Sales Tax Automation Solutions: What Businesses Need to Know

By Tram Le, originally published in Tax Notes

Selecting the right sales tax automation platform for your business is about more than choosing a vendor. Set up, integration, system and certificate management and a myriad of issues must be tackled to solve sales tax problems.

Because of the Wayfair decision and states’ economic nexus standards, more businesses are required to collect and remit sales tax across the country. As such, many businesses will either build tax decisions into their enterprise resource planning (ERP) and accounting software or seek out third-party sales tax automation solutions to help manage their responsibilities and reduce sales tax risk and errors.

As businesses look to third-party software and technology to handle the parts of sales tax management that can be automated, several issues must be addressed. All sales tax software solutions are not the same — from the software itself to the training, advice, or support provided by the vendor. Sales tax software does not and cannot always meet the specific tax situation of each unique business or industry. Software vendors may not have expertise and depth of knowledge with specific tax issues and nuances to accurately set up, implement, and integrate their software with a business’s ERP system.

To be accurate and do what a business needs it to do, the software must be properly set up and effectively monitored. This means understanding and mapping the products and services for all relevant jurisdictions, applying the appropriate rules and rates, and managing exemptions and certificates when necessary.

In setting up the software, users must address all the moving parts, down to the proper input of dates, tax codes, and transaction data that will generate correct tax calculations and decisions. Errors in the sales tax calculations, tax collections, and remittance for businesses cost time and money to fix, can affect customer relationships, and create potential legal liability.

The myriad issues surrounding the selection, implementation, and monitoring of automation software clearly demonstrate that it alone is not enough to solve all sales tax problems. This reality makes it imperative for businesses to work with an experienced sales tax professional to get it right.

When to Consider Sales Tax Software

The popularity of online transactions has grown exponentially. Businesses selling everywhere, with a broad sales tax footprint, have a greater need for tax automation software. Sales tax software provides tax determination on products and services, automates sales tax calculations, and provides data to collect and comply with filings and reporting requirements. With thousands of state, municipal, county, and special tax jurisdictions in the United States, businesses must have the correct sales tax rates for where they sell and properly tax the products and services sold.

Businesses with complex transactions should consider sales tax software. This includes retailers with drop-ship vendors selling products into multiple states, vendors selling through marketplaces fulfilled by Amazon, and software providers selling cloud-based products and services — all of whom need accurate tax determinations.

Businesses that benefit most from automation are those that have high-volume sales in multiple jurisdictions or that need mapping, which is connecting tax decisions to products and services. Without software, taxpayers manually keep up with state and local tax duties, which can be intense when determining the appropriate tax rates, rules, exemptions, expirations, and filing due dates.

Setting Up Automation

When businesses automate, the implementation and setup must be carefully evaluated and properly executed. It is never quick and simple. Selecting the appropriate nexus, nexus dates, tax type, and filing settings in the applicable state and local jurisdiction will depend on the circumstances of each business and each state’s requirements. A business must have a solid understanding of which activities are conducted in the state or locality, how products and services are being sold, where customers are, whether products and services are subject to tax, and whether exemptions apply.

Businesses must also know the tax type they are registered or need to be registered for. Some of the most complex states — such as Alabama and Colorado — have separate registrations for local home rule jurisdictions that administer their own taxes, with differing tax rates and bases, and separate licensing requirements for different tax types.

Registrations, Tax Types, and Returns

To get the right automation results, a business must understand how it is registered and where. In Alabama, businesses with no location in the state that sell tangible personal property into the state must register to collect sellers use tax.¹ Businesses in Alabama are required to register to collect state sales tax on sales to customers in the state. Alabama sales tax and sellers use tax are reported and remitted separately from local taxes
with varying rates.² Therefore, businesses must separately register with local jurisdictions to collect and remit local sellers use or sales tax.

Eligible remote sellers interested in Alabama’s seller’s use tax program may collect, report, and remit a flat 8 percent on all sales to the state without reporting and remitting the tax separately to localities. Businesses participating in Alabama’s Simplified Sellers Use Tax program must apply and report simplified sellers use tax on a separate return from businesses that registered to collect sellers use tax or sales tax in Alabama.³

The requirements for the type of license and tax to be collected and remitted depends on each business’s unique situation in the state — such as selling online with no inventory in the state versus selling online with a
store in the state. Setting up software with the incorrect tax type may result in under- or over-collecting and remitting the taxes and, in some cases, may be problematic with setting up to collect the wrong tax type — resulting in no statute of limitations for those filings.

In Colorado, both businesses with economic nexus (that is, remote sellers or marketplace facilitators with no physical locations) and those with physical locations in the state are required to obtain a state sales tax license and collect and remit all state and state-administered sales taxes — that is, cities, counties, and special districts imposing sales tax. Local sales taxes that are administered by the state are reported and remitted on the same form as Colorado sales tax.⁴

Colorado home rule jurisdictions have separate nexus rules and registration
requirements, varying taxability and exemption of products and services, differing rates, and separate tax collection and reporting obligations from the state.⁵ In general, sales tax is sourced to where products are delivered or shipped. In addition to the state-level registration, businesses must figure out whether they are required to register with, obtain a separate license from, and collect and report tax directly with a home rule jurisdiction. Equally important, businesses must be able to properly calculate, collect, and remit tax to localities where they conduct business or make sales.

Products, Services, and Exemptions

To accurately calculate sales tax, businesses must properly characterize all products and services and account for exemptions. States’ sales tax bases vary, especially for products such as clothing, food items, software, or taxable information or data processing services. These products and services must be mapped to the appropriate codes to match the tax decisions in states where businesses may be selling. Every line item — including shipping and handling — that is invoiced should be mapped appropriately.

Failing to do so may result in incorrect tax calculations because some products may be exempt or taxed at different or special rates. For example, businesses selling clothing into states that exempt or partially exempt clothing must map the products to the appropriate codes. Otherwise, clothing will likely be treated as a generic category and taxed in states that do not tax it. Software as a service or licensing software is particularly tricky to map — as states may differentiate between the method of delivery, access rights, or terms and agreement between the vendor and customer to tax the transaction or not.

There are also differences between state and local sales tax exemptions. For example, grocery foods are exempt in Colorado at the state level but may be subject to tax in state-administered or home rule jurisdictions.⁶ Therefore, businesses selling specific products may be exempt from state tax but subject to a local sales tax. Properly mapping products and services to the appropriate tax code for all jurisdictions, both at the state and local level where businesses have collection and remittance duties, will provide more accurate tax calculations.

For industries such as manufacturing, nonprofit, or wholesaling, managing exemption certificates is critical. Businesses must properly document and maintain records to support the exemptions. They must also verify that a purchaser’s sales tax license or exemption certificate is complete and valid at the time of sale. Documentation required to support exemptions varies by state. Where a sale may be exempt because the purchaser is an exempt entity or the use is exempt, maintaining improper, expired, or missing certificates could create risk and exposure.

There are key questions to consider before automating with a third-party software vendor:

• Do you need sales tax automation? Can your ERP system handle sales tax alone? Do you have enough transactions across jurisdictions to justify automation? If you are only selling into a couple jurisdictions with stable rates and rules, and have limited expansion plans, you may not need sales tax automation.
• Does the third-party sales tax software integrate with your ERP and accounting software? If not, then sales tax automation will not work or could require significant time and effort to work.
• Does the third-party sales tax software integrate with your ERP and accounting software? If not, then sales tax automation will not work or could require significant time and effort to work. Does the third-party software address home rule jurisdictions? If you are doing business in Colorado, Louisiana, and other states with home rule jurisdictions, some tax automation vendors may not be able to address home rule compliance.
• Does the third-party software vendor provide training and support services? Are there additional costs for training and support? Do the training and support staff have in-depth knowledge of sales tax requirements and understand your business situation? If not, you may be purchasing a tool that does not provide accurate tax rates, calculations, tax determinations, and proper sales tax compliance.
• Do you have resources internally or service providers lined up to do reporting? If there is a need for sales and use tax return filing and reporting, only some third-party software providers do so as an add-on service.
• Do you have the in-house resources to 6 manage tax automation, or do you need to contract an outsourcing solution to do so? Sales tax software is not a set-it-and-forget-it solution for any taxpayer. Risk and exposure fall to the vendor and provider when taxes are not properly calculated, collected, and remitted. You need to monitor what the service provides.
• Do you need an exemption certificate management system? If you are selling to exempt buyers or selling an exempt product, you will likely need a sophisticated way to automatically manage exemption certificates you collect and maintain for compliance in all jurisdictions. Third-party vendors may offer exemption certificate management systems a la carte or as an addon to a larger tax automation platform, offering an end-to-end solution from data acquisition through licensing, permits, exemption certificate management, calculations, and filings.
• What pricing level can your budget handle? Vendor pricing varies. Generally, there is a fixed-fee setup cost. From there, most are volume-based on the number of filings in a tiered pricing scheme. For taxpayers with a high number of invoices and transactions, costs can rise quickly. If selling high-volume, low-dollar products, dollar-per-filing costs can add up and will likely exceed the revenue generated from sales. A cost-benefit analysis may help businesses elect whether to use third-party software solutions. However, the cost of not automating and becoming noncompliant can be even higher — hence should also be considered.

Sales tax is complicated. It is important to carefully evaluate software and technology to manage risk and exposure. Expertise and knowledge of sales tax laws and rules is needed in every state and local jurisdiction where you collect and remit. Using sales tax automation to manage compliance obligations requires settings to be continually monitored and updated to reflect changes in sales tax laws and rules for rates, tax decisions, and exemptions. Working with a sales tax professional well versed in sales tax software will help avoid costly errors.

Tram Le (tle@taxops.com) is a member of the SALTovation team at TaxOps and an adjunct professor at the University of Texas at Arlington. She writes about hot topics in state and local tax affecting business operations and growth strategies. In this installment of Spreading SALTovation, Le discusses issues that businesses should consider regarding the use of sales tax automation software.

Get in Touch with the Author

Reach out to Tram to discuss sales tax automation at tle@taxops.com.

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