8 Common Sales Tax Mistakes and How to Avoid Them

Understanding and managing the complexities of sales tax is a fundamental part of running a business. Whether you're a small business owner or part of a larger corporation, understanding how to handle sales tax correctly can save your company from costly errors and potential legal troubles. In this blog post, we'll explore eight common sales tax mistakes and provide practical tips on how you can avoid them, ensuring your business remains compliant and efficient.

1. Misclassifying taxable and non-taxable items

One of the most frequent mistakes businesses make is incorrectly classifying items as taxable or non-taxable. Sales tax laws vary by state and even by locality, making it essential to know which products and services are subject to tax. Misclassification can lead to either under-collecting sales tax, which can result in significant liabilities during an audit, or overcharging customers, which can harm your reputation and customer relationships.

How to avoid it:

• Research state and local tax laws: Regularly review the tax laws for each jurisdiction in which you operate. The rules may differ for physical goods, digital products, and services. Tax exemptions often apply to specific categories, and understanding these exemptions is crucial for accurate sales tax management.
• Consult a tax professional: A tax expert can help you correctly categorize your products and services, reducing the risk of misclassification. They can also provide insights into complex tax nexus scenarios, where different states may interpret the taxability of items differently.
• Use tax software: Invest in automated tax software that updates tax rates and classifications in real-time, ensuring accurate taxation. Modern tax management systems can help mitigate the risk of human error, automatically applying the correct tax rates and exemptions based on product type and location.

2. Failing to register for sales tax in all required jurisdictions

Businesses must register for sales tax in every state or locality where they have a tax nexus—a physical or economic presence that obligates them to collect sales tax. Failing to register properly can result in penalties, interest charges, and back taxes. With the expansion of e-commerce, understanding where your business has a tax nexus has become more critical and complex.

How to avoid it:

• Identify your tax nexus: Determine where your business has a nexus, whether through a physical location, employees, or substantial sales. The concept of tax nexus is pivotal in sales tax management, and failing to recognize it is a common tax mistake that can lead to significant financial consequences.
• Stay informed about economic nexus laws: Economic nexus thresholds differ by state, typically based on sales volume or the number of transactions. Monitor your sales in each state to ensure compliance. With the Wayfair decision, even small businesses must be vigilant about economic nexus, as surpassing a state's threshold can trigger a sales tax filing requirement.
• Register promptly: Once you establish a nexus, register with the relevant tax authorities to begin collecting and remitting sales tax. Timely registration is essential to avoid penalties for late filing and non-compliance with state sales tax laws.

3. Incorrectly calculating sales tax

Sales tax calculation errors can occur due to incorrect tax rates, the wrong application of tax rules, or simply human error. Such mistakes can lead to either undercharging or overcharging customers. Incorrect calculations not only affect your bottom line but can also result in fines during an audit.

How to avoid it:

• Utilize updated tax rate tables: Ensure that your point-of-sale systems and invoicing tools are using the latest tax rates for each jurisdiction. Tax rates change frequently, and failing to update your systems is a common tax mistake that can lead to significant discrepancies in sales tax collections.
• Automate calculations: Implement tax software that automatically calculates sales tax based on the location of the sale and the type of product or service. This automation can help prevent errors, especially in businesses that operate across multiple states with varying tax laws.
• Conduct regular audits: Periodically review sales transactions to check for calculation errors and make necessary adjustments. Regular audits are a critical aspect of tax management, ensuring that your business remains compliant with current tax laws and regulations.

4. Neglecting to collect sales tax on online sales

With the rise of e-commerce, many businesses overlook the obligation to collect sales tax on online sales, especially if they sell across state lines. Since the Supreme Court’s decision in South Dakota v. Wayfair, Inc. (2018), states can require online sellers to collect sales tax even without a physical presence. This ruling has significant implications for businesses of all sizes and makes understanding and complying with sales tax regulations more difficult.

How to avoid it:

• Understand economic nexus laws for online sales: Familiarize yourself with the sales thresholds in each state where you have customers. Ignoring these thresholds is a common tax mistake that can lead to unexpected liabilities and penalties.
• Implement sales tax collection for online transactions: Use e-commerce platforms that support automated sales tax collection based on the buyer’s location. Many e-commerce solutions now offer built-in sales tax management features, helping to ensure compliance with varying state laws.
• Monitor changes in legislation: Stay updated on changes to online sales tax laws to ensure ongoing compliance. Tax laws are constantly evolving, and what is compliant today may not be tomorrow. Regularly reviewing legislative changes is a key part of effective tax management.

5. Filing sales tax returns late

Filing sales tax returns after the deadline can result in fines, interest on unpaid taxes, and other penalties. Each state has its own filing schedule, and missing a due date can be costly. Late filing is a common tax mistake that can easily be avoided with proper planning and organization.

How to avoid it:

• Set up reminders: Use calendar alerts or tax software to remind you of upcoming sales tax filing deadlines. These reminders are essential for businesses with complex tax obligations in multiple states.
• File early: Whenever possible, file your returns well before the deadline to avoid last-minute errors and technical issues. Early filing also provides a cushion if any issues arise that require additional time to resolve.
• Consider outsourcing: If managing filing deadlines is challenging, consider outsourcing your sales tax management to a third-party service provider. Outsourcing can help ensure compliance and avoid the pitfalls of late filing, particularly for businesses that lack in-house tax expertise.

6. Failing to keep accurate records

Inadequate record-keeping can lead to significant issues during a sales tax audit. Missing or inaccurate records can result in an inability to substantiate your tax filings, leading to penalties. Keeping accurate and detailed records is a cornerstone of good tax management.

How to avoid it:

• Maintain comprehensive records: Keep detailed records of all sales, including invoices, receipts, and tax-exempt sales certificates. Accurate record-keeping is essential for defending your business in the event of a tax audit.
• Digitize documentation: Use digital storage systems to organize and back up your sales tax records, making them easily accessible during an audit. Digital records are not only easier to manage but also more secure and less prone to loss or damage.
• Review records regularly: Regularly audit your records to ensure they are complete and accurate, and resolve discrepancies promptly. Consistent review of your records helps catch and correct errors early, preventing them from becoming significant issues later.

7. Not understanding tax exemptions and exemption certificates

Certain sales may be exempt from sales tax, such as sales to non-profits or government entities. However, failing to collect and store valid sales tax exemption certificates can leave your business liable for uncollected taxes. Understanding tax exemptions and managing exemption certificates is crucial to avoid costly tax filing mistakes.

How to avoid it:

• Learn about exemptions: Educate yourself about the types of transactions that qualify for tax exemptions in the states where you do business. Misunderstanding or overlooking exemptions is a common tax mistake that can lead to unexpected tax liabilities.
• Collect valid exemption certificates: Ensure that you obtain and validate exemption certificates at the time of sale, and store them securely. Proper management of exemption certificates is an integral part of sales tax compliance, helping to substantiate exempt transactions during an audit.
• Review exemptions periodically: Reassess your exemption status regularly to ensure continued compliance. Periodic reviews can help identify any changes in exemption status, preventing issues during audits and ensuring that your business remains compliant.

8. Overlooking use tax obligations

Use tax is a complementary tax to sales tax, owed when sales tax has not been paid on taxable items purchased for use in a state. Businesses often overlook use tax obligations, leading to unexpected liabilities. Understanding and accounting for use tax is an important aspect of comprehensive tax management.

How to avoid it:

• Understand use tax rules: Familiarize yourself with use tax laws in your state, especially if you purchase goods or services from out-of-state vendors. Overlooking use tax obligations is a common tax mistake that can result in significant liabilities during an audit.
• Account for use tax: Set up internal procedures to track purchases where use tax may be applicable and remit the tax accordingly. Proper accounting for use tax helps prevent underreporting and ensures compliance with state tax laws.
• Consult a tax advisor: If unsure about your use tax obligations, seek guidance from a tax professional to avoid errors. A tax advisor can help you understand complex use tax rules and develop strategies to ensure compliance.

Conclusion

By paying attention to these common tax mistakes and implementing strategies to avoid them, your business can navigate the complexities of sales tax compliance more effectively. Proper tax management, including understanding tax nexus, accurately classifying taxable items, and staying up-to-date with tax exemptions, can save your business from costly penalties and help maintain a good standing with tax authorities.

Do you need help with your sales tax compliance? Book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.