How Growing Sales Can Make Sales Tax Materiality a Reality
- Sales Tax
- November 22, 2015 | Stephanie Faris
Some of the most successful businesses of our time started as small-time operations in someone’s home. Entrepreneurs often try their ideas out at local fairs and on online marketplaces before establishing full-fledged operations. In those early days, aspiring business owners often make so little that the amount of money and effort required to report and administer sales tax collection is greater than the tax itself.
While businesses are always subject to local laws, small operations can weigh the risks of not paying small amounts of sales tax. A jewelry designer who makes less than a hundred dollars on Etsy may decide that the cost of the licenses and software necessary to calculate taxes is far more than any fees that would result from an audit.
Many accountants and businesses use "materiality" to determine whether or not it's worth it to collect and file sales tax. Materiality is an accounting concept, not a governmental one -- as far as the IRS is concerned, you owe taxes on your sales unless exemptions apply. With materiality, you can determines that the amount of tax that you owe is simply too small to be "material," and therefore take the risk that comes with not reporting it.
If you're doing things right, your business will grow. Whether that happens gradually or suddenly, you'll need to start tracking sales tax at a certain tipping point. It's important to look ahead and put a plan in place to either start collecting tax or cap growth at a certain level of sales.
In addition to registering with local government and waiting for the necessary approvals, you'll need to research tax rates for every area in which you do business, then set up your systems to add tax to each purchase.
Nexus and Materiality
If you're already paying sales tax, you may still need to consider materiality if you sell in states outside your own. You may occasionally sell items at an industry convention or a craft fair -- you'll have to look at whether you sell enough items during these events to make tax collection worth the effort. The more events you do in the same state, the more likely it is to be worthwhile to collect taxes.
Materiality is most relevant for online retailers, however. If you have a fulfillment center, local office, or representative in a state where this qualifies as nexus, you'll be required to collect and remit sales tax. However, as above, sometimes the amount you should collect is so insignificant you might not find it material enough to bother. This is also true if you use Fulfillment By Amazon (FBA) to get items to customers in various states. As states pass more regulations about sales tax on Amazon sales, you should carefully consider whether the risk of an audit is worth it.
Sales tax collection can be complicated, but failing to collect and report it can be expensive. Businesses should carefully monitor the materiality of their sales and be prepared to put sales tax reporting processes in place as they grow.