When Does a Company Need to Collect Sales Tax?
The main question most people have when it comes to sales tax is, “When does a company have to worry about collecting sales tax?” To answer this question, Michael Fleming will walk you through the four factors you need to look at in determining whether you need to start worrying about sales tax collection or not.
Michael is the founder of Sales Tax and More and is one of the country's leading authorities for state tax issues like consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers. He is a writer, speaker, and regularly presents on webinars.
In this episode, Michael goes to the other side of the table and is interviewed by Dr. Jeremy Weisz, an entrepreneur, and seasoned podcast host. Michael answers the most commonly asked questions he gets related to sales tax ranging from how a nexus is created, the different types of nexus, as well as the tax implications of selling in online marketplaces such as Amazon. It’s a great episode with much learning in it so make sure to stay tuned.
Here’s a glimpse of what you’ll learn:
When does a company have to worry about collecting sales tax?
The two types of nexus: a physical nexus and an economic nexus
What is a physical nexus?
What is an economic nexus?
Determining the taxability of your product
Determining the materiality of your product including profit margins
The importance of having capital reserves
Tax collection considerations when selling in online marketplaces like Amazon
Resources Mentioned in This Episode
Connect with Michael
Sponsor for This Episode
Sales Tax and More assists companies and their trusted advisors like CPAs with sales tax needs. They offer consulting and research, registrations, returns, and so much more. Over the years they have assisted thousands of sellers both foreign and domestic with their tax issues in the United States and in Canada.
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here's your host, Michael Fleming.
[0:26] Mike: Hi, I'm Mike Fleming, founder of Sales Tax and More and today's host of the Sales Tax and More Podcast, where we talk about everybody's favorite subject, sales tax. And today I have Jeremy Weisz on the line with us here. And he's done thousands and thousands of interviews with successful entrepreneurs and CEOs, and today we're flipping the script, and we're gonna have him interview me.
[0:57] Jeremy: Awesome. Michael, thank you so much for having me. Just a brief introduction for Michael, if you don't know him and his company, I consider, and many other people consider him one of the US as leading authorities when it comes to sales tax. And the episode is brought to you by Sales Tax and More, and they assist companies and their trusted advisors with their sales tax needs. They offer consulting and research, registrations, returns, and much, much more. And over the years, they've assisted thousands and thousands of sellers, both foreign and domestic, with their tax issues in the United States and Canada. You can go to salestaxandmore.com for more information, they have so much experience in this realm. And I'm excited to talk, Michael, about a few things. And you get some commonly asked questions over and over again. So I want to bring those up. And we kind of polled people and what their biggest questions were so you can answer them. And even before they pay you money, you know, so we're gonna tap in and pick your brain about some of the frequently asked questions. One of the top ones that I know you get is, when does a company need to worry about collecting sales tax? And so hopefully you can address that?
[2:13] Mike: Oh, yeah. And this is probably the number one question that we get. And, you know, it's really four factors that you want to be taking a look at. And the first factor is, you know, whenever you have a link or a connection with a state, and you may have heard the word nexus, that's what we call this link or connection, so whenever you have a link or connection with this state, then the state can require you to potentially collected its sales tax. That's not automatic. There's a couple of other steps we want to look at. But if you don't have this link or connection, then you're great, because the state can't require you to collect the tax, like a sales tax, or pay a tax like an income tax. There's just no responsibility there if you don't have this connection we call nexus. So once you determine if you have nexus, and by the way, there are lots of types of nexus, but you know, we break them down into two main types. You've got a physical nexus, which can be misleading. And we'll talk about that in a little bit here. And you have an economic nexus. This is a new concept for sales tax, and it was a result of the Wayfair versus South Dakota. And that just means if you have a certain amount of sales into a state, you could create nexus. You don't have to physical presence there. Yeah, absolutely. That's, that's huge. It really, it's what this Wayfair case did, is overturned 51 years of precedence. Supreme Court came out and said - We never should have introduced the concept of physical presence to nexus. It's just not something that is required to create this link or connection. So lots and lots of items can be a physical presence. For example, independent contractors. You know, we talked about in our case studies, how independent contractors can actually create nexus for a company if they're helping to establish or maintain a marketplace. So. . .
[4:25] Jeremy: Yeah, go to a different episode where we are you actually walk through a specific example of someone who didn't know this and what happened. Then independent contractor in a different state, so you could check that episode out, but that'd be an example of physical nexus, any other examples?
[4:45] Mike: Where you live or operate your business from. A lot of people nowadays tell me - Well, Mike, you know, I do everything in the cloud. I have a virtual office. I'm not physically located anywhere.
[4:56] Jeremy: I'm literally in the cloud.
[4:58] Mike: Yeah. How you defied the laws of physics. I'm not sure, but wherever you live or operate your business from, you know, that creates some sort of link or connection with a state. And the state's going to say that is enough to create nexus. Subcontractors, traveling salespeople, people go doing installations, implementations, training, going to trade shows, I mean, there are just tons of different activities out there.
[5:34] Jeremy: Complicated.
[5:36] Mike: Yeah, it gets pretty complicated, and the tough part is some things across the board are going to be creating nexus. You have salespeople in a state, then that's going to create nexus across the board. You have independent contractors in a state or traveling into a state to do sales, that's going to create nexus across the board. But some things are very different from state to state.
[5:59] Jeremy: If that salesperson’s, let's say, whatever independent contractor or employed and let's say they're in Wisconsin, but they have to travel to do business in Iowa and the Midwest, would you have nexus in those states where they travel into?
[6:13] Mike: Yeah
[6:14] Jeremy: You do?
[6:15] Mike: Unfortunately. Some states have a de minimis. You know, how often do they do it, how frequently they do it. But some of these states like Michigan and Arizona say that if you get people coming into the state for greater than 48 hours, cumulative throughout the year, then that's going to be nexus-creating.
[6:39] Jeremy: And what about trade shows? I mean, if you go to Vegas, let's say you go to Vegas every year for a week, and your people are making sales at that trade show. How do, you know?
[6:49] Mike: Well, Vegas is a little bit different because there’s so much of their economies based upon conferences, and trade shows, and conventions. So most states, you know, do one of four things. They say if you just attend as a consumer, it can create nexus. Other states say - Hey, you can come as often as you like as a consumer, but, you know, once you start exhibiting, then that creates nexus.
[7:17] Jeremy: So it does?
[7:18] Mike: Oh, yeah, absolutely, exhibiting in a lot of states. There are other states that say - Well, you can exhibit, you just can't solicit. Now, how you going . . .
[7:28] Jeremy: But like, why would you exhibit? That's just like, forget it. I’m not going to even exhibit.
[7:32] Mike: Exactly. So and then, the fourth group says - You can even solicit, so long as you don't accept orders. So those are usually the four ways that states look at this. Vegas is entirely different. Vegas says - You can do all of those things as often as you want. You can even you know, deliver products while you here. You can collect products while you're here. And that does not create nexus so long as you collect the tax on what you're selling. And at the end of the show, you give it to the promoter and say - Hey, Mr. Promoter, you can turn this in for me. Or, if he doesn't want to do it, or she doesn't want to do it, when you get home and you just mail it into the state. You can do that once a year. If you do it twice a year, it's nexus-creating. But if you do it up to once a year, then it's not nexus-creating. You still got to collect the tax, but not nexus-creating.
[8:25] Jeremy: Yeah, but other states may work differently. Obviously, if someone goes to a conference every year in California or something, right, so. Everything in Vegas stays in Vegas. So everything goes there. But that's its own animal, I guess.
[8:39] Mike: And some states have very good what we call de minimis exemptions. Like California, there's a, if you're there for less than two weeks, and less than $100,000 in revenue results from the show, then that's not nexus-creating.
[8:55] Jeremy: I mean like Dreamforce is going on right now. Right? Dreamforces is, I don't know, a week, two weeks. There are hundreds of thousand people that come through there, and a lot of them go there every year for an extended period and probably make a lot of software sales.
[9:06] Mike: Yeah, you know. So that could be nexus-creating.
[9:10] Jeremy: Yeah. Um, so physical. And I don't know if there's anything else on physical and then I'll let you talk about the economy.
[9:18] Mike: Yeah, I mean, pretty much, just remember that your employees, you, and third party -subcontractors, independent contractors, if they're traveling into a state, you got to be asking the question or asking someone like us - Can this potentially create a link or connection with that state where the state could then you know, require me to collect and remit the taxes. On an economic basis, again, states don't ever make anything easy on you. It's not like there's one rule.
[9:53] Jeremy: They want their money.
[9:55] Mike: They want their money. And, you know, the lowest thresholds out there are the states that say, like South Dakota, this is the case involved in the Wayfair case, $100,000, which is a fairly high number, or 200 transactions. And it's that “or 200 transactions” that really trip people up.
[10:16] Jeremy: That could be killer. Let's say you sell stickers or something, right? It's like, you can easily sell 200 packages of stickers, it’s equivalent to $1,000, and you have nexus.
[10:27] Mike: Absolutely. We're gonna talk about that. That's our third point. Before you go out and get registered, you know, just because the state says you have to do something, doesn't mean it makes good business sense. And sometimes you're going to want to ignore what the state says if your exposure’s not material, we got to use common sense when we apply that. So you know, the states don't tell you to use you know, use common sense. They just want you to do it from dollar number one most of the times. But your specific example there, I would not get registered. I would counsel my clients to wait until the state comes and finds them. You'll spend more money trying to do what the state says to do, getting registered.
[11:11] Jeremy: I've done that, Michael, and you've helped me. I speak from experience. Yes. You know you're doing and yes, I did it wrong before. So, yes, you'll spend a lot more.
[11:22] Mike: Yeah, it was always that. You got to take the cost of compliance and, you know. But let's go back to taxability. Because taxability is the second thing. So let's assume you do have this link or connection called nexus. Because if you don't have it, we're not talking about taxability. It stops with nexus. I mean, if you don't have nexus, you don't have any problems. No, don't go any further. Do not pass go. But if you do have nexus, now we're going to look at - Is what you're selling taxable in that state? And, you know, if you're selling widgets, they're going to be taxable pretty much in every state, you know, in the country. But there are certain products out there, like dietary supplements, and some clothing, and, you know, in some states you know, not a lot of services are taxable. I mean, so it all depends on what you're selling. So the second thing we need to do is determine if what you're selling is taxable. And if it is taxable, then we go on to the third step, if it's not taxable, well we stop right there. No need to go further. So the third step we started touching on, which is materiality. And you know, so if you have this link or connection we call nexus, if it's taxable, then we get to look at if your exposure is material. So in your card collection example there, a thousand dollars? I just you can't justify telling somebody. . .
[12:53] Jeremy: Just to register is gonna cost you, right, more.
[12:56] Mike: Absolutely. So you know, I can't people always say - Well, Mike, what is the material? And I can't tell you what is material for you, because for each company, it's generally going to be a little bit different. I mean, for those of you who have heard me speak before, I talk a lot about Coca Cola. In $100,000 to Coca Cola is a rounding error, where $100,000 to me is a heck of a lot of money. So just every company out there, what’s material to them is going to be a little bit different. I generally tell him to look at three things. I mean, you know, Jeremy, we have people calling us, you know, close to tears, they're so worried about this, you know. And if that's you, then you want to have a much lower threshold than someone who comes in, we'll choose Vegas here. I go to Vegas every weekend. I never lose. Nothing bad has ever happened to me in my life. And I don't think the states are gonna find me. You know, so. . .
[13:55] Jeremy: That’s one mentality, right?.
[13:57] Mike: They're polar opposites. Someone with the first one is going to have lower thresholds, personal thresholds. This has nothing to do with the state. This is that them saying - I'm going to get registered when my sales hit this level. And on the upper end, you've got people saying - I'm going to, I'm going to stretch a little bit further. And our clients are usually somewhere between $3,000 on the low end and $20,000 on the high end. If you want to drop down 98% fall within that. 80% they're going to fall between the $5,000 and $10,000 range. Now, the second thing you want to look at in materiality is what are your profit margins? I mean, you know, you wouldn't believe how many people I talked to are trying to build market share. And they're not making any money, or their 2% profit margins. I sometimes scratch my head and you know, say you work so hard to try to do this. I mean, it might be cheaper to go down to McDonald's, or better off, go down to McDonald's and get a job there, because there's so much work to not make money.
[15:12] Jeremy: Right at the end of the day you, you're not left with much.
[15:15] Mike: Exactly. So if you're on that lower end of the range, if you're building market share, if you've got really low margins, remember this, average sales tax rate is 8%. And if we add another 50% on top of that for penalty and interest, you're looking effectively at about a 12% exposure rate. So for every thousand dollars you spend, it's $120 in potential exposure and, you know, so as your sales go up, so does that $120. And you don't want to look at it as if the state found you this afternoon, but what happens if they find you three, four years down the road? So, you know, if the margins, if you've got a 2% margin, and 12% penalty, not only can you wipe out all the profits in one state, but you probably have put yourself out of business if a state finds you two, three, four years down the road. So the lower your profit margin, then you want to have a lower threshold. The higher your profit margin, then you can, you know, get a little bit of breathing room in there and in decide if you want a little bit of a higher personal threshold. And then the third thing are capital reserves. I mean, I've seen some really big companies, and you know, this time of year in the state of Washington found this one company and you know, they had to pay like $500,000. I mean, that's a big chunk of change. And the company told me - Mike, we can't pay it. We need some sort of payment plan because all of our money is tied up in inventory. This is a twenty million dollar company, so they were a good-sized company. Two points there, you know, this, you know, if you don't take care of it, it can cost you a lot of money. This company was not happy paying that. But getting back to reserves, if you don't have cash reserves, if a state does find you, and it's going to impact your business materially, then you want to have a lower threshold. You don't want a state to be able to shut you down or impact how you're doing business because you had a threshold that was too high, a personal threshold.
[17:39] Jeremy: Yeah, I was talking to someone the other day the other week, that they may have to shut down because it's not worth it for them to stay in business. And you know what they, the state says they owe, you know, so it's unfortunate, it does happen.
[17:58] Mike: Yeah, and here's, you want it know what’s even worse? Shutting down is not always going to save you. Because in a lot of states, there's a personal responsibility. So even if you go and shut down even, you know, in California, you generally have to have collected the tax and not remitted for the personal responsibility to really. . .
[18:23] Jeremy: Right, right, right.
[18:24] Mike: But in a lot of states, that's not the case. And they will pursue you and even if you bankrupt the company, they'll come after you personally. Even if you bankrupt yourself, states can be 10 times worse than the IRS was, at their worst, you know, 20 years ago, the horror stories you hear, so you got to be careful. That's why it's better to be proactive and take care of this stuff upfront. So you don't find yourself in one of those positions and, you know, having the state chasing you to the grave.
[19:00] Jeremy: Yeah. So just a quick recap, when a company needs to worry about collecting sales tax, they need to think about the nexus, the taxability, the material piece. Anything else that we should mention?
[19:13] Mike: Yeah, the absolute last one. Nowadays, you know, we see a lot of people selling on marketplaces like Amazon and eBay, in addition to their other channels. Or maybe just selling on those platforms, a lot of people very successful. And if you're only selling on a marketplace, there are 40 states at this point who have said - The marketplaces are responsible for collecting and remitting that tax on your behalf or on your client's behalf. So you got to make sure you're the one responsible for collecting the tax. We get a lot of calls right now and saying - Hey, I see that Amazon is now going to be collecting in the state of California. Do I need to get registered in California? And actually, the exact opposite is true. Now is the time that you want to start looking at if you'll already be registered, looking at which states you can de-registering in. Because in general, once you, once Amazon starts collecting or one of these other marketplaces, if you're only selling on marketplaces, you don't have any taxable sales anymore. Someone else is responsible for collecting that tax. So that wraps up the top four reasons. We've got nexus, which is just a link or connection with the state. We've got is what you sell taxable? And services, by the way, a lot of people think that services are not taxable. They are taxable in a lot of states. Materiality, which I also call common sense, you know, is the amount actually material. And are you the one who's actually responsible for remitting the tax, or is it a third party, like a marketplace?
[20:55] Jeremy: Cool, Mike, thank you. If you have questions, go to salestaxandmore.com and check out more episodes where, again everyone's favorite topic, sales tax. Thanks, Mike.
[21:06] Mike: Thanks, Jeremy.
[21:08] Outro: Thanks for listening. Be sure to click subscribe and check out all of the resources we have out on the web.