Administering the Sales Tax
Background
Collecting (and not Collecting) the Sales Tax
Administrative Burdens of the Sales Tax
a. Simplifying the Sales Tax
b. Local Sales Taxes
c. Collecting Sales and Use Tax for “Other” States
d. Records and Deposits
e. Overpayments and Refunds
f. The Role of “Tax Collector”
g. State Tax Audits
Final Comments
Background
The sales and use tax produced $165 billion in revenues for states and another $35 billion for localities in 1999. Forty-five (45) states levy a sales and use tax. In addition, 30 states allow localities to levy their own. Despite its size and pervasiveness, two recent developments have focused particular attention on the tax. The first is Internet sales (retail) and the concern of many state (and local) officials that their current tax status will cause states to lose a substantial portion of their sales and use tax revenues. While “e-tailing” accounts for only 1 percent of retail sales, officials remain worried. Many states have responded by entering into the Streamlined Sales Tax Project, essentially a collaborative effort to draft model state legislation to simplify and standardize collection procedures. They hope a successful model will increase compliance and encourage the federal government to allow states to collect sales taxes on now exempt (for all intents and purposes) interstate sales. The second development involves the continuing search for a consumption-based Federal tax system. Many believe that the current Federal income tax is a significant disincentive for savings and investment. One of the alternatives proposed is a Federal retail sales tax; a variant is a Value Added Tax (VAT). Each in its own way raises issues of administrative burdens and complexities that are part of these taxes. Any sales and use tax in principle should be simple to administer. But in practice, it is notably more complicated than seems necessary. Some sales are subject to the tax and some are not; some sales are taxed at one rate and others at another rate; some sales are taxed if used for one purpose, but not taxed if used for a different purpose; some people and organizations have to pay the tax and others do not; some must add local tax and its requirements to the state tax and its requirements while others only worry about the state levy. And there are record-keeping issues, deposit issues, etc., none of which are incidental to operating a business. These complications have often been a source for small-business owner aggravation and complaint. As a result, this issue of the National Small Business Poll focuses on small business Administration of the Sales Tax.
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Collecting (and not Collecting) the Sales Tax
Almost three in five (58%) small-business owners have at least some of their sales subject to a state sales tax (Q#1). (Owners in states without a sales and use tax were not included in the survey and are not included in published totals.) Retailers pay the tax almost universally and the two survey cases who report they don’t probably misclassified the “industrial sector” of their firms. But retailers are not the only small-business owners administering the tax.
Over 60 percent of contractors, a majority of manufacturers, and over 40 percent of those in the narrowly defined services collect sales tax on at least some of their sales. Owners with firms in the financial services are least likely to do so.
The owners who pay a sales tax, the average firm collects the tax on about half of his sales. But the average disguises a wide variation. Almost one-quarter (24%) collect the tax on all sales. Sixty-one (61) percent collect it on less than 75 percent of sales and 39 percent collect it on less than 25 percent of sales. Fifteen (15) percent say that they collect sales tax, but would not venture a guess on what percentage of sales. Even among retailers who primarily sell taxable goods, just one-third indicate that they collect the tax on all sales though half say that they collect it on more than 80 percent of them.
The reason for these collection levels, of course, is that every sale is not taxable. For example, the taxable sale of a product may also have a non-taxable installation charge on the bill. Or, a hammer sold to a consumer is taxable where the same hammer sold to the city’s roads department is not. Retail now comprises just over 20 percent of the small employer population.
Almost twice as many non-retail firms collect the tax as retail firms. Despite the fact that retailers charge the tax on a greater share of their sales than do others, administration of the sales and use tax is not solely a matter for retailers. In fact, an argument can be advanced that administrative problems are relatively more difficult for those who have less familiarity and/or experience with its operation. Any administrative burdens associated with collecting the sales tax therefore extend beyond the retail sector into other industries.
In contrast, 42 percent of small-business owners indicate that they do not collect the sales tax on any of their sales (Q#1). Most never have. In fact, just 5 percent of those who do not now do so, collected it at some point within the last five years (Q#16). The survey contains no information on the business change(s) that allowed their migration from collecting the tax to not collecting it.
The primary reason (54%) that these owners do not collect sales tax is that they sell exempt services (Q#14). Another 18 percent indicate that they do not do so primarily because their sales are to non-end- users such as other businesses. The remainder scatter their primary reason among a variety of other causes. However, sales outside the state’s jurisdiction, either to residents outside their states or abroad, is offered as the primary reason by less than 5 percent of those who do not collect it. These latter data suggest that sales tax revenue lost to cross-border sales is relatively small compared to the variety of other exemptions, at least among small businesses.
Another 3 percent say they sell to governments and/or non-profits. About 20 percent either responded “other” or did not offer a response. The relatively large number in this category could result from several factors including the lack of a single “primary” reason.
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Administrative Burdens of the Sales Tax
Despite frequent, bitter complaints, many owners subject to the tax do not believe that administration of the sales tax under current circumstances is a difficult business problem. Just 4 percent term administration of the tax a “serious business problem” though 23 percent term administration of the sales and use tax a “continuing hassle” (Q#2). Most rank it lower in their hierarchy of business problems. Twenty-five (25) percent consider it a “minor annoyance” while 39 percent of those subject to the tax say that they have “no real problems” with its administration.
Little appears associated with those more or less concerned about administration of the sales tax. The percentage of taxable sales is not related nor is the owner’s education level nor is years in business, i.e. experience. Industry generally is not related either, though owners of retail and service operations are slightly less concerned and others slightly more. Those in the West complain about the problem substantially more than those in other regions. Yet, nothing appears to distinguish administration of the sales tax in the West from its administration elsewhere in the country.
Though the level of general concern appears low, a majority believe the tax could be made easier to administer. Thirty (30) percent say that it could be made “a lot” easier and 24 percent say it could be made “a little” easier (Q#3). Thirty-nine (39) percent do not believe the tax’s administration could be simplified.
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a. Simplifying the Sales Tax
Small-business owners splintered when asked to identify specific items or means to ease administration of the sales tax. Twenty-nine (29) percent could not offer a specific issue (Q#4). The most frequently named was inconsistent tax rates (11%). Eight (8) percent identified “intended use” issues as did the number who just said “simplify.”
Seven (7) percent each mentioned greater uniformity of items taxed and payment schedules. Other suggestions, such as provision of software and on-line filing, were also voiced. However, when presented a series of potential administrative difficulties, respondents reacted more decisively.
Prompted with specific potential issues, small-business owners found much that they think could be improved. The first issue posed was different tax rates on different goods or services. For example, one item might carry a 5 percent tax and another item might carry a 3 percent tax. Thirteen (13) percent of those who believe that sales tax administration can be made easier say that different tax rates on different taxable goods or services creates “a lot” of administrative problems and another 16 percent say that it creates “some” problems for them (Q#5A). In contrast, 58 percent believe different rates do not cause a problem. The latter response can result from one of two reasons. The firm only sells goods that have a single rate; in that instance, differential rates hardly could be a problem. Or, there really is no particular burden. The data do not allow us to determine which is the more prevalent. However, differential rates, where present, tend to be confined to a limited number of items and therefore impact a limited number of businesses. As a general rule, sales taxes are levied on goods, but not on services. Even when that rule prevails, not all goods are taxed.
Food is an example of an item (a good) that often is exempt when sold as groceries for home consumption. In contrast, food prepared and consumed on the premises is almost always taxed. The distinction can blur on food heated in a microwave at a convenience store and eaten in the car. Differentiating between taxable and non-taxable items such as in the example above offers many potential administrative problems.
Twelve (12) percent of small-business owners report that distinguishing between
goods/services that are taxed and goods/services that are not taxed creates “a lot” of administrative problems for them and 24 percent more report that it creates “some” (Q#5B). In contrast 40 percent say that it creates no problems for them and 20 percent say that it creates only “a few.”
Exempt (and non-exempt) items therefore appear to create more problems than varying rates, though the reason may be their greater prevalence than any inherent administrative issue.
Some firms must tax everything they sell. They are not affected by exemptions. If these firms are removed from the calculation, the totals are quite different. Thirty-four (34) percent, instead of 12 percent, say that distinguishing between taxable and nontaxable sales creates a “lot” of administrative problems for them and another 23 percent say it creates “some.” Of those impacted, over half term it an administrative burden for them. These data underscore a very important point. An exemption can impact a greater or lesser number of businesses. The number affected will have a greater or lesser impact on the population’s total burden.
Modern cash registers help owners and their employees distinguish between taxable and non-taxable sales. Forty-one (41) percent report that they normally use pre-programmed cash registers or computers to differentiate between the two (Q#6). Presumably they do the same to distinguish between different tax rates on differentially taxed items. The drawback to this facility is that the owner still must know which items are taxable (and at what rate) and which are not in order to properly program the cash register. That procedure can be eased by clear, common-sense distinctions.
Still, almost 60 percent rely on other, generally non-automated, means to distinguish between taxable and non-taxable items. The second most frequently used
method is to tax everything. Twenty-two (22) percent say everything they sell is taxable so the potential problem does not arise for them. If nothing else, an across-the-board levy is the height of administrative simplicity. That still leaves two in five who depend on less formal methods. Eleven (11) percent rely on personal memory and 10 percent refer to special tables or lists.
Fourteen (14) percent report using other methods. The increasing use of “smart” cash registers (and scanning devices) will reduce the administrative problem over time, but these machines remain costly and the smallest firms will often not be able to justify them.
Not everyone pays sale tax. Non-profits are usually exempt. Similarly, non-end-users are usually not charged. Those residing in another state or country are also not subject to the sales tax (though the purchasers are almost always subject to the “use” portion of the tax in their state of residence).
That means the seller must determine, occasionally at the time of sale, who must pay the tax and who is exempt. Further, special records must be kept on these sales. Surprisingly, just 13 percent believe that such exemptions create “a lot” of problems and another 26 percent say that it creates “some” (Q#5C). However, another 13 percent believe it creates only “a few” while 45 percent do not believe these potential problems create difficulties for them.
Fifty-seven (57) percent of those who assert administration of the sales tax could be simplified indicate that they either have “a lot” of problems or “some” problems working with at least one of these three structural or exemption issues. Just 13 percent say that they have “a lot” or “some” difficulties with all three of them. In at least one sense, these numbers underestimate the burden because not all small-business owners face each situation.
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b. Local Sales Taxes
A variant of the potential administrative problems derived from different treatment of goods/services and people occur when a business is subject to different sales tax rules in different political jurisdictions. Initially, this issue raises questions about doing business in different states, but the more common problem appears to be local jurisdictions “piggy-backing” a local sales tax on the state’s. Thirty (30) states now have such local taxes. While piling sales taxes is obviously an issue for the states and their sub-units, it would also be an issue if the Federal government opted for a national sales tax.
Fifteen (15) percent of those who now collect sales taxes say the inter-jurisdictional differential creates “a lot” of problems and 22 percent say it creates “some” (Q#5E). However, if only those who claim to be subject to a local sales tax are included, 21 percent say the inter-jurisdictional differential creates “lots” of problems and 29 percent say it creates “some.” This result argues that when experiencing the piggybacked tax, the administrative burden becomes much greater than when dealing with the state’s version alone.
Forty-three (43) percent of small-business owners subject to a state sales tax are also subject to a local variant (Q#7). About half (45%) of those must collect sales tax for only one local jurisdiction (Q#7a). Thirty-four (34) percent claim that they must collect sales tax for more than one while 21 percent are not certain. Since most small businesses are single location entities, it is likely most of those also collect sales taxes for only one local jurisdiction. A small contractor is an example of an exception to that observation.
The degree of difficulty administering the two taxes simultaneously would appear tied to the similarity between the two. Similar structures should lead to easier administration than disparate ones. The most simple local sales tax would be a percentage add-on to the state’s, but that does not always occur. Affected small-business owners report that most local jurisdictions have sales tax rules and coverages that are close to their state’s. Nineteen (19) percent claim that local rules and coverages are “identical” for all intents and purposes to those operated by the state (Q#7b). Half (50%) believe that they are similar. But 17 percent say that the two are dissimilar or totally different. Fifteen (15) percent failed to make an evaluation. The number of cases does not permit comparison of the reactions among those who feel they are virtually identical and those who feel they are totally different.
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c. Collecting Sales and Use Tax for “Other” States
States are highly sensitive to any sales tax revenues foregone due to retail sales made to their citizens by entities lying outside their immediate jurisdiction. While the states should theoretically capture these revenues when their citizens voluntarily send a sales tax check to the Treasury for the goods they purchase (the use tax portion of the sales and use tax), virtually no one complies with the law and it is almost impossible to enforce. States therefore would like businesses outside their state to collect sales tax on items purchased by their citizens. Neither businesses nor the citizenry seem inclined to do that. So states lose revenue they otherwise would have had.
Catalogue sales created the issue, but over time and after court rulings it ebbed as a high-profile issue. Internet sales resurrected it. While those predicting a major erosion
of state tax revenues due to Internet sales now look foolish because only about 1 percent of retail sales occur over the Internet, the issue remains important to the states, symbolically and long-term, if not practically and immediate.
Six (6) percent of small-businesses are required to collect and file sales taxes in states other than their own (Q#8). The propensity is directly related to firm size. Seventeen (17) percent of those employing 20 or more people must collect it in more than one state. Just 5 percent of those employing fewer than 10 must. Larger firms are more likely to have multiple locations, and otherwise conduct business out-of-state. About half who say they must collect the tax for “another” state believe that it creates an administrative problem for them. However, many who report that they are not legally bound to collect taxes on out-of-state sales also say it is a problem for them (Q#5I). (Readers should recognize that the denominators in Q#8 and Q#5I are different.) That means a small percentage are collecting sales tax for other states, though they don’t feel legally obligated to do so. The interesting question is why they collect it. One likely answer is confusion over nexus issues.
Eleven (11) percent of those who pay sales tax on a portion of their sales say that they sell goods and services over the Internet (Q#9). That translates into about 7 percent of the entire population. The survey followed the question on Internet sales with one on the collection of taxes on sales made.
The Poll does not report data with fewer than 50 respondents and in this instance the number fell below (n=49). However, this limited number of cases suggests a wide variety of treatments. Most do not appear to levy sales tax. But some do for in-state sales only and others charge it on all sales. The data do not show whether the levy is a flat rate or varying by purchaser’s state, though the latter is doubtful.
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d. Records and Deposits
Sales tax collection records must be maintained and tax deposits made. One type of record that must be retained exclusively for purposes of the sales and use tax is exemption certificates and other paperwork showing the tax-exempt use of a product sold. A business would have no need to maintain such records without the existence of the tax.
Fourteen (14) percent say that maintaining these special records produces “a lot” of problems for their business (Q#5F). Another 22 percent indicate that it creates “some.” Still, the overwhelming majority have no problem with this paperwork. The reason may be that it is simply a minor ripple in the sea of mandated paper, or the reason may be that relatively few feel it necessary to maintain much of it.
Some states require that taxes be deposited with the government before sales are made, let alone before bills are collected from the customer. This means that small business must give the government a “free” loan. The Commonwealth of Virginia is an example of a recent transgressor. Small business is notoriously short of cash. Thus, these forced loans not only amount to a tax on a tax, but likely damage to the firm’s cash flow. Relatively few seem terribly concerned, however. Ten (10) percent say that the requirement creates “a lot” of problems for them and 22 percent say it causes “some” (Q#5G). One in 10 is a relatively small incidence and suggests only minor problems. Given the prominence cash flow issues occupy among most small businesses, the response suggests that relatively few small businesses are impacted.
The frequency of tax deposits can also become a cash flow issue. Yet, just 10 percent also say that the frequency of sales tax deposits causes them notable aggravation
(Q#5H). This view differs substantially by firm size. Those owning businesses employing 20 or more people are considerably more concerned. Sixteen (16) percent of this group report having “a lot” of problems with deposit requirements while 42 percent say that they have none. Smaller, small firms typically suffer more severe cash flow problems than larger ones. This suggests that those with larger liabilities are depositing more frequently on a relative basis.
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e. Overpayments and Refunds
Tax collectors are not usually tolerant of a firm’s failure to settle accounts on time. Penalties and interest almost always follow late payments/deposits. But there are times when sales taxes are overpaid and a small business needs to seek an adjustment or a refund. In these cases, the small-business owner would like expeditious, no hassle treatment in having his account reflect a positive change.
Eighteen (18) percent of small employers report that in the last five years they have requested a refund or sought an adjustment to current taxes due to a sales tax overpayment (Q#10). The primary reason (54%) for the overpayment(s) is a clerical error (Q#10a). However, unclaimed deductions for an unfulfilled transaction or a bad debt is responsible for overpayment 18 percent of the time. Tax paid on exempt transactions is responsible in 10 percent of cases. But whatever the reason for the overpayment, small-business owners frequently encounter difficulties getting the requested refund or adjustment.
Seven (7) percent report that requested change was “very” difficult to get while another 40 percent report that it was “somewhat” difficult (Q#10b). Thus, about half indicate that they had a problem correcting their overpayments. Most problems appear to center on adjustments, probably because it is the more frequently requested action. Just 4 percent claim to have difficulty with reimbursement for overpaid taxes (Q#5D).
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f. The Role of “Tax Collector”
There is no business interest in collecting sales tax revenues for government. A small-business owner therefore assumes the role of a tax collector and absorbs all of the costs and liabilities inherent. Some states compensate small-business owners for their time and expense by allowing them to retain a portion, usually a small percentage, of the taxes they collect. Nineteen (19) percent of owners collecting the tax claim that they can keep a specified portion to compensate them for the taxes collected (Q#12). While this financial consideration obviously helps small-business owners, most who receive it do not feel that the amount adequately compensates them for their costs. In fact, 42 percent assert that the retained revenues are “a lot less” than the costs of collecting the tax and another 27 percent say that it is “somewhat” less (Q#12a).
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g. State Tax Audits
There are several degrees of tax audit. Some are intensive where tax officials literally comb every pertinent record. Others are cursory in the sense that they may involve requests for additional documents or clarifications. The survey did not attempt to distinguish between them when it asked whether a state agency had audited the firm’s sales tax records. The response, however, suggests that states audit to some degree the sales tax records of a substantial number of small businesses.
Twenty-two (22) percent report that their sales tax records have been audited by a state agency in the last five years (Q#11). The likelihood varied by firm size. Forty-four (44) percent of those employing 20 or more say they had faced such a check while less than half that proportion did among those with fewer than 10 employees.
Even when a small business neither collects the sales tax nor is required to do so, tax enforcement officials can and do audit business records to ensure that these firms need not do so. Fifteen (15) percent of small employers who are not required to collect sales tax report that they have undergone such an audit in the last five years (Q#15).
Nearly one in four of those employing 20 or more people say the same. The frequency of audit is somewhat less among this population than reported by those who collect the tax. Still, it is not uncommon for those who are outside the sales tax system to undergo a sales tax audit.
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Final Comments
The sales tax is administered directly by well over half of the nation’s small-business owners even when those who operate in states without a sales tax are counted. While infrequently collected on all sales due to exceptions and non-covered sales, the tax’s administration represents a substantial undertaking by those affected. From afar, the principal administrative problem would appear to stem from the notable exceptions and exemptions within the structure of the sales tax. While these inconsistencies in the tax clearly cause problems for many small-business owners, the use of modern cash registers, the seemingly focused impact of the exemptions, and the generally clear dividing line between goods and services appear to mitigate the potential difficulties for many.
Arguably, the major administrative problem for small-business owners involving the sales tax occurs when more than one jurisdiction with more than one set of rules and rates are involved. The primary difficulty would appear to be inconsistencies (or other difficulties) generated by state and local sales taxes rather than generated by sales taxes in varying states. However, that is likely true only because so many more have multi-jurisdictional responsibilities associated with localities than with other states. It is also not clear if the multi-jurisdictional problems stem from different tax coverages (and rates) or from different procedures such as deposit requirements and dates. These results offer a note of caution to both those who would extend the sales tax to Internet sales and to proponents of a national sales tax. A similar tax with different, even if similar, rules can create unnecessary and unwarranted administrative problems. This is particularly noteworthy given that those who must implement the rules do not have the luxury of the narcissistic perspective often demonstrated by those who create them.
Given the potential problems associated with administering the sales tax, the frequency of strong criticism is surprisingly small. That is encouraging and not typical of most taxes that small-business owners must address. However, there are areas where improvements are possible. There are also areas where a tolerable administrative burden could be intolerably increased.