Ever since the South Dakota v. Wayfair decision in 2018, small businesses that previously faced sales tax compliance obligations in one or two states have found themselves expected to collect and remit sales taxes from customers in states all over the nation. While this has helped states to benefit from sales tax revenue that was previously going uncollected, it has done so at the cost of heaping unsustainable paperwork burdens on small business owners who are suddenly expected to manage similar sales tax compliance burdens as large, multistate businesses like Amazon or Walmart.
But while this poses a truly existential threat to small businesses that find they simply do not have the time or resources to become tax experts across 46 different states with a sales tax, it has continued to fly under the radar. The main reason: the businesses with the ability and knowledge to comply mostly are doing so, while other businesses have not been. And to this point, states flush with revenue have by and large not felt the need to pursue uncollected revenue too aggressively.
That may be changing, however. TaxValet, a sales tax compliance business, recently reported that sales tax audit rates for its customers have quadrupled. In 2021, less than 1 percent of its customers faced a sales tax audit, while in 2023 that number rose to 4 percent. Of TaxValet’s customers that faced an audit, 92 percent were audited by a state other than their home state.
While a 300 percent audit increase should be cause for concern on its own, the truth is that this is the tip of the iceberg. Businesses contracting with a sales tax compliance company like TaxValet are likely more on top of their compliance obligations than others. Other small businesses relying purely on software or an Excel spreadsheet on their home computer are in even greater danger. NTUF estimated back in 2022 that around 50,000 fully remote businesses, most of them small businesses, were noncompliant with their state sales tax obligations and aware of it. The number is likely even higher if one includes businesses that are noncompliant and unaware as well as hybrid businesses that also have brick-and-mortar locations.
It’s important to remember that sales tax is not like business income tax, in which unpaid taxes represent dollars that the business has been able to keep and benefit from in the meantime. Businesses out of compliance with their sales tax obligations never collected those sales taxes from customers in the first place, and would have to cover any unpaid obligations out-of-pocket. Most businesses do not have enough cash on hand for obligations that would amount to 5 percent or so of their gross sales revenue going back multiple years.
Boosted state revenues in the wake of large-scale federal aid during the pandemic helped to defer this issue somewhat, as flush states felt less need to go searching for scraps. But it’s no coincidence that the spiking audit rate coincides with slower state tax collections and tighter budgets.
This is why terming the post-Wayfair surge of audits an existential threat to many businesses is not hyperbole. States are beginning to go after businesses for money that they cannot pay, and this means that innovative, productive small businesses will have no choice but to close up shop. Making the problem worse is that these businesses’ creditors will be out-of-state tax bureaucrats and legislators who have less incentive to come to a workable solution than local representatives would.
There is a need for a nationwide framework that would set some ground rules and simplify tax compliance for businesses selling around the country, as well as provide relief for businesses who are currently out of compliance and want to become compliant. Such a system would not only help bring sales tax compliance more in line with the compliance burdens for other taxes, it would also help states collect revenue that is currently going uncollected from currently noncompliant businesses.
Leading the legislative charge is Senator Maggie Hassan (D-NH). Last month, Senator Hassan put forward a discussion draft that would go a long way towards addressing these issues. Senator Hassan’s proposal, while still in its early stages, proves particularly timely as the post-Wayfair audit surge begins to bite.
Congress needs to realize that increasing audit rates represent the first few small rocks tumbling down the mountain before the avalanche. Should it fail to act now, it will be too late to prevent the large-scale small e-retail business collapse that large-scale audits will inevitably trigger.