I have had the opportunity to work with creative, tenacious entrepreneurs who add disruptive technology and new functionality to our world. I understand that as these wonderful people are creating, they do not always think about the best way to maintain the sales and customer infrastructure they need on the back end. A new court ruling could have implications for their business.
To help you all understand how the new sales tax laws could impact your business, I have deconstructed the new rulings to give you the bottom line on the fundamental requirements you must have in place to sleep peacefully, knowing you have the financial clarity to be prepared.
My experience working with the sale of a business, capital raise due diligence and audit prep gives me an understanding of complying with the new out-of-state sales tax requirements. I can see the look on your face when you ask your tax person, “What information do I need to understand my exposure to the new sales tax law, and they say, “It depends…”
Are Your Customers Out-of-State?
The recent ruling of the U.S. Supreme Court in the South Dakota v. Wayfair, Inc. case (June 21, 2018) has garnered lots of attention from business owners and finance professionals alike. The new law in South Dakota – if you sell a minimum of $100,000 in sales OR 200 transactions to South Dakota customers from anywhere in the US, you must collect and remit that sales tax based on South Dakota’s laws. There are thousands of technical tax issues and caveats that follow suit, with legislators expanding states’ legal ability to collect sales tax on sales executed anywhere in the United States; this should be more than enough to make you think it has got to be 5 o’clock somewhere.
Don’t be distracted trying to learn all the technical aspects of what is required; instead, work with tax professionals at a CPA firm or similar services. When you muster the courage to ask how to prepare for an impending sales tax audit, the person you are talking to is going to say – It depends.
Your tax person will ask many difficult questions, which you can’t answer to off the top of your head. I have worked with hundreds of companies going through audits at a national accounting firm, and I have been the CFO of both large and small entities. The wide range of systems and information about sales and customers that I have seen has been lackluster; in my estimate, a mere 15% of companies have the correct data on their customers organized in a way they would be able to answer questions when the tax professional says – It depends.
Be Ready for It Depends…
You can quickly feel overwhelmed just thinking about being subject to a sales tax audit for each state that you ship your product to. I’ve compiled the following list as a comprehensive guide to strength-testing your customer database, to see how it will hold up when this sales tax issue inevitably affects you.
1. Can you produce data that shows sales by customer that will reconcile with that year’s tax return submitted to the IRS? Or are you the type of business that does not consistently keep sales data that matches the corresponding financial data? Companies that are not subject to Sarbanes-Oxley, State regulatory filing requirements, or an annual audit do not keep sales data that matches their summary financial documents. In the case of the sale of the business, this becomes a due diligence issue, as the acquiring firm or investor cannot substantiate and analyze the sales to comfortably know what they are buying.
2. Can you dig into your customer data by state and by transaction? Can you determine the number of transactions by state? South Dakota’s new law states that if you have 200 transactions, you are subject to the collection and remittance of sales tax. There is NO dollar limit, or requirement on the 200 transactions. You could make 200 hair bows in your garage then send them to South Dakota, and you will still have to collect and remit sales tax.
3. Do your customer records consistently distinguish between billing and shipping addresses, and how easy is it to report? Is there a clear business rule and process that makes the shipping address distinct from the billing address?
4. If your business model is subscription services, but includes the sale of a product at the beginning of the relationship, can you segment the sale between product and service? For example, if you are a software-as-a-service, (SaaS), company and you sell hardware to run the service at the beginning of each sale, can you produce records that agree with the information in #1, to distinguish between product and service?
5. If your revenue is generated from maintenance and/or installation of items are you able to distinguish customer sales records between the sale of the product and the labor to install? The tax on labor for maintenance and/or labor in each State that charges Sales Tax is different, and you must be able to distinguish the difference between Labor and Parts in your operations, sales, and billing systems. Examples, where this applies, are large long-haul trucks, machinery, or pipelines used in construction, all of which include a sale followed by installation or maintenance.
Be Prepared with a Solid Infrastructure
Strategy discussions with your CPA must include an analysis of how to manage through these new regulations that are inevitably going to make their way through your state’s legislature. Politicians in states other than South Dakota are eager to push similar bills through their system, and it will be a popular but non-controversial pursuit. How exactly will each state implement such sales tax laws? My crystal ball says that only time will tell.
The bottom line is that, once again, I am giving another example of the cost of having the wrong infrastructure in your business. The costs related to sales tax compliance in this new world will be substantial. The good news is, with a solid data capture and reporting infrastructure, you can use the same data for analysis, reporting and audit preparation. Let’s work together to get you running your business with the financial clarity to know where you are headed!
Mindy Barker, CPA