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For most of the business community, the events that have unfolded this year have proven to be incredibly challenging, but state and local governments, with their already limited resources, are stretched to an unprecedented level.
Considerable media attention has been focused on the states’ efforts to ease the financial burden that has been imposed on businesses that have been forced to curtail operations, lay off or furlough employees, or shut down entirely during the last several months.1 However, these relief measures will not be permanent.
According to Moody’s Analytics, state general fund revenues are projected to dip by an average of 20% in the coming months, leaving state policymakers scrambling to patch this massive budget hole.2 Thirty-three states are projecting budget shortfalls of more than 10%. Among three of the largest, California is predicting a 2020 budget deficit approaching $54 billion, New York $13 billion and Illinois $3.4 billion.3 Something must be done to turn the tide and increasing sales/use tax collections will play a large part in closing the forecasted state budget deficits.
For years, states have focused on expanding the net of goods and services subject to sales tax. The taxation of digital transactions has been at the top of list with all but two states adopting legislation or regulations to tax remote transactions in conformity with the 2018 Wayfair Supreme Court decision. The boom in remote sales post COVID-19 provides fertile ground for increased tax revenues.4
With limited resources, states have become increasingly sophisticated in identifying possible audit targets. Some of the techniques that have become more prevalent include the use of data mining and artificial intelligence to concentrate their efforts. This includes:
While the states are almost certain to increase their collection efforts, companies are not defenseless. Below are some of the actions that can be taken to minimize risk of unanticipated audit activity.
Review Existing Sales Tax Compliance Processes:
For many organizations, sales tax and sales/use tax compliance is viewed as an administrative nuisance. The economic nexus rules resulting from the Wayfair decision have increased awareness among financial and tax executives of the need to conform with the sales tax collection requirements, but few are mindful of the true cost sales/use tax presents to their organization. That is because the true cost can range from 4-10% of sales if compliance efforts fail to properly collect the correct amount of tax on customer sales or are paid on purchases from vendors.
Since Wayfair was decided in 2018, 43 states have adopted conforming legislation, and companies have scrambled to comply. Despite best efforts, many have discovered significant obstacles or developments which may warrant visiting/revisiting compliance decisions including:
Sales Tax Compliance
Currently 45 states and the District of Columbia impose a state sales tax, and 38 of those states, plus Alaska, permit the imposition of local tax. Within those jurisdictions, no one state or locality follows the same rules regarding taxable vs. nontaxable activities. It is incumbent on the taxpayer to interpret the myriad of different requirements, and this is a virtually impossible task without knowledgeable and easily accessible resources. To aid in the process, Duff & Phelps’ Sales and Use Tax specialists encourage taxpayers to carefully explore their options and seek independent outside advisors that help apply your organization’s specific facts and circumstances to the complex nuisances with the sales/use tax system. Doing so can not only minimize risk upon audit, but also give rise to overpayments in prior years and yield tax savings for current and future periods.
Sources
1.https://www.duffandphelps.com/insights/publications/state-and-local-tax/covid-19-sales-and-use-tax-and-unclaimed-property-guidance
2.See Dan White et al., “Stress-testing states: COVID-19,” Moody’s Analytics (2020), https://www.economy.com/economicview/analysis/379097/StressTesting-States-COVID19
3.https://www.politico.com/states/california/story/2020/05/07/california-faces-54b-budget-deficit-1282926; https://www.thecentersquare.com/new_york/with-13-billion-state-budget-deficit-looming-and-doubt-about-federal-aid-new-york-lawmakers/article_988908f4-9947-11ea-addc-33e3daac2daa.html; https://www.illinoispolicy.org/reports/budget-solutions-2020-a-5-year-plan-to-balance-illinois-budget-pay-off-debt-and-cut-taxes/
4.During first quarter 2020 online sales increased 14.8% over first quarter sales during 2019, this was before the advent of the COVID-19 crisis. https://www.census.gov/retail/mrts/www/data/pdf/ec_current.pdf. During the last couple of months online retailers are witnessing increased online sales that are doubling or tripling prior periods. https://www.forbes.com/sites/kaleighmoore/2020/04/17/retailers-selling-non-essentials-see-double--triple-digit-increases-in-online-sales-during-covid-19-crisis/#442c91436431
5.Over 30 states impose sales use tax on the sale of digital goods. These guidelines vary by state and even those that do not tax digital services have guidelines which impose tax on the sale of certain forms of software or services that often are associated with otherwise taxable transactions, such as maintenance and warranty contracts.
6.History has proven that many companies fail to take preventative measures to close control weaknesses that previously led to unanticipated tax adjustments. See example study conducted by the sales tax software provider Avalara at https://www.avalara.com/us/en/learn/guides/triggers-sales-tax-audit.html.
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