By: Liz Armbruester
COVID-19 defined 2020 and will strongly influence 2021. Everything from learning to shopping to working was dramatically changed as the pandemic set in. But, what about the changes to tax compliance? While it may be too soon to tell what changes are to come for sales and use tax, it’s hard to ignore the impact the pandemic has had on state and local governments this year. Revenues have declined in most states and the longer the pandemic lasts, the more pressing it will be for states, cities, and counties to balance their books.
As we move into 2021, here are two trends in tax compliance that small businesses should be aware of as they plan and adjust their strategies.
Taxability may expand to exempt goods and services
While it’s highly unlikely that states will add to the economic burdens of taxpayers by raising sales tax rates, there is the likelihood that states could expand their tax base to drive new revenue streams. Some of the products and services that have been in high demand throughout the pandemic, like groceries and digital goods, are currently exempt in many states. However, broadening the tax base to include traditional tax-exempt goods and services can be a less regressive tax policy move for states to recoup revenue losses.
We’ve already seen attempts by several states to expand their tax base. Facing significant budget woes due to the pandemic’s impact on key industries, the state of Wyoming attempted to put a tax on groceries, but the bill was voted down immediately. On the digital services front, Maryland, Nebraska, New York, and Washington, D.C., all proposed new taxes on digital advertising services in 2020.
For small businesses carrying tax-exempt goods and selling tax-exempt services, it will be important to monitor for similar legislation in 2021. Due to the widespread nature of digital advertising and other services, as well as the regularity of grocery, expanding the tax base could provide a source of much-needed revenue for governments.
Unregistered online sellers could face penalties
According to McKinsey,10 years’ worth of U.S. ecommerce adoption was compressed into three months in 2020. As a result of this ecommerce acceleration, more small businesses are actively engaging in online sales. While digital commerce has offered small retailers a reprieve to continue reaching customers amid restrictions and shutdowns, it also comes with a hefty tax burden.
More than 43 states, the District of Columbia, and some local governments in Alaska now tax remote sales via economic nexus, meaning the connection that creates a tax obligation (nexus) for a business is based on sales or transaction volume rather than physical presence. To date, we’ve seen many states observe an unspoken grace period for the enforcement of these laws, but as revenues dry up governments are under pressure to increase audits as soon as possible.
Small online sellers are ideal targets for economic nexus audits because many are unaware of the laws or that they have created new obligations through sales. And, due to the rapid nature of ecommerce expansion in 2020, the likelihood that sellers are unaware of new obligations or are missing correct registrations is heightened. Some states have already drawn a line in the sand when it comes to enforcement. In October 2020, Kansas Revenue Secretary Mark Burghart said the department intends to go after non-compliant remote sellers, starting with large sellers before moving on to small sellers.
For small businesses selling online, understanding economic nexus laws and any obligations they may have will be essential in 2021 to avoid audit penalties and disruptions to customer service. Managing the myriad of tax laws across the U.S. can quickly become overwhelming, so tax automation solutions will likely be a critical tool for small businesses to manage tax compliance.
Effective tax compliance will have a direct impact on small businesses in 2021 as they expand their online presence and governments work to drive revenue through sales tax. Small businesses that enlist the support of tax technology will spend less time managing tax without compromising the accuracy needed to comply.