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Unresolved multistate sales tax exposure should be evaluated carefully because it can affect more than a company’s tax filings. It may also affect accrued liabilities, financial statement disclosures, transaction readiness, lender confidence and audit risk.
When a business has sold into states where it may have had nexus but did not register, collect or remit sales tax, management should determine whether the exposure is probable, reasonably estimable and material to the financial statements.
The first step is identifying whether a sales tax liability exists. Nexus can arise from physical presence, such as employees, inventory, offices or onsite services, but it can also arise from economic activity. Since the U.S. Supreme Court’s Wayfair decision, states can generally require sales tax collection based on sales volume or transaction activity even when the company has no physical location in the state. Common thresholds include $100,000 in annual sales, 200 transactions or another state-specific standard. Once those thresholds are crossed, a business may have an obligation to register, collect and remit tax.
For financial statement purposes, sales tax exposure is usually treated as a non-income tax contingency rather than an income tax issue. That distinction matters. Sales tax is generally collected from customers and remitted to taxing authorities, but when a company failed to collect it, the company may be responsible for paying the tax from its own funds. If management concludes that assessment is probable and the amount can be reasonably estimated, the company should generally accrue the liability. That accrual may include the uncollected tax, interest and penalties if those amounts are expected to apply.
If the exposure is material but cannot be reasonably estimated, disclosure may still be needed. Financial statement users should understand the nature of the uncertainty, the jurisdictions involved, the periods under review and the facts that prevent a reliable estimate. For example, a company may know that it exceeded economic nexus thresholds in several states but may not yet have reconstructed taxable sales by state, product type, customer location and exemption status. In that case, disclosure can be important even before the final number is known.
The underlying analysis should be based on facts, not assumptions. Businesses should review where they made sales, where inventory was stored, where employees worked, whether marketplace facilitators collected on their behalf and whether customer exemption certificates were properly maintained. This is where sales tax compliance often becomes difficult. States use different rules, different thresholds, different taxability standards and different filing schedules. A product or service that is taxable in one state may be exempt in another. Local taxes can also change the calculation.
Unresolved exposure can become especially important during financing, audits, mergers, acquisitions or expansion. A buyer or lender may view unpaid sales tax as a direct reduction in enterprise value because it represents a potential future cash outflow. In a transaction, unresolved exposure can lead to purchase price adjustments, escrow requirements, indemnity negotiations or delayed closing. In an audit, poor records can make the problem worse because the taxpayer may have limited ability to challenge the state’s estimate.
Companies should also consider the lookback period. If the business never registered in a state, the statute of limitations may not have started to run. That can create exposure going back to the date nexus first existed. In contrast, if the company filed returns but made errors, the lookback period may be more limited. This difference can materially affect both the reserve and the disclosure.
The best financial reporting approach is a documented, supportable analysis. Management should quantify exposure by state, period and transaction type, then determine whether the liability should be accrued, disclosed or monitored. The analysis should be revisited regularly because business activity, state thresholds and enforcement priorities can change.
Once exposure is identified, companies should move from estimate to remediation. A nexus review can determine where obligations exist. A transaction review can separate taxable, exempt and marketplace collected sales. Exemption certificate review can reduce exposure where documentation supports it.
A Voluntary Disclosure Agreement may also help reduce the financial impact. In many states, a company that comes forward before being contacted by the state may be able to limit the lookback period and reduce or eliminate penalties. Interest often still applies, and eligibility depends on the facts, but this can materially reduce the ultimate amount owed.
Companies should also improve controls around multistate tax compliance. That includes monitoring sales thresholds, maintaining a filing calendar, documenting taxability decisions, keeping exemption certificates current and reconciling gross receipts to filed returns. For growing businesses, automation can help, but it does not replace judgment. Someone still needs to confirm that the system reflects the company’s products, customers, states and sales channels correctly.
The practical goal is not just cleaning up the past. It is building a process that prevents the same exposure from reappearing. A current reserve, a remediation plan and stronger internal controls give management, auditors and financial statement users a clearer picture of the risk and the path forward.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact DiAndria Green, Partner in Bennett Thrasher’s State and Local Tax (SALT) practice, or call us at 770.396.2200.
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