Tech entrepreneurs and company leaders are often so laser-focused on company growth that sales tax is not top-of-mind. But since the 2018 Wayfair decision – a ruling that allows states to impose sales tax obligations on companies with economic presences – many technology companies still disregard an important tax obligation, leading to costly and complicated compliance situations.
Join leaders of Cherry Bekaert’s Sales Tax team for a short series that will focus on important issues affecting your technology company. Tax Partner Megan Hutchinson moderates the first episode as Lauren Stinson, Sales & Use Tax Leader, and Don King, Indirect Tax Director, cover these areas and more on:
- Taxability considerations for technology
- Sourcing challenges
- Impacts on M&A transactions
Listen to the rest of our series:
- Episode 2: Sales Tax Best Practices for Technology Sellers
- Episode 3: Three State and Local Tax Issues Tech Companies Need to Address Now
- Episode 4: State Credits & Incentives Your Tech Company Should Take Advantage Of
Other relevant insights:
- Sales and Use Tax: Technology and the Evolving Definition of Sales Tax Nexus
- Why Growing Tech Companies Need a Sales Tax Strategy Now
- Addressing Technology Companies’ Sales Tax Exposure in the Acquisition Process
HOST: Cherry Bekaert's technology podcast. I'm Megan Hutchinson, a tax partner in Cherry Bekaert's Technology Group. Today we have Lauren Stinson and Don King from our sales and use tax practice.
LAUREN STINSON: I'm Lauren Stinson. I am a tax partner in our sales and use tax group, and I lead our sales and use tax practice.
DON KING: I'm Don King. I'm Indirect Tax Director in the Nashville office. I recently joined Cherry Bekaert about three months ago and spent the last 11 years in technology.
HOST: Today we will be talking about what technology companies could be missing with their sales and use taxes. Lauren, can you start by setting the stage and giving an overview of the issues technology companies face when it comes to sales and use tax?
LAUREN STINSON: The Wayfair decision was a U.S. Supreme Court decision in 2018 that allowed states to impose sales tax obligations on companies not only if they had a physical presence in the state but also if they had an economic nexus or economic presence in the state. If a company sells enough into a state, and each state defines "enough" differently, it can have sales tax obligations.
Many technology companies are aware Wayfair exists but may not be doing anything about it because they focused on rapid growth rather than profitability. Now we're seeing companies confront sales tax obligations, especially during due diligence or when preparing for a transaction.
DON KING: Nexus is one of the first places to start. The Quill decision in 1992 identified that physical presence causes nexus. Physical presence can include property in a state, employees in a state, or company-owned trucks operating in a state. Physical presence required registration, collection, and remittance of sales tax on taxable items.
Wayfair expanded nexus in 2018 to include economic presence. Many states set thresholds, such as $100,000 in sales or 200 transactions per year, that create economic nexus. Larger states like California and New York may have higher thresholds, for example $500,000. Each state defines its thresholds for economic presence.
As you expand sales into different states, you can generate nexus. States are aggressive about registration and collection because they prefer to collect tax from one company rather than thousands of customers. Remote workers create a similar issue: employees located in different states can create physical nexus. You must determine where you have a filing responsibility and how far back that responsibility goes—did you have nexus three or four years ago, or did it start more recently?
Physical nexus will always trump economic nexus. If you have physical nexus—meaning an employee in the state—you will have sales tax obligations even if you do not meet economic thresholds. Physical presence remains a primary consideration.
HOST: Many technology companies get confused about sales tax because they associate it with tangible goods. A lot of technology companies sell intangible products and services. How do you determine which products are subject to tax and in which state for technology companies?
DON KING: We spend a lot of time helping technology companies define exactly what they're selling. Products and services have evolved rapidly, and tax laws are often five or ten years old and don't clearly define modern offerings. The challenge is fitting new products into older tax law.
We review contracts at a granular level to determine what a product does and how it's delivered. Different tax laws apply to electronically delivered software, SaaS, and licensed software. There are many distinctions that affect taxability.
One example is a digitally delivered book. Many states tax digital products and treat them differently than software. A digital book that simply lets you click to a page or save your place is often considered a digital product. If the product allows you to change the story based on interaction or criteria, it can be considered software. A video game is a clear example of interactive software. Those distinctions can change taxability across states.
There are also differences between streaming and downloading, and between subscriptions and outright sales. Each state's rules vary, so you must analyze taxability in all 50 states.
HOST: Sourcing revenue is another challenge. How do companies determine sourcing for tax purposes?
DON KING: Sourcing is always a challenge. For physical products, sourcing is generally based on where the product is shipped to—the customer's shipping address. Some rules may consider the ship-from location, but destination sourcing is the general rule for tangible personal property.
Digital products are more complex because you may not know where the customer is physically located. The customer's address is the general rule for sourcing, but some states try to use IP address or billing address to determine location. States may assert that the benefit of the service is received in their state, while other states may assert the opposite.
There are tools like MPU, multiple points of use, which can help companies with employees located across the United States. Companies may purchase software based on headquarters or billing address while employees in multiple states use it. Some states allow allocation based on user locations or usage, enabling companies to source transactions proportionally to where use occurs.
HOST: Digital sourcing also raises proof issues, especially when selling direct to consumers online. Shopping carts may not collect a proper ZIP code needed to source the correct rate, and ZIP codes can span multiple taxing jurisdictions.
DON KING: A ZIP code example is instructive. Two locations a mile and a half apart can be in the same ZIP code but different taxing jurisdictions. Without the correct address, technology platforms may not know which rate to charge. That impacts audits and customer service.
If you have the wrong address or cannot determine the correct taxability or tax rate, you face two problems. First, auditors may assess tax liabilities. Some local jurisdictions, such as in Colorado, attempt to apply local rates to entire ZIP codes, which can lead to overlapping claims and potential liability in multiple cities. Second, customers will complain if you overcharge them, causing consumer services issues. If you undercharge, auditors will flag it later.
HOST: We have just scratched the surface of how complex sales and use tax is for technology companies.
LAUREN STINSON: Thank you.
DON KING: Thank you.
HOST: Thank you.
