How-to guide: Streamlined sales tax (USA)

Introduction

This guide will assist in-house counsel, private practice lawyers, tax and human resource departments with understanding the streamlined sales tax to simplify sales tax collection.

This guide covers:

Overview of the streamlined sales tax initiative
Should your company consider implementing streamlined sales tax?
Implementing streamlined sales tax

This guide can be used in conjunction with the following How-to guide: Sales and use tax considerations in e-commerce and Checklist: Drafting a business-to-business (B2B) contract with automatic renewals.

Step 1 – Overview of the streamlined sales tax initiative

1.1 History of sales taxes

Sales taxes are imposed by states, not the federal government (ie, there is no national sales tax), and are placed on the lease or sale of goods and services in the United States. The first sales tax legislation was enacted in West Virginia in 1921. While income tax was the primary revenue source for the federal government, and property taxes provided revenue for local governments, states began to recognize sales tax as the best way to generate revenue at the state level. The trend started in 1933 when 11 other states followed West Virginia’s lead and by 1940, 18 more states had a sales tax in place. Today, ‘consumption taxes’ like the sales tax are imposed on the end user or consumer at the point of purchase. When a sale made by a retailer is subject to sales tax, the retailer is generally required to collect the tax from the purchaser and report and remit that tax to the state tax authority. Sales made for the purpose of reselling goods (eg, a sale from a wholesaler to a retail outlet) are generally not taxable.

Nationwide, sales tax still represents a significant portion of total state revenue and is estimated to bring in about 24 per cent of states’ total revenue. However, in those states that do not have income taxes the percentage of the total revenue is much higher. In Florida, for example, the absence of an income tax pushes the percentage of revenue from transactional taxes up to about 81 per cent of the total state tax revenue.

1.2 Establishing a nexus

Sales tax nexus is the connection between a seller and a state that requires the seller to register then collect and remit sales tax in the state. There are many ways to create a nexus (eg, having a physical presence or reaching a certain sales threshold within a particular state).

Historically, states were limited in their ability to impose tax on out-of-state corporations because of the due process clause and the commerce clause in the US Constitution. The requirements of these clauses can be satisfied if there is some nexus, or minimal connection a business has with a state that creates an obligation to collect and remit sales tax. In one of the earliest cases to deal with this issue, the Supreme Court considered the requirements for a state to impose a tax under the due process clause and stated that ‘[t]he simple but controlling question is whether the state has given anything for which it can ask a return.’ See Wisconsin v JC Penney Co, 311 US 435 (1940).

The due process requirements for taxation were given further definition when considered in a subsequent case. There, the court stated that ‘a taxpayer avails itself of the benefits of an economic market in the forum state, … even if it has no physical presence in the state.’ Thus, at least under due process considerations, the amount of contact that an out-of-state taxpayer could have with a foreign state without being subject to taxation is negligible. See Quill Corp v North Dakota, 504 US 298 (1992).

As the due process requirement for taxation was minimal, the primary test for state taxation hinged on whether there had been a violation of the commerce clause. One significant case dealt with a mail order business whose only connection to the taxing state was through mail or courier who delivered the marketing materials and the purchased goods. There, it was held that the company did not have sufficient contact with the taxing state to overcome the limitations imposed by the commerce clause restriction on taxation and established a ‘bright line’ standard requiring the retailer to have a physical presence in the taxing state. See National Bellas Hess, Inc v Dept of Revenue, 386 US 753 (1967).

Subsequently, states began to recognize the potential loss in revenue due to the explosion in internet sales, and they began to get more aggressive and creative in imposing taxing liability on internet sellers. Some states enacted legislation that imposed an obligation on out-of-state internet retailers to collect and remit state sales tax on tangible personal property or services sold through links on websites owned by state residents. See NY Tax Law section 1101(b)(8)(vi) (also known as the ‘Amazon law’). Another angle that states began to use was to impose tax on companies through ‘affiliate nexus’. Those laws impose a requirement to collect and remit tax if the group has a ‘component member’ (as defined in Internal Revenue Code (IRC) section 1563(b)) that is a retailer that has a physical presence in the state. See former Colorado Revised Statutes section 39-26-102(3)(b)(II) (citation added for context to provide an example of a ‘component member’ tax law, as now repealed).

In 2018, the Supreme Court again considered the nexus standard for sales and use taxes in the case of South Dakota v Wayfair, 585 US 162, 138 S Ct 2080; 201 L Ed 2d 403 (2018). This time, though, it abandoned the bright line, physical presence test established by Quill, calling it ‘unsound and incorrect’. The Court concluded that a retailer achieves substantial nexus simply by carrying on business in the jurisdiction and noted that modern e-commerce made the physical presence requirement ‘artificial in its entirety’. Instead, a new nexus standard, termed ‘economic nexus’, was established. Since the Wayfair decision, most states have adopted new rules defining nexus and the imposition of a sales and use tax obligation.

1.2.1 Economic nexus

Economic nexus refers to a business presence in a US state that makes an out-of-state seller liable to collect sales tax. A state can now require a business to collect and remit sales tax for that state even if they do not have a physical store or sales representative there. This also applies to remote sellers who sell products or services for delivery into the state. This new standard is enough to trigger nexus for a state and creates a tax liability once a set level of transactions or sales activity is met. It essentially breaks the qualifying threshold into two components:

sales revenue generated (eg, $100,000) in a specified time period; or
volume of sales (eg, 250 transactions in a specified time period).

States have enacted legislation with varying levels of dollar and transactional thresholds, so while there is commonality in the designated criteria, there is still no uniformity in the laws of the various states and local jurisdictions. When reviewing the requirements, businesses should consider whether the state has based their threshold on sales or transactions, or sales and transactions. In addition, businesses should consider how the sales threshold is determined (eg, gross sales or retail sales).

Business owners need to understand their sales tax nexus and corresponding liability to avoid needing to pay uncollected taxes plus fines and interest. Ultimately, businesses need to determine where they have nexus, check the state-level requirements and determine their tax liability, and file and remit their taxes.

1.3 Streamlined sales tax initiative

1.3.1 Background

Recognizing the need for some type of uniformity, the Streamlined Sales and Use Tax Project was created in 1999 by the National Governors Association (NGA) and the National Conference of State Legislatures (NCSL). The goal of the initiative was to simplify sales tax collection due to concerns that a sales tax regimen that dated back to the 1930s would not survive 21st-century commerce, and sales tax had grown to represent a significant component of total state tax revenues. Consequently, these coalitions directed their tax administrators to develop a simpler, more business-friendly sales tax system. The result was the Streamlined Sales Tax Agreement. The purpose of the Agreement is to simplify and modernize sales and use tax administration in order to reduce the burden of tax compliance. The Agreement focuses on improving sales and use tax administration systems for all sellers and for all types of businesses. Of the 45 states with a general sales and use tax, approximately half have passed the conforming legislation to implement the streamlined sales tax.

1.4 How does streamlined sales tax work?

The Streamlined Sales Tax Registration System (SSTRS) was designed by its member states to provide taxpayers with a simple and free system to register for sales and use tax in multiple states. Offered as a solution to the complexity of state sales tax, the SSTRS provides a simplified registration system that allows companies to register in each state in which they have a nexus with one filing. Use of the SSTRS is optional, and retailers may choose to register directly with states. Sales tax is reported and paid directly to each state, using the state’s online filing system based on the filing frequency determined by that particular state. Registering through the SSTRS portal is free, and it can be done quickly. SSTRS provides a resource to ease the burden on companies that have discovered that they may have filing responsibilities in numerous states due to the new economic nexus rules or because of expansion into a new market. SSTRS also saves businesses time by making reporting and remitting taxes due more efficient.

Step 2 – Should your company consider implementing streamlined sales tax?

2.1 Preliminary concerns

When considering whether to implement streamlined sales tax, there are some underlying factors that the business must consider, as described below.

2.1.1 Are sales subject to sales taxes?

Although a business may have sales into a state that exceed the economic nexus threshold for that state, the underlying transactions themselves may not be taxable. Some types of sales that may not be subject to tax include:

sales for services, as opposed to goods or products, are generally not taxable;
sales for resale (ie, sales made to another merchant who will resell the goods purchased) are not taxable; and
exempt sales (ie, sales made to a manufacturer for incorporation into another product) are exempt from sales tax.

Specific exemptions vary from state to state. For example, Florida generally does not collect sales tax on purchases of items such as:

prescription drugs;
groceries (unprepared food);
long term residential real property leases; and
seeds and fertilizers.

Additional exemptions may exist based on the industry. In Florida, sales tax exemptions for the healthcare industry generally include:

hypodermic needles and syringes;
medical services;
prescription drugs;
medical gases;
prosthetic or orthopedic appliances; and
single-use medical products.

The list above is not exhaustive but provides some common examples of non-taxable transactions. A business should gain a full understanding of their sources of revenue and how their sales may be impacted by the definition of taxable transactions in any states where they conduct business. Note that streamlined sales tax laws do not expand the definition of taxable goods or services.

2.1.2 Does the business have significant sales to multiple states?

The business should prepare reports that break down sales into each jurisdiction. These reports will typically be prepared by the accounting staff of the business. If you sell across state lines, it is likely that you will be required to collect sales tax in the states where you do business. You should have meticulous record-keeping procedures to track invoices and sales so that you know exactly where your sales come from. Because the ‘new’ economic nexus standards being implemented by most states post Wayfair are based on dollar sales volume and transactional sales volume thresholds, these reports should reveal both sales in dollars as well as the number of transactions.

2.1.3 Has nexus been established in multiple states?

With the information gleaned from the analysis done in the prior two evaluation steps, the business should be well positioned to determine where it may have sales tax nexus. Businesses that sell across states must take note of all local and state business regulations, including tracking developments and filing frequencies. As there is still disparity between the many states on what actually constitutes nexus, it is recommended that resources that provide the nexus standards in all states that charge sales tax are utilized. It is also important that you comply with state-level requirements governing how to file and remit sales tax too.

2.1.4 Do you need to apply for a sales tax permit?

In states that impose a sales tax, a business that will engage in taxable sales must obtain a sales tax permit. The permit is usually obtained from the state’s department of revenue. Some units of local government, such as cities or counties, may also impose a sales tax on all or some of the same transactions that are taxed under state law. The registration is an agreement that the business will collect and remit sales taxes as required by law.

2.2 Sales tax compliance concerns

Determining where the business needs to register to pay state sales taxes will subsequently create tax filing obligations once the business is registered. Below are some of the considerations a business should evaluate when looking at the sale tax compliance function. Keeping on top of ever-changing sales tax obligations can be challenging if you are not familiar with the state tax regulations. Taking all these factors into account may lead a business to register with the SSTRS to streamline systems and processes to meet their responsibilities.

2.2.1 Are resources available?

The primary consideration for a business is to decide whether they have sufficient ‘human’ resources to manage state sales tax obligations in-house or if there is a budget to hire additional resources to assist. The alternative is to consider outsourcing some or all tasks.

The business should also evaluate current IT capabilities and determine if current systems are sufficient to comply with all additional compliance, monitoring and oversight activity. As with human resource capabilities, the business should audit existing resources against what the expected needs will be and develop a phased timeline to ‘plug’ gaps and plan for any required adjustments to mitigate potential exposure.

2.2.2 Are current processes adequate?

When considering whether current processes for collecting and reporting sales taxes are adequate, the business can begin by asking their accounting professional or outside auditor (if there is one) to provide some additional information. Examples of useful management information include:

volume of inquiries from state and/or local taxing jurisdictions; or
outcomes of sales tax audits performed by government revenue departments.

If there are large volumes of letters of inquiry from state and/or local taxing jurisdictions, this could be an indication that there may be state tax exposure due to lack of adequate registration and/or compliance processes. If there is a large volume of state tax audits that are regularly ongoing, or audits with significant assessments upon their conclusion, this would indicate an internal weakness in sales tax compliance that has alerted the authorities to potential violations.

2.2.3 Expected changes in the business plan

Changes to the business plan or sales and marketing operations of the business may impact compliance burdens, and result in unexpected sales tax implications. A few examples of the types of expansion plans that could have sales tax implications include:

acquisition of an ongoing business;
expansion of business into new markets; or
expansion of an e-commerce platform.

Sales tax compliance should be an integral part of business and organizational planning on a continuing and ongoing basis. Undertaking an assessment of the impact on sales tax liability is particularly important where changes are made to the organizational structure of the business or target markets. This is an important compliance consideration throughout the lifecycle of the business.

Step 3 – Implementing streamlined sales tax

3.1 Registration with states

The first step in implementing streamlined sales tax (SST) is to register with the SSTRS through their portal. Then, the business may register with the various member states as part of the SSTRS. Currently, full member states – being those states in full compliance with their streamlined sales tax – include Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. One state – Tennessee – is an associate member state, meaning that it has achieved substantial compliance with the terms of the agreement, but not necessarily with each provision. Sellers have the option to register in Tennessee when registering through the SSTRS. Registration may be done through the SSTRS or with any state directly.

While utilizing the SSTRS resources makes the initial process easier, there are also drawbacks to using that registration process, including the following:

it may take longer to get access to an account in some states instead of applying directly with the state Revenue Department;
the business may not be issued an actual sales tax permit (although the alternate SSTRS exemption certificate may be used);
the assigned filing frequency may be incorrect because SSTRS does not ask for estimated tax liability. This could result in under- or overpayments, or payments not being made on schedule;
SSTRS may not provide enough information to state revenue officials to contact a business –SSTRS does not ask for responsible party or officer information. This is important as key stakeholders need to be contacted (eg, if there are liability issues that are time-critical); and
once a business has registered through the SSTRS, they will be required to collect and remit sales tax for each registered state beginning with the registration date. A business may use a certified service provider (CSP) to make payments (see Section 3.2 below), or may open an account with each state itself to make payments.

The business must weigh up these disadvantages against the ease of using the system. The alternative is to do all registrations directly with the states, using internal resources or an outside third-party professional service provider.

3.2 Ongoing processes

Ongoing sales tax compliance can be extremely cumbersome. In addition to state tax returns needing to be filed in a timely manner, there are often regular notices or communications coming from any number of the states where the business is registered. In addition, there will probably be state tax audits that will need to be managed as well.

When you register using the SSTRS, you have the option of selection a CSP to assist with filings. The CSP is an agent that is certified under the Streamlined Sales and Use Tax Agreement. They will perform all the seller’s sales and use tax functions, other than the obligation to remit the taxes due. A CSP is designed to allow a business to outsource most of its sales tax administration responsibilities, such as:

sales tax registration;
sales tax calculation;
exemption certificate processing for invoices;
sales tax returns preparation, filing and remittance;
notice management; and
audit support.

Although using a CSP is not a requirement to register with the SSTRS, any taxpayer that will contract with a CSP must register through the SSTRS.

Some of the reported benefits of using a CSP include:

ease of registration with states;
initial set up, particularly because the complexity in the tax treatment of things like food, clothing, drugs, software, digital goods, etc as part of the mapping exercise of taxable transactions can be enormously valuable;
management of exemption certificates from customers; and
filing and remittance, as the CSP becomes responsible for the timely and accurate filing of sales tax returns and the remittance of sales tax funds.

A key disadvantage of using a CSP is that the business must utilize the SSTRS to register for sales tax to use a CSP. Note, however, the SSTRS system does not cover all states that have a state sales tax (see the list of member states, above at Section 3.1). So, theoretically at least, the business may have nexus only in non-member states, in which case there would be no commercial sense in registration with the SSTRS and subsequently using a CSP.

3.3 Maintaining compliance and updates

Beyond the initial registration and ongoing filing, businesses must actively maintain compliance with evolving SST regulations and updates. This includes:

Staying informed of legislative changes. Sales tax laws are subject to frequent changes at both the state and local levels. Businesses need to monitor these changes, which may include alterations to tax rates, product exemptions, and nexus rules. Subscribing to state revenue department newsletters, participating in industry associations, and consulting with tax professionals can help businesses stay informed.
Regular review of product taxability. The taxability of products and services can change over time. Businesses should conduct periodic reviews of their product catalogs to ensure accurate tax collection and remittance. This is particularly important for businesses selling digital goods, software, or other items with complex tax classifications.
Updating software and systems. Businesses using automated sales tax software or certified service providers (CSPs) need to ensure that their systems are regularly updated to reflect the latest tax rates and rules. This includes applying software patches, updating tax tables, and verifying the accuracy of tax calculations.
Managing exemption certificates. Maintaining accurate and up-to-date exemption certificates is crucial for avoiding tax liabilities. Businesses should establish a process for collecting, verifying, and storing exemption certificates. Regular audits of these certificates can help identify and address any discrepancies.
Audit preparedness. Businesses should maintain thorough records of their sales transactions, tax calculations, and filings. This documentation is essential for responding to state tax audits. Conducting internal audits can also help identify potential compliance issues before they are discovered by state authorities.
Training and education. Ongoing training for staff involved in sales tax compliance is essential. This ensures that employees understand the latest regulations and procedures and can accurately handle tax-related tasks.
Handling state notices and correspondence. Promptly addressing any notices or correspondence from state revenue departments is crucial. Failure to respond to these communications can result in penalties and interest charges.

Additional resources

The Minnesota Department of Revenue, Streamlined Sales Tax and the Wayfair Decision (28 January 2021)
Sales Tax Institute, What is the Streamlined Sales Tax Project (SSTP)?

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Topics

Harmonised sales tax