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It’s important to understand the different types of entity-level tax types typically imposed on businesses.
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Those taxes are:
An income tax that is imposed at the corporate level, levied by federal and state governments, and is based upon revenue and certain deductible expenses. This tax type is only imposed on C corporations. Pass-through entities, such as partnerships, S corporations, limited liability companies, and sole proprietorships, are not taxed at the entity-level. Instead, all profits are passed through to the owners and taxed at the individual level.
Sales and use taxes are a consumption-based state-level tax on the sale, transfer, or exchange of certain tangible goods and services. Sales taxes are typically added to the sales price and charged to the end user of the product or service. Alternatively, use taxes are imposed on goods and services used or stored in a locality where sales tax is usually imposed, but no sales tax is collected.
Also known as payroll taxes, employment taxes are levied by federal and state governments and are paid on the wages and salaries of the employees. These taxes are used to finance social insurance programs, such as Social Security and Medicare. Roughly half the payroll taxes are paid for by the employer, while the other half is withheld directly from the employees’ wages.
Property taxes are a state-level tax imposed upon property such as land, buildings, improvements and, in some jurisdictions, certain tangible personal property such vehicles. It is based on the fair value of the property. These funds are used to fund public services such as schools, roads, law enforcement, fire departments, and other services that benefit the community.
Sales tax is a consumption tax imposed by state and local governments. Currently, 45 states and the District of Columbia have a state-level sales tax regime. There are also 38 states that have locality-level sales tax regimes. Alaska, Delaware, New Hampshire, Montana, and Oregon are the five states that do not charge a state-level sales tax. However, the municipalities of Alaska and Montana impose a locality sales tax.
On average, sales tax revenues make up between 30-50% of a state’s total tax revenue, making it crucial for functionality.
State and local governments typically use the revenue to pay for community services, such as police and fire departments, infrastructure projects, schools, and environmental projects. Sales tax revenue becomes a significant piece of a state’s budget during economic downturns when income taxes collected from resident individuals and businesses decrease. Occasionally, state and local legislatures pass a temporary increase in the state tax rate in order to pay for specific projects.
Each state has their own regulations on who is responsible – the seller or the purchaser– and what goods and services are subject to the tax. This can have implications on who is liable for the tax, who can sue on the tax, and who can claim a refund for the tax. Most states impose sales tax on the person who makes the retail purchase. In that case, the seller is an agent that is responsible for collecting and remitting the tax. Other states impose the sales tax on retailers for the privilege of making retail sales in the state. Then, the seller can either absorb the tax or pass it to the consumers.
Each state also has its own regulations on what type of transactions are taxable versus exempt to sales tax – no two states are alike. Typically, sales of tangible personal property are subject to sales tax, unless specifically exempt. Certain services may also be taxed. In recent years, states have been increasingly focused on the taxation of services such as Software as a Service (including cloud computing, digital goods, and web-based applications), services to tangible personal property, and business services.
States typically offer sales tax exemptions for specified purchases that are tax-free. A sales tax exemption certificate enables a purchaser to make a tax-free purchase of a good or service that would otherwise be subject to sales tax. The purchaser is responsible for obtaining the certificate and giving it to the seller. Each state has different sales tax exemption certificates available. They typically require certain elements such as name and address of purchaser, name and address of seller, description of the good or service, reason for exemptions, and a signed statement.
One example of a common exemption certificate available is for goods that are purchased for resale. Common scenarios where this may be relevant are:
Sellers must keep the relevant resale exemption certificates on file for audit purposes.
“Nexus” is broadly defined as the requisite contact between a taxpayer and a jurisdiction that allows the jurisdiction to tax the taxpayer. Each state defines nexus differently. From several key decisions made prior to 2018, including the notable 1992 case of Quill Corp v. North Dakota, the Supreme Court affirmed that physical presence was necessary in order for a state to have the right to tax a taxpayer under the Commerce Clause.
While each state defines “physical presence” differently, it is generally defined as property or payroll in the state. Therefore, things like an employee, an office, a warehouse, or even a bank account or loan can create a physical presence within a jurisdiction.
In June of 2018, the Supreme Court overturned the Quill Corp case in South Dakota v. Wayfair, therefore allowing states to collect sales tax from businesses that have an economic presence in the state. In other words, a business only needs to have sales to customers. Since the verdict, most states have implemented an economic presence threshold that businesses must exceed to be subject to sales tax collection. This is usually defined as a set number of sales or total sales revenue.
Sales tax nexus laws for each state can be complex, and often contain regulations for nexus-creating activities beyond a physical and economic presence. A marketplace facilitator is a business that owns, operates, or controls a marketplace and contracts with third parties to facilitate the sales of their goods and services through the marketplace. Examples of marketplace facilitators are Amazon, eBay, and Etsy. The majority of states have marketplace facilitator legislation that requires the marketplace facilitator to collect and remit the sales tax from the customers on behalf of the sellers. As a general rule, states typically have the same threshold of marketplace facilitator nexus as they do for regular economic nexus, but there are some exceptions.
Over 30 states have enacted affiliate nexus legislation. Under these laws, an out-of-state business can establish a physical connection to a state through an in-state affiliated entity with which it shares a connection. Each state has a different definition for the nature of the relationship that must exist in order for affiliate nexus to be triggered. Common relationships include an out-of-state seller employing in-state independent contractors, utilizing in-state advertising or maintenance services, or using a substantially similar trademark or trade name.
Click-through nexus is a specific type of affiliate nexus. It generally states that an out-of-state seller without substantial physical or economic presence in a state can still have sales tax nexus through an agreement with an in-state person or business that refers or directs sales back to the seller for a commission or other consideration. For states with click-through nexus laws, if an in-state business directs a buyer through a link or a website to purchase tangible personal property or services from an out-of-state business, the out-of-state business would have click-through nexus.
States typically tax all tangible personal property (“TPP”) unless otherwise exempt. Each state’s list of exempt property vary.
Certain services can also be taxable. There is no general consensus on how each state taxes services, so it is important to understand each state’s regulations. In general, a service provider is required to pay sales or use tax on items they purchase from another vendor for use in performing the services. Some states distinguish personal and professional services– such as services provided by attorneys, accountants, physicians– from general services. Each state may have its own provisions regarding a sale that involves both a service and the transfer of property. This will usually result in the entire transaction being treated as taxable. Each state also may have provisions regarding a sale of both a taxable service and a tax-exempt service in the same transaction. This can affect the taxability of the transaction as a whole.
Specific industries can also be subject to different regulations for sales and use tax purposes, depending on the jurisdiction. The taxability of Software as a Service (“SaaS”) varies by state. There are some states that regard SaaS as computer software, which is typically defined as tangible personal property and, therefore, taxable. Other states, especially those who do not tax services, consider SaaS tax-exempt. As the world is becoming more dependent on application-based software, states are taking this concept a step further and have defined “digital goods” as either taxable or exempt as well. Typically, digital goods include products such as e-books, movies and television, and music.
In many states, the FinTech industry can be defined as a cloud computing service. This generally means that a consumer purchases access to a cloud service’s hardware or software instead of purchasing the hardware or software themselves. There are three different categories of cloud computing services:
[1] Software as a Service
[2] Infrastructure as a Service
[3] Platform as a Service
An increased number of states have recently been addressing the taxability of each type of cloud computing. It’s important to understand what service the FinTech company is providing, as well as the current regulations of the states.
In general, nexus-creating activity for sales purposes also creates an income tax obligation. Any payroll or property within a state will trigger both a sales tax obligation and an income tax obligation. Most states follow the same, or similar, rules for triggering economic nexus for sales tax purposes as they do for income tax. In other words, once a business has a sufficient amount of sales in a state, income tax nexus can be created.
Another method of triggering income tax nexus is by using the factor-based nexus standard. Under the factor-based nexus standard, a company is considered to have done business in a state if it had property, payroll, or sale that exceeded a certain threshold. A common example is:
However, there is an exception. Public Law 86-272 is a federal provision that states that companies can perform the following activities in a state without creating income tax nexus:
Note that P.L. 86-272 does not exempt the company from an income tax filing obligation. Instead, the taxpayer would indicate protection of the sales on the return and no tax liability.
Each state has a different set of rules and regulations regarding the frequency of filings and the process to file. The majority of states require taxpayers to file on the 20th day of the month following the end of the taxable period. States usually require taxpayers to file and remit either monthly, quarterly, or annually. There are also some states that have different frequencies for filing the return versus remitting the funds, such as California. In general, the volume of gross receipts of the taxpayer dictates the filing frequency; the greater the receipts, the more frequent the filing obligation.
Each state or municipality with a sales and use tax regime will have its own return that will need to be completed. Generally, the return will require the taxpayer’s sales tax identification number, federal employer identification number, business address, total gross sales, total taxable sales, total taxable purchases, and any credits, payments, or exemptions that apply. Some states require taxpayers to electronically file and remit their sales and use taxes via a state-specific online portal. For others, paper filing may be available.
Sales tax should be filed timely, which requires sales tax to be charged at the time of invoicing and remitted to each state timely.
In order for your company to file timely, the company must first be evaluated for which states they need to file in. This can be completed through a nexus study. A nexus study looks at the specific states the company is conducting business in and determines if the company meets the requirements to file. Depending on the amount of states and localities, the timely filing of sales tax can become an incredibly time consuming and tedious process. There are software that will automatically file the sales tax returns if it’s properly implemented to guarantee timely and accurate filings.
Every state charges a different sales tax rate, and it can change from product to product. This makes it complex and challenging to make sure the appropriate amounts are being charged. There are several softwares that will determine the appropriate rates automatically, which make this process much simpler. Sales tax should be charged at the time of invoicing the customer to ensure your company is collecting the appropriate amount and won’t have to pay for it itself.
Choosing the correct sales tax software will help ensure smooth collections, filings, and payments.
Initial Evaluation
Based on the products the company is selling and purchasing, or the services being provided, Exbo can help evaluate if sales and use tax should be collected.
Nexus Study
Once determined, Exbo can perform a nexus study to determine which jurisdictions the company has a filing obligation in.
Identify Options and Opportunities
Once the nexus study has been performed, Exbo will help identify sales tax solutions to ensure timely and accurate filings, as well as potential exemptions available to reduce the tax liability.
Complete Invoicing
Simultaneously, Exbo will help ensure the invoices are correctly capturing sales tax. This will reduce human error.
Process Mapping
Exbo will work together to create a written memo documenting the full process and set standards to ensure timely filings.
Process Presented
Exbo will present a fully developed plan and memo for the sales tax collection and filing process.
Implementation
Implementation of Software
Exbo will help implement the new software and process as described in the memo that has been approved by your company. This will ensure a smooth transition.
Ongoing Support
Exbo will evaluate and monitor the process as sales continue. Exbo will help make sure timely filings are occurring with minimal disruption.
Navigating the sales and tax use obligations for your company can be a complex and time-consuming process. Exbo Group can help educate, implement a process to ensure compliance, and provide tax-saving opportunities based on your company’s products and industry.
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