At one point in time, sales tax was relatively simple for small businesses to manage. Many merchants had a single storefront in a single jurisdiction — the sales tax rate rarely changed and they could easily determine how specific products were taxed. Fast forward to today and the reality is much different.
Modern small businesses are selling across a myriad of in-person and online channels to customers around the country and even the world. Long gone are the days of small businesses only contending with a single sales tax framework. As a result, getting tax right on every transaction can be very difficult, but understanding the factors that make sales tax complex and the tools available to navigate it can protect small businesses from audit risk and enhance their customer experience.
Factors that affect tax calculation
The process for collecting sales tax varies from business to business but remains similar at a high level. For every sale, if a business has nexus, it needs to:
- Assess item taxability
- Determine the appropriate tax rate or rates
- Apply tax to the sale at checkout
- Collect tax from the customer during payment
Still, every business and every transaction can trigger differing sales tax rates and rules. Each state has its own rules about what should or shouldn’t be taxed in their jurisdictions. Likewise, each state has its own rules around product taxability (what makes a product taxable). For example, in Texas, deodorant is taxable, while antiperspirant is exempt. Beyond varying rules, tax rates are also constantly changing. In 2021 alone, there were more than 7,000 tax rate updates in the U.S. and Canada.
With all of this in mind, the complexity of calculating sales tax grows further when selling online or remotely.
Remote sales considerations for tax calculation
Many small businesses today have thriving online operations that enable them to sell to customers across the U.S. The internet has leveled the playing field for small businesses that want to compete on a larger scale. Still, the opportunity created by ecommerce has also expanded tax complexity.
Known as economic nexus laws, 45 states, the District of Columbia, and parts of Alaska require remote sellers to collect sales tax based on the location of the customer. These laws require businesses to register to collect sales tax in jurisdictions when an annual sales revenue and/or transaction quantity reaches a certain threshold set by the state.
As a result of economic nexus laws, if you sell into multiple states and reach the threshold, you must know the tax rates and rules in each jurisdiction — something that varies widely. With more than 13,000 sales and use tax jurisdictions in the U.S., it’s clear how this can be a challenge for small businesses. So how can businesses make sure they are calculating the right rate?
They can reference tax rate tables or upload them to their sales systems, but these must be updated regularly to keep up with ongoing regulatory updates. These are also often organized by ZIP code and don’t account for the nuances of product taxability. And, if a small business is manually using these practices, it’s likely they’re spending ample time and money on sales tax management. At the end of the day, the most accurate way to determine a tax rate is to look it up based on address, which is where technology can help (and save time and money).
Technology applications for tax calculation
If a small business is selling online and in-person and into numerous states, their tax footprint is likely significant. When it comes to calculating sales tax, they must be able to calculate the correct rate across every channel in near real-time — sounds simple, right?
Technology can automate tax calculations, which not only saves time and money but can reduce the risk of non-compliance. To put the savings into perspective, a 2021 survey found that on average small businesses spend nearly $12,000 per month and 131 hours manually managing sales tax compliance.
Cloud-based automated tax calculation tools use regularly updated tax rates and rules to increase the accuracy of calculations for businesses. In addition, these tools have up-to-date product taxability information, tax-exempt data, sales tax holiday rules, and more — all of which can impact tax calculations.
Small businesses selling in our omnichannel economy have to manage a myriad of sales tax rates and rules to ensure they’re getting the calculation right on every transaction. Small businesses can benefit from automating tax calculations so that they aren’t responsible for monitoring tax changes, making updates, and manually assigning rates for transactions.
Liz Armbruester is SVP of global compliance operations at Avalara. Liz has more than 20 years of leadership experience from a variety of technology sectors, including media, services, and software.
Tax stock image by Bartolomiej Pietrzyk/Shutterstock