Why you should start collecting other states’ sales tax sooner rather than later
Written by: Steve Estelle
Larry, the Controller at a mid-sized distributor of measurement and testing equipment, had been busy managing existing sales tax compliance processes and attending to all the other concerns controllers have. Daily, his staff was adding new customers and new addresses for existing customers to the master data file, recording exemption certificates, crediting and rebilling customers who sent in their exemption certificates after the company issued their first, second, or even third invoices, identifying tax codes for new products in their tax automation software, compiling monthly sales and fixed asset addition data, preparing monthly and quarterly sales and use tax returns, reconciling the sales and use taxes payable accounts, and investigating the latest sales tax mystery or customer question “why was tax charged (or not)?”
Perhaps because those activities were keeping them busy, one thing Larry and his staff hadn’t been doing is tracking the company’s activities in states where they weren’t collecting sales tax. Larry hadn’t even thought of it until he ran into the VP of sales at the donut shop before work one day.
The sales VP, Sherri, was standing in line with her eyes closed. She’d flown in late the night before with four members of her team from Texas where they were attending a 3-day trade show. Although Sherri was used to short nights, she was particularly tired that morning because they’d been celebrating a huge win before the flight. She and her team had been courting a potential customer for over two years and finally won them over at the trade show. Her stupor and need for some serious wake-up juice led her to the donut shop that morning. It had a reputation for comforting donuts and strong coffee.
Larry noticed her while seated in a booth. As Sherri walked toward the exit with her bag of mini-cinnamon buns and extra-large coffee, Larry waved to her. She shuffled over and sat down in the booth, which surprised Larry a little as they didn’t really know each other that well.
“You look a little tired,” said Larry
“Yes, very,” and Sherri began to tell Larry about the celebratory effort the night before. Larry wasn’t aware it took place out-of-state, however, until Sherri said “Texas.”
“Texas?” Larry asked.
“Yes, we were in Texas for a 3-day trade show. That’s where we made the $500,000 sale to Snifton.”
“I didn’t know there was a trade show in Texas,” said Larry. “Is it there every year?”
“Yes,” said Sherri, “we’ve been going there for years. Why?”
“It raises a tax issue. We haven’t been collecting Texas sales tax because I didn’t think we had much presence there. I thought all of our sales were orders from our catalogue.”
“Well, they might be,” said Sherri “but at least one member of my team visits customers in Texas monthly to maintain our visibility. We attended a training seminar there a few years ago too.”
“Really?” said Larry, “I think we might have an issue.”
“I can you get my teams’ travel details for Texas. Would that help?” Sherri offered.
“Yes,” said Larry, “That would be a big help.”
Sherri sent Larry travel details for the company’s top three sales states–Texas and two others. Larry forwarded this information along with sales information and exemption assumptions to the company’s state and local tax consultant. As Larry had feared, the consultant opined that the company had a collection responsibility in these three states going back many years. As the consultant explained, here were Larry’s options:
- Enter a voluntary disclosure agreement with each state and pay the tax the company should have collected over the last four years plus interest; or
- Register and begin collecting and remitting sales tax in each state without disclosing the company’s failure to collect in the past.
Larry didn’t like the first option—paying between $400,000 and $500,000 depending on how quickly he could collect exemption certificates from the company’s exempt customers. He didn’t like the second option either—risking an audit, which would result in a liability far greater than $500,000 and would include penalties. This second option would also require a footnote in the company’s financial statements and require a conversation with the bank about the company’s loan covenants. And both options required a difficult conversation with the CFO and CEO. Larry was not looking forward to that.
The worst part about this scenario is that the $400,000 to $500,000 was going to hit the company’s bottom line. If long ago they’d registered and collected the tax, there would have been no P&L or cashflow impact. Larry cringed.
As Larry has learned, monitoring your company’s activities in states where you don’t collect sales tax is important enough to add to your daily task list because the consequences for registering too early are less expensive than those for registering too late. Persons responsible for sales tax compliance should communicate regularly with the sales force and human resources to track the activities occurring in each state. Without this communication, you risk waiting too long, and depending on your sales volume the consequences could be pricey.
Have questions? Contact our expert on this topic, Steve.