Sales Tax Fundamentals
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What Are the Real Impacts of Not Being Compliant?
byApril 5, 2022
All actions have consequences. For non-compliant businesses not collecting or remitting sales tax, those consequences can be seriously detrimental to their success – not being sales tax compliant has a specific set of repercussions. We spoke to sales tax expert Diane Yetter, President and Founder of the Sales Tax Institute, to find out the real impacts for companies who are not sales tax compliant, and what they can do about it.
Why compliance is important
Let’s look at why compliance is important from two perspectives. If you’re the type of person who appreciates a positive spin on things, you’ll like Yetter’s view that “being compliant in sales tax improves your bottom line.”
If you’re more receptive to an issue’s downsides, Yetter also makes a convincing argument. “If you choose to ignore an asset, or you don’t know taxability rules and how to figure out the right [sales tax] rates, every error you make is an average of 9% of your gross revenue,” she notes. (To learn more about how taxes can vary widely from product to product, it’s worth reading this post.)
While 9% of gross revenue is nothing to sneeze at, it’s certainly not as bad as other, worse outcomes. “Not being compliant with sales tax could put your company out of business,” she says. Even if the worst case scenario doesn’t happen, there can still be fallout. Yetter explained that a client of hers was recently told by the New Jersey tax authorities that they had sales tax obligations they weren’t meeting.
“They had $700,000 in sales into New Jersey,” she explains. “Just for [sales made in] 2021, they’re looking at $46,000 that’s going to come out of their pocket. That’s just the tax! You add interest and penalties to that, and it could be another 40-50% addition to that tax. It may be up to $70,000 just for one year.”
Now that you understand the stakes of not being compliant, here are the most common impacts:
Penalties and interest
The two most common types of financial repercussions from a state for non-compliance are penalties and interest. Let’s say you haven’t been collecting sales tax even though you have a sales tax obligation in the state. (For guideposts on when companies should consider registering for a sales tax license in a state, read this article.)
“Failure to collect, remit and file sales tax is anywhere between a 10-25% penalty [of your tax amount], dependent on the state,” Yetter says. “States may charge 5% [per month you didn’t collect, remit or file] to a maximum of 25%. Some of them do a flat, one time penalty of 10%.”
States may also collect interest payments on sales tax not collected and remitted. “Most of the states are probably between 7-9% interest, but there are some states like Wisconsin, which is 18%,” Yetter says. While she says there’s a possibility you can negotiate that rate down with the state, your business will likely have to pay some interest penalties.
If you should have been collecting tax for a couple years in a state, things can get expensive. (If you need a refresher on the sales thresholds for collecting tax in a state, here’s an explainer.) “When we do tax liability estimates, we use an additional 40% penalty – it’s a rough estimate for a 3-4 year liability because the lookback period varies,” she explains. “If you haven’t been complying for all that time, take your potential tax bill for the last 3-4 years and multiply it by 140%.”
If your business decides to come forward to a state that you should have been collecting and remitting sales tax there but haven’t, it’s possible to negotiate a Voluntary Disclosure Agreement (VDA) and abate any potential penalties. That doesn’t mean it’s free. Yetter has seen interest abated in certain circumstances in states like Texas, but most states require interest payments. “If it’s a state where the interest rate is, let’s say, 9% of your gross taxable sales, but your oldest interest liability is 18%, you’re still looking at a 12-15% percent average,” she says.
Keep in mind that voluntarily disclosing your tax liabilities to the state is one way to potentially lower your tax bill. If you get caught by the state, the conversation is different. “If a state finds you, the VDA is usually off the table,” she explains. “If you got a letter from California [informing you of sales tax liabilities that stretch back 10 years], and that’s when you decide to take action, you’re looking at a 10 year lookback period, not a limited lookback of three years. You have to be proactive.”
Criminal penalties, lawsuits and reputational damage
If you’re required by a state to collect tax and you haven’t been, there are civil penalties with financial repercussions for your company. On the other hand, if you’ve been collecting sales tax and not remitting, there are other serious penalties. “It’s just as bad – if not worse – to collect sales tax and not remit and file to the states,” Yetter says. “That’s criminal fraud and can get you in an orange jumpsuit. It can also cost you a boatload of money. Usually when it’s tax collected and not remitted, you will not get an abatement of penalties, interest or have a shortened lookback period. You’re required to turn over 100% of the tax you collected, and you may not qualify for any voluntary disclosures at all.”
Companies can also be litigated against by both states and class action attorneys for collecting the incorrect amount of tax.“If you’re over-collecting tax because you’re not paying attention and figure you’ll just charge tax on everything, you can be sued for class action,” Yetter notes. “Not only are you going to end up paying the tax, but you’re going to pay damages. You’ll pay three times the tax as a fee to the class action attorney, and then you’ll pay the tax too. If you’re under-collecting tax, you can also get sued and be accused of defrauding the state.”
There are also reputational risks for not collecting and remitting sales tax. In 2018, an e-commerce electronics retailer had issues stemming from an alleged under-collection of sales tax to their customers in Connecticut. “Not being compliant can get you in a boatload of financial and reputational messes,” Yetter says.
A reduction in valuation
Your company can be worth less money if you have unpaid sales tax liabilities for one simple reason: you’re going to have to pay interest and penalties out of your profit. That could have very real effects if you’re looking to get acquired. “We do a lot of due diligence for clients looking to buy companies,” Yetter says. “When we’re looking at the data of the seller, we’re finding exposure. We make recommendations to the buyer that you either walk away from a deal if the exposure is too big, or you reduce the purchase price because the value is lower.”
Yetter says they’ve recommended companies with sales tax obligations to do a VDA with all the states they have liabilities in and place those owed funds in escrow – even though it will reduce their valuation. While this takes money out of a deal that the company’s owners may have received, it may still be preferable to not being purchased at all.
Automation can help you become sales tax compliant
A sales tax solution like TaxJar can help you avoid the negative impacts of non-compliance. Our solution automates the entire sales tax life cycle across all of your sales channels so you can grow your business. TaxJar can also help you keep track of your sales tax liabilities across multiple channels using our reporting dashboard, including sales from marketplaces like Amazon. This helps your company prepare for upcoming tax obligations no matter which channel your sales are coming from. Learn more about how to automate your sales tax compliance by speaking with our sales team.