Any company that's required to collect sales tax must ensure they comply with the rules. Failure to collect taxes due, file required tax forms, or remit payments can have serious financial consequences, leading to failed audits, back taxes, fines, and penalties.
Sales tax compliance is especially complicated given that there are over 12,000 sales tax jurisdictions in the United States, each with its own rules and requirements.
The good news is that managing sales tax compliance doesn't have to be an impossible task. If you follow just six simple steps, you can ensure that you operate within the rules and protect your company from getting into trouble with tax authorities trying to collect unpaid funds:
- Understand sales tax nexus
- Register for sales tax permits
- Determine taxable products and services
- Collect the right amount of sales tax
- File and remit sales tax
- Maintain accurate records
Whether you're collecting sales tax in one state or thousands of jurisdictions, sales tax compliance doesn't have to be a headache if you follow these steps.
Step 1: Understand Sales Tax Nexus
Businesses don't have to pay sales tax everywhere they sell products or services. Their connections with the location must be significant enough to establish nexus.
In the past, a company needed a physical presence in a state to have nexus and be required to collect tax. However, the Supreme Court overruled the physical presence requirement in a case called South Dakota v. Wayfair, Inc., opening the door to states taxing online purchases.
Under the current rules, nexus can now be created in one of several ways, including the following:
- Physical nexus is created if a store has in-person connections to the state. This can happen if it has office or retail locations, stores inventory, or employs many people within the state.
- Economic nexus is created if a company engages in a certain level of economic activity in a state, even if it has no physical presence there. State laws differ on how much business a company must do, but typically they must either have a certain number of transactions (often 200+) or over a certain amount in sales (often $100,000).
Companies could also have affiliate nexus if they have a specific relationship with another entity that has a physical presence in a state, such as a subsidiary relationship. Or, if the company has a relationship with a third-party seller with a physical presence in the state, this could create nexus as well.
Companies must track their physical and economic connections with each state they do business in or have other connections to. Tracking enables them to ensure they begin fulfilling tax obligations as soon as nexus is established. Otherwise, the company could end up being penalized by a state where they should have paid taxes but didn't.
Numeral makes it easy to track nexus. We monitor when your business has established nexus, send alerts, and even take care of registering with the state on the company's behalf. Best of all, you can track nexus with Numeral completely for free.
Step 2: Register for Sales Tax Permits
Once a company has established nexus and has tax obligations to a state, the business must register for a sales tax permit.
Each state has its own registration process. For example, in Florida, companies can register online or submit a paper form, Form DR-1. This form requires specific information about the registering business including:
- The legal name of the business entity and the trade name or Doing Business As name if the company operates under a different name than its legal one
- The company's mailing address
- The physical street address of the business location
- The date that the company first engaged in taxable activity at the location where the business is being registered
- The North American Industry Classification System (NAICS) Code for all business operations
- Information about owners, managers, general partners, directors, officers, grantors, trustees, personal representatives, or LLC members -- depending on how the company is structured
- Information about the number of employees in the state, the type of employees, the kinds of services they will provide, the wages paid to employees, and whether the company uses a payroll agent
Other states have different forms and different requirements. However, most jurisdictions require this basic information. Be sure to pay careful attention to the registration requirements, deadlines, and fees that apply in each location to avoid consequences for non-compliance with sales tax rules.
Before registering in a new state, you should also consider your prior exposure. If you've been selling to customers in a state without collecting sales tax, registering puts you on their radar, and some states will look back and assess tax on historical sales.
If your exposure is significant, you may want to consider a Voluntary Disclosure Agreement (VDA). VDAs let you come forward proactively about missed past tax liabilities, and most states reward that by limiting the lookback period and/or waiving penalties, which is far less costly than an audit.
Numeral can handle registrations for customers automatically. As you're approaching nexus in a state, we send you an alert and automatically register in new states when needed with our Autoregister feature.
Step 3: Determine Taxable Products and Services
Sales tax compliance is complicated by the fact that not all products and services are taxable, and the rules for exempt goods vary by jurisdiction. Some examples of items that are often considered non-taxable include:
- Unprepared foods (groceries)
- Prescription drugs
- Residential property leases
- Fertilizers and seeds
- Prosthetic and orthopedic devices
- Single-use medical products
Software as a service (SaaS) and digital goods may also be non-taxable, although a growing number of jurisdictions are starting to tax products and services delivered electronically.
When it comes to services, on the other hand, some states default to not taxing most services, but some services remain subject to sales tax. Services to businesses, services to real property such as carpentry work, and professional services such as legal work are often not taxed, but the rules do differ by location.
Companies must understand what products and services they provide are taxable versus non-taxable. They also must have plans in place for handling mixed transactions, which occur where some taxable and some non-taxable items are sold. This means having a system to correctly classify items at the point of sale and collect tax only on those items that require it.
The right software solution, such as Numeral, can automate this process, integrating with your billing platforms to ensure that when customers across different states make purchases, they are taxed only on items that are taxable within their location.
Step 4: Collect the Right Amount of Sales Tax
Sales tax rates also vary by location. For example, while California charges a 7.25% sales tax rate, New York's sales tax rate is just 4%. Further complicating matters, some cities and counties impose an additional sales tax. For example, customers in Philadelphia may be required to pay:
Some states follow origin-based sales tax rules, with the sales tax rate based on where the seller is located. Others use a destination-based system, which means the sales tax rate is based on the location where the product is being delivered. Companies must determine whether origin or destination-based rules apply to a given transaction and then apply the correct tax rate for the relevant location.
To make matters more complicated, sales tax has a lesser-known counterpart: use tax. When you purchase taxable goods or services from an out-of-state vendor who doesn't charge sales tax—say, software or equipment—you're generally required to self-assess and remit use tax directly to your state. It's frequently overlooked, but states increasingly audit for it.
While this is often confusing for businesses, sales tax software like Numeral can make this process effortless. Numeral automatically determines what rules apply to each transaction, what tax rates apply, what products are taxable, and how much tax is due. Customers are charged the correct amount instantly and effortlessly, and your business stays in full compliance with sales tax rules in each state where you have nexus.
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Step 5: File and Remit Sales Tax
Companies don't just have to collect sales tax from customers. They also must file the appropriate forms with taxing authorities in areas where they have established nexus and must pay the required sales taxes due to the state, county, or city that is collecting the money.
States impose different filing schedules, which are often based on the volume of sales a company does and the amount of sales tax collected. It's common for companies to be required to file tax forms and make payments on a monthly, quarterly, or annual schedule.
Even in months with no taxable sales, most states still require you to file a zero return confirming no liability. Skipping a zero return is treated similarly to a missed filing; you may face penalties and fines.
Before moving onto how to file and remit, it's worth noting that if you sell through platforms like Amazon, Etsy, or eBay, marketplace facilitator laws may affect your obligations. In all 45 states that have sales tax, these platforms are required to collect and remit sales tax on your behalf for sales made on them. In this case, you typically won't owe tax on those transactions. Some states do, however, require you to report marketplace sales on your return even when the facilitator has already remitted the tax.
To file, you'll log into each state's tax portal and submit a return reporting your total sales, taxable sales, tax collected, and any deductions or exemptions for the period. Payment is typically made electronically at the same time. Each state has its own portal and return format, so the process varies, but the core information required is largely the same across them.
It's important to avoid mistakes during the filing process including:
- Missing the deadline: A missed deadline can result in fines, interest on unpaid taxes, and other penalties. Since each state has its own schedules, missed deadlines can be an especially big issue for companies with nexus in multiple jurisdictions.
- Filing in the wrong jurisdictions due to unrecognized nexus. If a company does not realize that it has nexus in a particular location, it may not file the required forms and could risk owing back taxes, interest charges, and penalties.
- Failing to keep accurate records. Companies need documentation to prove compliance with state tax laws. Keep all supporting documentation after filing sales tax forms until the statute of limitations has passed for an audit.
When mistakes occur in filing and are found later, companies can submit an amended return. This can usually be done electronically. When an amended return shows more tax is owed, it's important to make payment at the time of filing. If the change shows that too much tax was originally paid, then the company will need to report an overpayment.
Amended returns typically should be accompanied by documentation including accounting records, an explanation of the error, proof sales tax was refunded to customers if applicable, and an explanation of how the updated sales tax amount was computed.
Timely remittance matters because most states classify sales tax as a "trust fund" tax, meaning you've collected it from customers and are holding it on the state's behalf. Failing to remit can expose business owners to personal liability, not just the business entity.
Step 6: Maintain Proper Records and Stay Audit-Ready
Departments of Revenue conduct audits periodically to ensure sales tax is paid as required. Companies must be prepared and ready in case they become the target of these audits as they will need to demonstrate that they have met their sales tax compliance obligations.
This means businesses must keep records of:
- Invoices
- Returns
- Exemption Certificates, which are collected when items are purchased by a tax-exempt buyer such as an eligible nonprofit or government agencies
All of these documents must be stored until the time deadline for an audit has passed. The statute of limitations varies by jurisdiction but is usually several years. This means businesses must maintain a substantial amount of records for a long period of time.
Exemption Certificate Management (ECM) software solutions like Numeral can help. We store all exemption certificates, invoices, returns, and other key documents in one central place. Records are easily searchable to find the information needed, and licensed tax experts can help answer questions to ensure that every business is audit-ready.
Challenges in Managing Sales Tax Compliance
Managing sales tax compliance presents challenges for every company, and it's crucial to be well-prepared for them. Some of the biggest challenges in managing compliance include:
- Multi-state compliance requirements: The more states in which a company has nexus, the more difficult it is to fulfill all of its tax obligations due to differing laws, multiple forms to file, and payments to make on different schedules.
- Changing tax laws: Laws are evolving, with a growing number of states expanding the digital products that they tax. Keeping abreast of new developments is critical as it's a company's responsibility to follow tax rules.
- Industry-specific challenges. Some companies, such as eCommerce businesses and SaaS companies, face added complexities due to doing business in many jurisdictions, some with complicated rules. For example, Connecticut mandates that SaaS is taxed at full tax rates, but SaaS for business use is taxed at a reduced 1% rate.
Overcoming these challenges is crucial to successfully scale operations across multiple states or internationally. If you're expanding, book a demo with Numeral to see how we can help you stay compliant with just a few minutes of your time each month.
Solutions for Simplifying Sales Tax Compliance
Although businesses face challenges when it comes to sales tax compliance, they can also find solutions. Some of the best ways to simplify sales tax compliance include:
- Training staff to understand and follow best practices such as collecting exemption certificates at the point of sale when exempt entities make purchases.
- Making informed choices about in-house compliance management vs. outsourcing. For some businesses, especially those with complicated tax situations, outsourcing compliance could be the best choice to avoid costly fines and penalties. For others, outsourcing is cost-prohibitive.
- Using tax automation tools such as Numeral. With Numeral, companies can spend as little as five minutes monthly on sales tax compliance while enjoying the peace of mind that comes with knowing they've embraced a solution trusted by leading eCommerce and SaaS businesses.
Implementing effective solutions, like Numeral, as early as possible helps companies establish best practices that protect them against audits and ensure successful sales tax management.
Sales Tax Compliance FAQs
What is sales tax compliance?
Sales tax compliance is the process of meeting your obligations to collect, file, and remit sales tax to the states where you do business.
What is sales tax nexus, and how do I know if I have it?
Nexus is the connection between your business and a state that creates a sales tax obligation. It can be physical—such as having an office, warehouse, or employees in the state—or economic—such as when you’ve exceeded $100,000 in annual sales or 200 transactions in the state, though rules vary by state.
How often do I have to file and remit sales tax?
It depends on your sales volume and the state, though it’s almost always monthly, quarterly, or annually. Most states also require you to file a zero return in periods with no taxable sales.
What is commonly exempt from sales tax?
Common exemptions include groceries, prescription drugs, clothing (in some states), and sales to nonprofits or government entities with a valid exemption certificate. Exemptions vary by state, so you’ll need to verify taxability in each state where you have nexus.
What triggers a sales tax audit?
Common triggers include discrepancies between your sales tax returns and other filings, high exemption rates, late or missed returns, and expanding into new states without registering.
What happens if I miss a sales tax filing deadline?
You’ll face late filing penalties, late payment penalties, and accruing interest. In some states, business owners can be held personally liable for unpaid sales tax.
What is a Voluntary Disclosure Agreement (VDA)?
A VDA lets businesses with past sales tax exposure come forward proactively. Most states will limit the lookback period and waive penalties in exchange, making it far less costly than waiting for an audit.
What is the difference between sales tax and use tax?
Sales tax is collected by the seller at the point of sale. Use tax is owed by the buyer when sales tax wasn’t charged, such as on purchases from out-of-state vendors, and must be self-reported. Learn more in our sales tax vs. use tax guide.
Do I need to collect sales tax on SaaS or digital products?
It depends on the state. Some states tax SaaS and digital goods; others don’t. The rules vary widely and continue to evolve, so you’ll need to check taxability in each state where you have nexus.
How do marketplace facilitator laws affect my sales tax obligations?
In all 45 states that require sales tax, marketplace facilitator laws require platforms like Amazon, Etsy, and eBay to collect and remit sales tax on marketplace sales on your behalf. Note that you’re still responsible for sales made through your own website or other direct channels.
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