels, rakes, picks and hoes used for agriculture purposes are exempt.
Why Are Accurate Indirect Tax Calculations Important?
Failing to accurately calculate indirect tax can have major repercussions in the long run. Below is an example of how just one product miscalculation can have a negative domino effect on a business:
- Product A sold is not taxed, but in reality, should have been taxed
- Year 1 sales total $200,000 and grows 15% per-year over a three-year period i.e., Jan 2020 - Dec 2022
- Total sales revenue over a three-year period amounts to $694,500
- With an average tax rate of 10.25%, that’s over $71,186 of tax which is not collected.
- On top of it, penalty and interest is collected, and in this case would amount to roughly $60K+
Aside from the time lost trying to resolve these issues, paying significant fees to undo the damage is an added financial strain that can negatively impact business growth. It’s safe to say that no one wants to deal with that.
How to Avoid Indirect Tax Errors
Avoiding incorrect sales tax calculations is not just a recommendation; it's a critical necessity. It ensures compliance with tax laws, cost efficiency, customer trust, audit preparedness, and a competitive advantage.
Organizations that invest in accurate tax calculation processes and technologies are better equipped to navigate the nuances of sales tax, protect their finances, and maintain a positive reputation in the marketplace. Accurate tax compliance isn't just about numbers— it's about safeguarding your organization's financial health and its standing in the eyes of your customers.
Every business has to deal with sales tax. Zamp takes care of your sales tax needs from start to finish, so you can focus on running your business. Get in touch with our team to learn how we can help.
Sachin Kunjalwar is the Director of Indirect Tax Content at Zamp with 11+ years of experience (prev. Thomson Reuters, Avalara & Amazon). He specializes in sourcing US Sales Tax, EU VAT, and Canada Tax content, and he has extensive knowledge of Tax Audit Defense & Reverse Audits. Sachin resides in Hyderabad, India with his wife and two sons (16 and 9 years old). He enjoys playing Sudoku, Carrom, and Table Tennis in his free time.