Why should small business owners care about sales tax?

As a small business owner, you have a big to do list. Pretty far down on that list (if it is even there) is making sure that you are meeting your sales and use tax obligations. The world of sales and use tax can be confusing (even for those of us who work exclusively in the field). This is why the issue of sales tax makes people cringe. How does a small business owner make any sense of it? It doesn’t seem possible. But taxes are unavoidable, and the consequences of messing them up, potentially catastrophic to your business. Doesn’t it seem like the issue of understanding and compliance – where tax is concerned – should be higher up on your list?

sales tax for small business

The answer is a resounding YES. If you are selling anything (not just tangible goods) sales tax is something you need to be familiar with. If you don’t collect it when you should, the state could come after you. With the average sales tax rate over 8%, a tax error could totally wipe out any profit you have on the sale. And you certainly don’t want to collect it when you shouldn’t; this can get you in different trouble – either with the state or your customer.

How sales and use tax effects your customers

So, how do you begin to untangle the complicated issue of sales tax? The first step is to really understand how your business is impacted. The impact of sales tax on your business is driven by the nature of what you are selling. To illustrate this, I thought it would be easier to think about it from the perspective of the consumer:

Purchasing in the store

Let’s say you need to purchase a copy of QuickBooks — a fairly typical purchase for a small business owner. There are many ways to purchase QuickBooks, and all of them result in very different sales tax outcomes. But let’s start with the basics. If you walk into a Best Buy store and purchase a physical copy of QuickBooks, every state (that charges sales tax) is going to tax it the same way. That physical copy is tangible personal property and, as such, sales tax will be charged on it at the store.

Purchasing online

That’s straight forward enough. Now, let’s say instead of going to a store, you purchase QuickBooks online (it is 2014, after all), download it and install it on your computer. In some states, such as California and Florida, this purchase would not be subject to tax. On the other hand, states like Illinois don’t make a distinction, and the online purchase of QuickBooks would be subject to tax. As you can see, making this purchase online instead of in a physical store could reduce your cost depending on the state. Figuring out if this purchase is taxable or not has just become a little trickier.

Purchasing in the “cloud”

We’ll take it a step further. Let’s say that instead of purchasing QuickBooks in-store or downloading a copy online, you use their “cloud” offering. In this case, you are using QuickBooks online on their servers without having downloaded anything to your computer. The way this transaction would be treated also varies from state to state. Since nothing was “delivered”, some states treat this as a service.

small business sales tax

Examples and scenarios

Now let’s look at each of these QuickBooks purchases across different states. In Kansas, the in-store purchase would be taxable. And, if the software was downloaded and installed on a computer, that purchase would be taxable in Kansas as well. However, if you paid to use QuickBooks in the “cloud,” the purchase would be exempt since Kansas exempts cloud services.

In South Carolina, the in-store purchase would be taxable. However, if the software was downloaded and installed on a computer, that purchase would be exempt in South Carolina. And if you paid to use QuickBooks in the “cloud,” the purchase would be taxable since South Carolina taxes cloud services. Confusing, yes? Does it make sense? No. But this is tax, and this is what happens, especially when there are different states involved.

To throw in one last wrinkle, there are states that tax the purchase of software (such as QuickBooks) based on where the software is installed. In most states, if the software is downloaded, it is taxed at the location of the user. If the software is purchased as a hard copy, it would be taxed at the location where you purchased it. But when it is a cloud service, then it might be taxed based on the location of every user logging in!

How sales and use tax affects your small business

sales tax and small businessLet’s switch perspectives now. If you are in a “service” business — like a graphic designer — what you charge for and what you deliver can result in differences in sales tax, like the examples we just saw. If you create a design for a client and deliver it via email, many states would consider this an intangible. But, create storyboards and charge them for the boards? You just sold them tangible property and that is taxable. What if you are a computer consultant? If you are consulting on 3rd party software, that might be considered a professional service. But if you created your own application and are selling it to multiple people, you are licensing or selling canned computer software. And those rules that apply to Quickbooks would also apply to your software.

We hope we haven’t overloaded you with sales tax information. We wanted to demonstrate that knowing when and how sales tax applies can be very tricky. What we’ve outlined above is just one example, and a simple one at that, but the same idea applies to most any company: as a small business owner, what you sell and how you deliver it will affect the taxability. Knowing the different tax scenarios and applying tax correctly is crucial to your business’s success.

Don’t leave your business open to tax liability! Take the first step toward understanding the basics of sales tax.

Learn more on how sales and use tax affects your small business

Diane will be presenting on this topic and much more at the Sales Tax Institute’s “Sales Tax 101” webinar on February 20. This webinar was created specifically for anyone who needs help understanding sales and use tax. We’ll discuss the above and other issues such as important sales tax terms you should know, sourcing (which jurisdiction gets the tax) and exemptions at the webinar. For more information and to register for the webinar, click here.

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About the author

diane yetterDiane L. Yetter is a strategist, advisor, speaker, author and expert witness in the field of sales and use tax. She founded The Sales Tax Institute, a premier think tank that offers live and online courses to educate business professionals about sales and use tax.  Named one of Accounting Today’s 100 Most Influential People in Accounting for 2011 and 2012, she is a sought after speaker and has authored three books and numerous articles on the subject of sales tax and use. Find her on Twitter.





Photo credit: Alan Cleaver,  LendingMemo,  kenteegardin

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Comments

  1. Because tax rules and regulations change from year to year, and knowing that many small businesses have a limited staff on hand to become knowledgeable of these changes – sometimes it is easier to outsource some of your financial processes to make sure you have all of your bases covered. Utilizing an outsourced financial services firm, you are gaining the knowledge base of a whole group of people who specialize specifically in these financial matters. This way you ensure that you are making all of the right calculations and filing all the right paperwork to stay in compliance.

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