As a small business, collecting sales taxes can cost you time and money. But the consequences of not doing sales taxes right can be even worse. Dealing with “home rule” states can make things even trickier because those states allow local communities to set and process sales taxes themselves. It’s important to be aware of home rule sales tax issues to avoid potential pitfalls.
What is home rule?
In general, home rule states allow local governments the authority to administer something differently than state law does. This can cover a lot of areas of government, including sales tax, and, in fact, 38 states allow local jurisdictions to impose their own sales taxes. In most of these states, localities must follow state guidelines in levying sales taxes, and sales taxes are collected on their behalf by the state.
However, there are a few states where local jurisdictions not only have the power to levy taxes but also have authority to make their rules—such as defining nexus—and to administer and collect sales taxes themselves. These states are Alabama, Alaska, Arizona, Colorado and Louisiana. Alaska is a bit of a special case because it has no statewide sales tax, but local jurisdictions can independently levy and collect sales tax according to their own rules.
These are the states in which home rule really makes a difference to businesses that collect sales tax. Not all jurisdictions within these states opt to administer their own sales taxes, but those localities that do can amount to their own separate sales tax governments.
It’s important for small businesses to keep in mind that in home rule states, each locality may define nexus in its own way, as well as requiring its own separate registration, filing and payment process. So what you know about other states, or even what you know about that particular state, may not apply to all the localities with which you do business within the state.
Take, Colorado, for example. It’s the most complex home rule state, with 70 cities that make their own sales tax rules.
If your company is based in Denver, a home rule city, you’ll have nexus in Denver as well as in the state of Colorado. So if you sell something to a customer in Denver, you will need to charge the Denver sales tax, as well as the state tax. While both taxes will be collected in one amount all at once during the transaction, you will need to report and remit the two different tax amounts separately — the city tax to Denver and the state tax to Colorado.
However, if you sell to a customer in Boulder, another home rule city, you will charge state sales tax because you have state nexus, but you will only charge Boulder sales tax on that transaction if you have nexus in Boulder—as Boulder defines it. If you do have nexus in Boulder, you will need to collect Boulder sales tax and state sales tax and remit them separately.
Trouble at home
In a home rule state with several different jurisdictions and different rules for each, it’s easy to collect sales tax incorrectly, with a number of potential negative consequences.
One of the biggest risks in home rule states is that of over collecting sales tax. If you assume that because you have nexus in a home rule state, you have nexus in all its localities, you could end up collecting sales tax in places where it’s not actually required. This can expose you to scenarios that are particularly unwelcome to small businesses.
For example, if you’re collecting sales tax for a particular jurisdiction, that jurisdiction may assume that you have intentionally established business there. This could lead that jurisdiction requiring you to get licenses and perhaps even pay more taxes, such as business & occupation taxes. Proving that you don’t have to follow those regulations because you don’t actually have nexus can take valuable time and resources that are in limited supply for many small businesses.
Overcollection certainly doesn’t make customers happy, either. While providing a poor customer experience is bad enough, what’s even worse is the risk of customer lawsuits over collecting too much sales tax. While larger companies may find such legal battles annoying, having to fight such a lawsuit can be devastating for a small business.
Undercollecting in home rule states can also be a problem. As in non-home rule states, undercollecting sales tax can expose you to the risk of an audit—something no small business wants to undergo—as well a potentially being required to pay back any owed amount, plus penalties and fees.
Audits by local jurisdictions can present some unique challenges. Even in the same state, each locality may have its own audit rules and process. For example, in Colorado, you could theoretically be audited by several different localities, plus the state, and undergo entirely procedures in each case. In non-home rule states, a single state audit would also cover any localities that may be involved.
And in home rule states Colorado, Louisiana and Alabama, local governments can hire their own private tax auditors. These private companies may have more resources and motivation than cash-strapped government auditors to find businesses that are potentially undercollecting.
If you don’t have a physical presence in a home-rule locality, you generally won’t have nexus there and do not have to collect sales taxes for transactions with customers based there. However, if you use a third-party service—such as Fulfillment by Amazon (FBA)—to distribute goods to remote buyers, you may have nexus in the place where Amazon stores those goods for you and not even know it.
In Arizona, for example, if you have goods stored and shipped from an Amazon fulfillment center in Phoenix, you would have nexus in Phoenix, which is a home rule city, as well as in Arizona. Since Arizona state sales tax is based on the origin of the shipment rather than the destination, you would be required to collect the local Phoenix sales tax on those transactions, along with the state sales tax, to be remitted separately.
However, Arizona has passed legislation that puts more restrictions on how cities can administer sales tax and starting in 2017; there will no longer be separate local sales tax returns in Arizona.
A simple solution
If you have sales tax obligation in home rule states, sales tax automation can be a useful solution. Avalara AvaTax easily integrates with PrestaShop and automatically calculates the right rates for both state and local taxes, wherever you might be doing business. In addition, AvaTax offers affordable plans designed especially for small businesses to help you make sure you’re getting sales taxes done right. Learn more here.