As we predicted at the beginning of last year, 2022 brought heightened enforcement and increased sales tax audit activity for remote sellers and all sellers. Heading into 2022, sales tax experts, this author included, were predicting that states were ready “to [start] being fairly aggressive in their enforcement against existing online sellers.” [Forbes, Sales Taxes in 2022 – Issues to Watch for Online Retailers, by Liz Farmer (November 30, 2021)]. Not only did Dillon Tax Consulting represent taxpayers in more sales tax audits than in any prior 30 years of my experience in multistate sales tax, but the states were far more aggressive in their pursuit of additional revenues than in previous experiences. So what are some of the reasons for this, and why do we predict that it will continue in 2023?
2023 – Expect this to also be the Year of the Sales Tax Audit
more sales tax audits [in 2022] than in any prior 30 years of my experience in multistate sales tax
It has been 4 ½ years since the U.S. Supreme Court’s landmark decision in in South Dakota v. Wayfair, which enabled states to require remote sellers with no physical presence in a state to collect sales tax on sales of taxable products and services delivered to customers in that state. Since then, every state has adopted an economic nexus threshold, through which a remote seller’s sales now establish sales tax nexus. In this time, states also adopted marketplace facilitator provisions, under which they require marketplaces that meet the definition of a “marketplace facilitator” or marketplace provider to collect and remit sales tax on behalf of all sellers transacting business with customers in the marketplace. In the absence of physical presence, economic nexus provisions adopted by states impact a qualifying marketplace facilitator’s sales tax compliance obligations as well. States typically ramp up sales tax audit activities against an impacted group of taxpayers three (3) to four (4) years after adopting a change affecting that impacted group. This is because the typical statute of limitations for auditing registered taxpayers is 3 to 4 years.
States continue to expand their laws and interpretations of existing law to impose sales tax on software and digital products (goods and streaming services). Software and platform-based services continue to expand and become more ubiquitous for commercial and residential consumers. Sales tax laws have always lagged well behind technology. The nature of this technology makes it difficult to define or put into a specific sales tax classification. So, as states struggle to define these evolving technologies, taxpayers struggle to understand their obligations relative to their purchase and sale.
States also continue to interpret what it means to be a marketplace facilitator. As noted above, if a marketplace is deemed to be a marketplace facilitator, it is responsible for the collection and remittance of sales tax on all sales transacted on its marketplace platform. Third party marketplace sales are projected to account for 59% of all global ecommerce and 38% of all global retial sales growth by 2027. [see Edge by Ascential, 2022 Future of Marketplaces Report, by (Nov 17, 2022); see also, Marketplaces, “Third-party marketplace sales to account for 59% of all global ecommerce by 2027”, by Paul Skeldon (27 Jul 2022). States adopted these marketplace definitions in an effort to “cast a wide net” and ensure that companies such as Amazon and eBay would be required to collect and remit sales tax on all sales transacted on their platforms. However, the unintended consequence is that neither states nor marketplaces are confident as to what constitutes a marketplace facilitator or whether marketplaces are meeting their obligations relative to their platform’s sales.
In 2022, we experience increased audit activities from states (in particular Texas, Illinois, Wisconsin, New York and D.C.) around these issues, and we expect this to continue. As such, 2023 is also the year in which state sales tax audit divisions will contact registered taxpayers to verify compliance, and to verify that taxpayers registered when they first triggered economic nexus in the state. Many taxpayers registered in several states subsequent to crossing the states’ economic nexus threshold – most typically because they adopted a “wit and see” approach to see what competitors would do, or what would come of the post-Wayfair landscape, or due to sheer ignorance of these obligations. State sales tax auditors see this as “low-hanging fruit”, that they can pluck simply by verifying that the taxpayers’ sales tax account start dates are accurate relative to sales and the economic nexus threshold.
States also see the audit as a means of verifying that taxpayers’ exempt sales (eg, sales for resale, sales to exempt entities) are supported by valid exemption certificates. This typically proves problematic for parties to drop-shipment transactions, either because they lack documentation, or they lack the appropriate resale certificates acceptable to the state on audit.
it is critical for sellers to routinely monitor their sales to ensure that they are properly coded as taxable
As states continue to expand their sales tax base – particularly through informal policy changes and interpretations of existing laws – it is critical for sellers to routinely monitor their sales to ensure that they are properly coded as taxable. This is particularly true for sellers of digital goods and services and Software As a Service (SAAS), such as online subscription-based gaming, information and website platform-driven consumer tools. In addition, as more businesses have permitted employees to work from home during the pandemic, or have hired employees in additional states - even those employees in a non-sales, administrative capacity - these companies have unintentionally expanded their sales tax nexus footprint, necessitating the need for increased sales tax compliance.
It is imperative that companies proactively seek the regular guidance and input of experienced sales tax professionals, not only to ensure that they are registered in each state in which they have nexus, but also to ensure that they are compliant with the ever-changing sales tax laws. Companies should routinely review their sales tax nexus, sales tax decision matrices, sales tax automation mapping, certificate management, and proactively address historical compliance gaps to minimize sales tax audit exposure risk.