Complexities in sales tax

Jake

I’m your host, Jake Jones, Multimedia Producer and Brand Influencer at Zone & Co, and I’m joined this week by two of our partners at Avalara: George Padilha, Senior Strategic Alliance Manager, and Sam Blass, Sales Executive. Thanks for joining me today, guys.

George

Nice meeting you. Thanks for having us.

Sam

Excited to be on the show! Thanks for having us.

Jake

There are two things in life you can be certain of: death and taxes. While it’s not always a “fun” topic, making sure your company is tax-compliant is an important part of ensuring your business’s success. Today, we’re going to introduce you to some of the complexities surrounding sales tax. George, Sam, again—thank you both for being here. Really excited to get into this topic about sales compliance, but before we do, I wanted to give you both a space just to talk a little bit more about what you do and what Avalara is. 

Sam

Thanks, Jake. What you mentioned is similar to what we hear on calls—everyone likes talking about sales tax. It’s such a fun topic, you know. So, I’m a sales executive here at Avalara, and I help my clients and customers navigate evaluating Avalara’s solutions to assist with automating tax compliance. Avalara is a cloud solution that integrates into a multitude of ERPs and accounting systems to help automate tax collection and remittance back to the states. We assist our clients in everything from tax guidance and research through automation of this pass-through activity that we have to navigate on a day-to-day basis as these companies run their business. 

Jake

Perfect. And George, tell us a little bit about yourself. 

George

Thanks, Jake. My name is George Padilha. I’ve been with Avalara for about six years, and the reason why that is important is because I work hand-in-hand with Sam. So, if any of Zone & Co’s clients ever decide to move forward with Avalara, I work with Zone & Co in the background to make sure that you guys are running on all cylinders. Whether it’s an issue with upgrades, whether you have a new customer account manager and you need to figure out who that is, I’m Zone & Co’s go-to person for everything. So, my job is to make everything run as smoothly as possible. Anytime you have an issue, you reach out to Zone & Co, and I’m the guy in the background escalating it. And after being here for six years, I know a lot of people, and that really helps make things move a lot smoother. 

Jake

Thank you both again. Really excited to have your expertise here. We certainly appreciate all that you do for us here at Zone, but especially glad to have you both here for your expertise on tax law. We’ve talked before about the complexities of sales tax—obviously we’re going to dive into that a little bit here. But, you were telling me some of your favorite funny tax laws, and I feel like that would be a great place to start—to just talk about how ridiculous some tax laws can get, especially when you look from state to state. So, George, I know you mentioned a couple in our first conversation, so why don’t you share some of your favorites. 

George

Yeah, absolutely. It’s just amazing how disjointed the United States is with sales tax. But if sales tax wasn’t complicated in the United States, we wouldn’t be in business. So, our job is to make companies’ lives easier. And there are some interesting sales tax laws: take a bagel in New York. Well, a bagel is considered a food so it’s tax-free. However if you slice that bagel in half, all of the sudden there’s a tax associated with it. Why? It’s considered a prepared food, and prepared food is taxable in the state of New York. Take donuts. If you buy five donuts or less in the state of Texas, it’s taxable. However, if you buy six donuts or more, it’s tax-free. No idea why that’s the case! Also, in the state of Indiana, a Cookies ‘N’ Creme Hershey bar is tax-free. However, a regular Hershey bar is taxable. Any idea why, Jake?

Jake

I assume it has something to do with more elements put into it, but I don’t know. 

George

That’s close. So, a regular Hershey bar is taxable and a Cookies ‘N’ Creme Hershey bar is tax-free because the Cookies ‘N’ Creme Hershey bar has wheat flour in it. And wheat is considered a food and subsidized item in the state of Indiana, which makes it tax-free. But it’s not just limited to products. Snow removal in Ohio is taxable, but in Illinois it’s tax-free. So imagine being a controller or a VP of finance trying to figure out what these sales tax rates are in one state. It’s easy to do in one state. But if you start going into more and more states—anything over three, and you really should start looking at automating. There were 32,000 sales tax changes in the last couple of years alone. Being able to keep up with that is really tough. 

Jake

Those are really funny, and I certainly wouldn’t have to be paying taxes on donuts in Texas. At least half a dozen? We’re getting those donuts. Sam, did you have any other funny tax laws that you’d like to add?

Sam

I think George said it pretty well. I would say I don’t find much of it funny because I’m on the frontlines and I deal with a lot of the frustrations of the folks that have to navigate the sales tax space. So, funny is not the word I would put—more so frustrating and complex. But the only one I can think of would be the local jurisdictions. So, Zone & Co is a software company, right? You’re selling software in one local jurisdiction in Colorado and it’s taxable, but there’s another jurisdiction down the road where it’s non-taxable. Navigating that inside of your systems can be very difficult. Those are the frustrations and complexities that I see on a daily basis when talking to customers and clients. 

George

One of those interesting complexities about software is that there are 250 different ways of charging sales tax to software in the United States. It’s insane. Whether it’s canned software, whether it’s custom-made software, whether it’s cloud-based software, there are 250 different ways of charging. It’s just incredible.

Jake

That is incredible. We’re already naturally getting into some of the complexities, and I do want to get more into that, but before we get much further, why is compliance so important?

Sam

That’s a great question. You never want to have the day where the tax man calls and you don’t have your ducks in a row. If there’s one quick-shot to a company that can set everything back rather quickly, it’s a letter from the taxman. Getting in front of it early allows you to pave a path that ensures you’re not hitting those speed bumps in regards to a large liability that you could have offset by accurately collecting in the first place. This pass-through or transactional tax—that is sales tax—ensuring you’re passing that on to the end user when possible or substantiating a sale with an exemption certificate and ensuring that it’s valid. These are all things that can allow you to avoid any of those future headaches when a state comes calling in regards to the sales tax compliance. 

George

One thing I’ll add to as well, is that forty-two states in the United States right now are operating at a deficit. No politician has ever gotten elected by saying hey we’re gonna raise your property taxes or we’re gonna raise your income taxes. Sales tax is the way they get the most amount of revenue for their state. Now, if you think about it, if they’re not getting revenue from income taxes or property taxes, and they’re getting it on sales tax, they want to make sure that they get that amount. So, what states have actually done is hire more and more auditors to actually go and look at these companies and say hey, have you charged the correct amount of sales tax? And you want to be as accurate as possible. And the reason why is because if you undercharge, you’re cutting into your margins. But if you overcharge, you’re not going to be competitive with other companies that are selling the same product. So you really wanna be as accurate as possible so you don’t have that liability. 

Jake

Great explanation, guys. Thanks again for explaining why it’s important for companies—you don’t want to be over or under there; you want to be competitive. Let’s get back into some of the tax law complexities. What makes tax law so complicated?

Sam

You can easily boil down the complexities of tax law. In the United States, every state has a different approach to sales tax. And once you are broadening your scope outside of the US, you’re even more so, you know, VAT in the EU is managed completely differently than transactional tax in the states. Or, PST HST in Canada is managed completely differently. The way you remit those taxes back to the governing bodies, the law around what you charge or the amount of tax that you charge is different in regards to each country. The goal of a company is to grow as large as you can, right? Let’s spread our wings. And when you do that, you are essentially letting in all these complexities and in each state the laws are different and in each country the laws are different. It’s a beast for a small accounting team to handle. So, if you’re able to leverage software that has the content and the information stored and managed inside of it, you know, it just allows peace of mind to ensure that as you scale, you’re not leaving yourself a headache down the road in regards to a call from the tax man.

George

So there’s a couple different reasons why sales tax is so complicated. In the United States there’s over 12,000 jurisdictions that all have different sales tax rates. So that alone, that’s one. Then there’s something called Nexus, which is the obligation to collect sales tax in a certain demographic. So the problem is there’s multiple different layers of this Nexus. The Nexus that everyone knows in the past has been phsyical presence. However, there’s been a lot of different layers that have been added on for this requirement to collect sales tax, one of which was famously a click-through Nexus. So, banner ads on websites, that’s how Amazon got dinged by the state of New York. New York was trying to get Amazon to collect sales tax for the longest time, and they kept on saying, ‘We don’t have any physical presence.’ Well, how they ended up getting caught was they were posting on the Boy Scouts of America website and they had a banner ad, and if you clicked on it, to the residents of New York it went to Amazon. Well, it went to the Supreme Court of New York and the Supreme Court sided with the state, saying, ‘Yes, that is considered a physical presence so now you’re required to collect sales tax for that reason.’ But additionally, since 2018, there’s this Supreme Court case called Wayfair v. South Dakota that essentially added a new layer, which is called economic Nexus. So it didn’t matter if you had physical presence anymore. What you were required to do was to collect sales tax based on the sales of every state. So for example, in Texas and in California, all they care about is the dollar amount. $500,000 in sales. Once you get past that number, now you’re required to collect sales tax. However in Georgia, it’s $100,000 in sales or 200 retail transactions. Which means that you can sell a widget for a dollar apiece in the state of Georgia, and if you sell 200 widgets, with a total revenue of $200, you are required to collect sales tax. However in Connecticut, it’s $100,000 in sales and 200 transactions. So you can sell a turbine engine for a million dollars apiece in the state of Connecticut. If you sell a hundred of them you have $100,000,000 in sales, and since it doesn’t reach that 200 transactions threshold, you can have $100,000,000 in sales and not have to collect sales tax. Whereas in Kansas, if you sell even a dollar, you have to collect sales tax. So every state is different, every state has different sales tax rates, every county has sales tax rates, every city has sales tax rates. Then everyone has a different requirement for what to collect and how much to collect and what triggers that. So, it’s $500,000 in sales in California and Texas, or $100,000 in Georgia, those are different requirements as well. Then, adding on top of all that, you have exemption certificates, and each state has different exemption certificate requirements. So, Florida—you can apply for an exemption certificate November 1st, and it expires December 31st and you have to reapply because it resets every December 31st of every year. However, in New Jersey, it’s every five years. So every state is different, so it just makes it more and more complex. 

Jake

Wow, that is so much to keep up with. And again, thankful for y’all’s expertise to just know some examples off the cuff there. George, I know something we had talked about before the podcast was also looking at all these different complexities with the states, but then you talk about going cross-border, selling globally. That just adds more complexities to it. Did you have anything you wanted to add to that?

George

Yeah, one-hundred percent. There’s so many things involved, whether it’s doing cross-border, you have to pay VAT taxes, everyone has their own landing itemization classification, so every state has a different code. So, clothing for example, in the United States could be 121.141.345, whatever it is. Germany will have a completely different number. Canada will have a completely different number for these item classification codes. So we can handle that and we can translate that. Then a lot of times you need representation for filing those taxes, so you need a physical person in those countries to sell to. So that also can be a problem. And VAT taxes as well. A good example is, I have a VP that lives in Toronto and he ordered a GoPro online. Well, that GoPro was listed online for $200 bucks. Great, he ordered it—it was $100 cheaper than anywhere else. So he gets it in the mail and all of the sudden the postman has his package and is like, ‘Hey, here’s the GoPro and here’s a bill for $100.’ My VP goes, ‘What?!’ He’s like, yeah, apparently the VAT taxes weren’t included in this purchase so now you’re required to pay it before we can hand you this item. So, that does a couple of things. It gives you a bad experience online, and with all these online retailers, as I mentioned before, if you under-charge, you’re not being competitive because you’re cutting into your margins, which in that case could affect your business altogether. But if you over-charge you won’t be competitive at all. So it’s really important that you can be as accurate as possible, and that’s going to give someone a bad experience if you don’t calculate it accurately. And if you give someone a bad experience, there’s so many choices, why would you want to go to a website that does that, right? You probably wouldn’t. 

Sam

The codes that you align when you’re shipping products overseas, those codes that you’re aligning to each product to ease the cross-border flow, they update every five years. I think it was just this past year these codes were updated. We had a client that we were working with who didn’t update these cross-border codes—harmonization codes—and their products were being held up at the border, which was causing delays in shipments to their customers. They’re getting customers calling in, ‘I’m looking for my product, where is it?’ Well, it’s stuck at the border, right? If we would’ve known that the classification code was being updated, we would’ve been able to align that on their shipping label, we would’ve been able to update their systems accordingly, they wouldn’t have this influx of customer issues of products being held up at the border. And so, it comes down to both a compliance discussion, but also a customer experience discussion in regards to additional payment they may have to shell out when they receiving this, whether it’s for additional taxes that need to be paid or duties that weren’t paid at the border that now are being absorbed by the end-user, and if they just would’ve been aware of that upon purchase, it’s a much easier purchase for the customer. 

Jake

You guys have brought up so many great points—I did want to bring up one other thing that George had mentioned just a second ago about thousand-plus sales tax changes within a year. Did you want to talk any more about that? I’d love to hear about that layer of the complexity. These laws are already complex, but then you add that they’re changing constantly, so tell me more about that. 

George

So if it was just a thousand that would be easy for companies to manage, but in the last couple of years it’s been 32,000 changes. Because there’s 12,00 jurisdictions that all can change their taxes. So whether it’s an additional bond—let’s say you’re building a stadium, let’s say there’s a special assessment that’s built, and those, a lot of times, are added to sales tax, whether it’s 0.5% or a percentage point. And the thing is that different cities—take Denver for example—you could be across the street and there’s a stadium tax that you have to pay, but that’s only in a certain location within Denver; it’s not all of Denver. And a lot of times because of gentrification or gerrymandering or redistricting, depending on what side of that political fence you’re on, all of these localizations change. So because of this redistricting, you can’t rely on that zip plus four anymore because these sales tax rates are based on congressional districts, and if you’re changing those congressional districts every few years, then those sales tax ranges change also. But what doesn’t change is that zip plus four. So it really is not an accurate way of having sales tax—it can be very outdated. No sales tax agent is going to say, ‘Hey we’re going to let you off with a warning.’ They’re going to ding you, and you’re going to pay those—even if you don’t have to pay the fines you’re going to have to pay the interest. Over the course of five, ten years, that does start adding up. 

Sam

Yeah, that’s a good example, George, that I use quite often. Where I live currently, where I’m at, you know, speaking on the podcast, I’m in a residential area. Well behind me, across the street, is a business district. We have the same zip code, but the tax rate is different across the street from where I’m at. So if you have a company leveraging a zip code based type of calculation, depending on what side of the street they’re sending it to, they may actually be charging an incorrect tax amount there. So either they’re over-charing the end-user, they’re under-charging the end-user. Either way they’re leaving themselves open for a possible compliance risk. 

Jake

This is such a complex topic and I know for me, personally, I’m overwhelmed hearing all these different things that I could be missing and misunderstanding about the law here. So, I want to ask this question, and we’re going to have several episodes diving into more about this topic of how it got so complicated. We’re going to hear some stories of experiences of having to deal with these complications in real time, but it’s a shift towards some hope: How do businesses stay compliant? And is there a shift in thinking in a way to make it easier to manage? 

Sam

Jake, I would say the first step in staying compliant is taking just a little bit of time to understand, back to George’s point, what is Nexus? Understanding Nexus. And Nexus is the obligation to collect and remit sales tax. That’s step one. Understanding where you are obligated to collect and remit based on your business activities. There’s a plethora of resources online to help explain what Nexus is, lean into a CPA, call Avalara, there’s plenty of information on our website around Nexus and services that Avalara can provide to help clean up a mess that may have been made and/or automating solutions so you don’t have to worry moving forward. But, understanding Nexus would be the first step in my opinion. 

Jake

George, Sam, we’ve had a great conversation about introducing the complexities of sales tax, and again, I’m so glad to have had you both on to hear your knowledge and share what you know about how complex it is. Hearing about all the different state laws and whether funny or not so funny, as you mentioned Sam, it’s been great to understand how complex this topic really is. I’m excited for future episodes so we can talk more about how we can tackle this. So, thank you both again for being on. 

Sam

Yeah, Jake, thanks for having us. This was a blast and we’re excited to come back. 

George

Yeah, absolutely, I had a great time. Thank you so much and look forward to being invited back anytime you want us to.