For firms in rapid growth phases, sales and use tax compliance is typically low on the priority list. And then suddenly it matters.
However, as firms expand into different states and/or add latest revenue streams, tax exposure might also quietly grow in the background. There are over 12,000 separate sales tax jurisdictions in the U.S., and each has its own rules and rates. So even a small mistake may result in serious penalties or pose a challenge during due diligence.
At its most elementary level, sales tax is the amount a business charges customers for taxable goods or services. Use tax applies when a business purchases taxable items and no sales tax has been charged (which is often the case with out-of-state suppliers).
For example, if a California-based startup orders $10,000 price of apparatus from a supplier in Oregon, the company likely owes California use tax. The aim of this technique is to supply a level playing field for local and distant sellers.
However, complexity arises because rules vary greatly by state and industry. For founders, this complexity becomes greater than just a compliance nuisance—it’s a business risk. Failure to comply may delay financing, reduce appraisals and, in some cases, result in personal liability.
From a legal perspective, nexus is a merger that requires a company to gather and remit sales tax in a given state. Historically, this required a physical presence corresponding to an office, warehouse, or worker. However, following the Supreme Court’s 2018 ruling in South Dakota v. Wayfair, Inc. states have imposed obligations based solely on economic nexus, that is, a certain level of sales or transactions inside a state.
Most states set the annual sales threshold at $100,000. So even fully distant SaaS or e-commerce firms can launch nexus without realizing it. Currently, greater than 45 states implement business affiliation standards, so it is extremely necessary for startups to usually review where their activities may trigger liabilities.
Mapping tax liabilities
A quarterly “network map” can assist you to track thresholds and avoid surprises.
Things get complicated, nonetheless, because not all the things a company sells is taxable.
Tangible goods are almost at all times taxable. However, digital products corresponding to software as a service vary: some states tax them fully, others exempt them, and a few only tax certain components and may do so at different rates.
Services are often tax-exempt, but they are also increasingly taxed as states expand their base to capture digital and skilled offerings. Understanding the nuances is not only about accounting detail. Providing accurate price and revenue forecasts is crucial.
Moreover, market facilitation regulations mean that platforms corresponding to Amazon Or Apple they often collect and remit sales tax on behalf of third-party sellers.
Startups that sell directly through their very own website or issue invoices must handle these obligations themselves – even selling on a marketplace may require the company to register and file with the state. Segmenting the market and direct sales in the accounting system helps avoid double taxation or missing remittances.
It is price noting that a large area that will trigger an audit is the tax due on untaxed purchases. Another is to mix a non-taxable service with a taxable product/service, i.e. area Burkland often appears with our clients.
Additional details on ignored areas that will cause exposure:
- Shipping and handling: It is taxable in some states if included as a part of a sale and is exempt if itemized individually.
- B2B sales: Typically, the exemption is excluded if the buyer provides a resale certificate or exemption (missing or invalid certificates are a common reason for an audit).
Do your due diligence before doing all your due diligence
Sales and use tax issues don’t just come to light during audits. They also appear in diligence.
Buyers and investors often discover unpaid liabilities, which may result in escrow holds or valuation adjustments. In turn, clean compliance records display operational maturity and readiness to scale. Penalties, back taxes and interest are painful enough, but once the state starts an audit, it’s often too late to realize access to voluntary disclosure agreements. Proactively following the rules is the only secure path.
So sales and use tax may appear to be a back-office problem. But for fast-growing firms, it’s much greater than that. It’s strategic. Founders and finance teams can gain an advantage by working with a tax expert. Additionally, consider:
- Mapping linkage exposures across states and updating this quarterly report;
- Regularly checking the taxation of products and services;
- Tracking and checking exemption certificates; AND
- Automate compliance with robust software tools.
A wise sales and use tax strategy protects your runway, builds investor confidence and prevents costly distractions in the future.