This is a question I have been asked almost daily lately. Whether it’s a new business owner approaching me, or owners of existing businesses, I am regularly asked the simple, but sometimes complicated question, “should my business be collecting sales tax”? It may seem simple to answer, but in reality, there is no hard and fast answer anymore. Many factors dictate whether a business is required to collect. In this week’s post I’ll do my best to walk business owners through their responsibility and requirements when it comes to sales tax.
But first, a note to readers. Every state and local jurisdiction has different rules regarding sales tax. Rules can differ from amount to collect to how often a business owner must remit payment. I can’t stress enough the importance of consulting with a local expert or the taxing authorities directly for more information on requirements specific to where your business operates.
What is Sales Tax and Who Sets the Rates?
If you have ever bought anything you know the advertised price and the price you pay are never the same. The difference is most likely due to sales tax. Sales tax is considered a consumption based tax and is only imposed when goods are purchased by the end user. Taxing authorities often impose sales tax as a way to finance various projects such as public use facilities (think of public hospitals) or to cover operating costs of state and local governments as well as public services such as emergency services. In some cases, these taxes may also be used to expand roadways and public use streets. These are just a few examples of where sales tax revenues may be used. The tax rate itself is typically a combination of a state base rate plus a county rate, which may vary from county to county. The rates are consistent with the budgets established to meet the needs of the public
Who Must Pay Sales Tax?
Who pays sales tax depends primarily on the purchaser’s intent of the goods being purchased. In most cases, the end user is responsible for paying sales tax. Business-to-business (B2B) transactions are more commonly sales tax exempt because businesses may or may not be the end user of a good. A business that is not the end user and is not responsible for paying sales tax may present a sales tax exemption certificate, a state provided certificate basically stating to the seller that they will not being using the goods, but instead selling them back to someone else who may be the end user.
Who Must Collect Sales Tax?
For every payer of sales tax there is a collector and the collection responsibility falls on business owners. If end users are required to pay sales tax, then business that sell to consumers (B2C) must collect sales tax. This seems pretty straight forward when you think about it but when we start to dissect what products and transactions are subject to sales tax it can become complicated. For example, in Georgia, sales tax is not only collected on the sales of most goods, but is also collected on some labor performed. This recently enacted legislation has been a struggle for business owners to grasp given the unique nature of imposing sales tax on a service. Again, every state is different but it remains the responsibility of every business owner to determine which items and transactions are taxable and which are not. Business owners should also keep clear documentation for tax collected and not collected in case of an audit.
How Does Sales Tax Collection Work?
Once a business has successfully established itself as a legal operating entity and has determined it is indeed required to collect and remit sales tax it must first register with the appropriate state(s) for a sales tax withholding ID number. A withholding ID number is typically required in every state that a business has a liability in, although some states participate in the Streamlined Sales and Use Tax Agreement. As for collecting, that's quite simple; as sales are made, the final sales price is marked-up by the combined sales tax rates, which is collected and held by the business owner until they are required to make a payment to the taxing authorities. It’s important to track sales by state, county, and local levels (where applicable) to ensure appropriate allocation when remitting sales tax. Everyone is going to want their fair share.
Something to note here is that sales tax is a liability to every business and should not be deducted as an expense. I see this very often and have spent countless hours educating my clients about the difference between including it on the P&L versus the Balance Sheet. Regardless of where it is reported on the financial statements, the cash received for every sale related to sales tax should not be used by the business for operating purposes. Businesses that use cash from sales taxes they collect tend to find themselves in hot water pretty quickly because they are often short when it comes time to pay the taxing authorities or they become too cash-strapped to run their business. The proper accounting system established from the onset of business will dramatically reduce the likelihood of this from happening.
How Often Must a Business Make Sales Tax Payments?
How often a business is required to pay the taxing authorities is dependent on the rules set by each respective state. In most cases, states set the collection rules so rarely will you find an instance where a county requires monthly payments and the state requires quarterly payments or vice versa. The payment frequency is also usually provided by the state when a business applies for a sales tax withholding ID number. It’s best to follow the instructions provided by the taxing authorities for tax payments, especially if they change. Payments are also usually made to just one party for the full amount via a sales tax return, which breaks-out payments by county and local levels so the taxing authorities know how to allocate the funds.
What Happens If a Business Fails to Collect or Pay?
If a business is required to collect and remit sales tax and fails to do either or both, the business could be in a world of trouble. Messing with state and county sales tax can get a business shut down. State revenue officials can easily come to your place of business and pull your license to operate. No matter who approaches me about this or their opinion on the matter, I always explain that it can single-handedly be what shuts a business down or temporarily halts operations. There is harsher enforcement that may be taken by but this is in the realm of worst case scenarios.
I covered a lot of technical material this week and it's only the tip of the iceberg. Given that this topic that has been red hot in my firm over the past couple of months I felt it was time to spread awareness. Contact me for a consult or follow-up with your state’s revenue department if you’re unsure of whether your business should be collecting and remitting sales tax. Whatever you do, don’t ignore the issue. It’s better to come clean and catch-up than to continue to disregard your responsibility as a business owner.
Have tips on how to ease the burden of collecting or paying sales tax, or maybe a story to share? Leave it in the comments below.