The True Cost of Sales and Use Tax Non-Compliance

In short: At best, Sales and Use Tax (SUT) non-compliance may cost a few hundred dollars in fines. At worst, it means back taxes, penalties of up to 40%, interest and even lawsuits. Many states let businesses come forward through a Voluntary Disclosure Agreement (VDA) for lower penalties, but only before the state makes contact. Your firm can help clients understand their nexus and build a solid compliance plan.

In a best-case scenario, Sales and Use Tax (SUT) non-compliance may cost a few hundred dollars in fines. In a worst-case scenario? Penalties, fees, back taxes and possibly even litigation damages can devastate a business. 

Let’s look at all the non-compliance penalties businesses can face. We'll also cover strategies your firm can use to help soften the blow.

What does non-compliance mean?

A business is ‘non-compliant’ with sales and use tax rules when it fails to collect and remit tax in states where it has established nexus. Before 2018, nexus was fairly easy to manage. Physical presence was the main factor businesses had to consider when working out where they owed tax.

Then, in 2018, South Dakota v. Wayfair introduced the concept of 'economic nexus.' Suddenly, remote sellers everywhere became liable for tax obligations in many more jurisdictions. 

This decision did not just create many more tax triggers. It also made nexus much more complex. With economic nexus, businesses need to track economic nexus triggers in every single state, as well as in some county and local jurisdictions. Each state can set its own SUT rules. That makes the rules very daunting for remote sellers to navigate. As a result, many businesses have shrugged their shoulders, unsure where to start. 

What happens when businesses are non-compliant?

States make a lot of money from sales and use tax. They are highly motivated to collect any unpaid tax, especially after the economic damage caused by COVID. SUT is a massive source of state income. This is especially true since South Dakota v. Wayfair, as that ruling opened up a significant new revenue stream.

In terms of timing, states are now pushing hard to go after the money they're owed. Most states have a three-year audit period for a sales and use tax audit. With the close of 1Q-2022, the three-year audit period under South Dakota v. Wayfair (June 21, 2018) now applies. So states are gearing up for a big audit season. They have their sights on businesses that haven't complied with remote seller tax laws. 

Many states have been sending nexus questionnaires and audit requests to businesses flagged for tax non-compliance. So any business that thinks it has met or passed thresholds needs to act fast to avoid hefty penalties. 

Why are Voluntary Disclosure Agreements valuable?

Many states offer businesses a safety net called a Voluntary Disclosure Agreement (VDA). Businesses and their accountants can use this tool to come forward and ‘admit’ their non-compliance. For a closer look, see What Is a VDA (Voluntary Disclosure Agreement) and Do You Need One?.

It's a bit like debt consolidation. In many cases, states will settle on a lower penalty because the business has come forward to 'settle up' its unpaid tax. The catch is that once the state has contacted a business, it can no longer submit a VDA. So if any of your clients know they are non-compliant with remote sales tax, now is the time to submit those VDAs.

What can non-compliance cost? 

Businesses that don't submit a VDA in time may face significant penalties. For example, say a company had $300,000 in sales in Arizona in 2021. Arizona has an economic nexus threshold of $100,000. And the business failed to collect or remit any of that tax.

Arizona has a state sales tax of 5.6%. It also lets local governments collect a local option sales tax of up to 5.3%. That makes a combined tax rate of as high as 10.9%. Right away, this business owes the state of Arizona at least $16,800 in unpaid tax (5.6% of $300,000). It could owe more, depending on which jurisdictions it sold into. And that's just the beginning.

Arizona is also tricky because the state changed its economic threshold three separate times. The original threshold, issued in 2019, was $200,000. In 2020, it was cut to $150,000. In 2021, it was cut again, down to $100,000. Passing these thresholds in either the current or previous calendar year triggers nexus. That means each year between 2018 and 2021, more and more remote sellers triggered nexus in Arizona. 

Extra penalties and fees also add up for a range of other issues. These include failing to register with the state, late payment or nonpayment of SUT tax, and interest on nonpayment.

Here’s what those penalties can look like:

• Failure to collect, remit, and file: 10-25% of the tax amount, with a max of 25%
• Interest on tax not collected and remitted: average of 7-9%, but some go as high as 18%
• Penalties for multi-year non-compliance: up to 40%

As you can see, a hefty back tax bill builds up quickly. And it can get worse.

Can long-term non-compliance lead to lawsuits and civil penalties?

If a business fails to collect tax in states where it triggered nexus over the long term, it may face civil penalties. It's an even bigger issue if a company collects tax but doesn't pass it on to the state. That counts as civil fraud at a minimum, and possibly criminal fraud.

Some companies stay non-compliant for several years. They make no effort to fix the issue or don't respond when the state tries to set things right. These companies can end up being served and sued. If this happens, penalties can be as much as three times the tax bill in damages, on top of the total back taxes.

Companies also need to think about the bottom line. If accountants are doing their jobs well, unpaid SUT tax will show up as liability contingencies in financial reports and audits. These liabilities can lower a company’s valuation and make it less attractive to potential investors.  We cover this in more detail in Contingent Liabilities and Wayfair: The Impact on SUT and Audit Teams.

What is the best path forward?

As you can see, SUT non-compliance is no joke. With so many unwelcome outcomes possible, every business should understand its nexus obligations. It should submit VDAs where they apply, as soon as possible, to limit the damage. Then it should move forward with a solid compliance plan.

For some, this may mean adjusting prices to leave more room in their margins and stay profitable. Others may make other changes to cut overhead, so they can absorb higher costs without hurting their bottom line.

Whatever a business’s situation is today, setting up and maintaining compliance is the only way to ensure long-term success. Your firm can help by offering SUT advisory services and proactive nexus studies. You can also identify key areas of risk, offer compliance scores and help clients take every step needed to meet their sales tax obligations.

This can include managing state registrations, filing VDAs and negotiating reduced penalties with the state on your client's behalf. You might even offer audit support if the client comes to you after the damage is already done. Related reading: Accountant Checklist: Determining the Best Application of a VDA.

How Taxually handles this

Taxually’s LumaTax runs a nexus analysis on your sales, helps you register in the states where you must collect, and prepares and files multi-state sales tax returns, including Canadian GST/HST. LumaTax is currently available to enterprises and accounting firms. For the full workflow, read how to automate US sales tax filing in every state.

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