The COVID-19 pandemic has had a widespread economic impact on businesses of all sizes. Similarly, the pandemic has wreaked havoc on U.S. state budgets with some experts forecasting that budget shortfalls through 2022 could amount to $434 billion. In fact, the Center on Budget and Policy Priorities is estimating that states like California and New York will see a decline in revenue in tens of billions.
Much of this decline in revenue is attributed to a drop in tax revenue that states are reliant on to fill their coffers and balance their budgets. From sales tax to income tax to industry-specific tax like excise for oil and gas, states have seen a drop in expenditures that have struggled to surpass pre-pandemic levels. For example, tourism drops in Florida, Nevada, and Hawaii have had a direct impact on sales tax collections and lodging taxes in the states. Ultimately, states will need to find ways to recoup losses and establish a budget in the coming years, which will likely lead to tax increases, expanded taxability rules, and increased enforcement of tax laws.
Echoes From the 2008 Recession
As tax authorities grapple with budget shortfalls and weigh their options to drive revenue, it’s likely that many companies are going to be vulnerable to tax compliance risk without even knowing it. Fortunately, businesses can learn from the precedent set during the 2008 economic downturn. Following 2008, tax authorities tightened rules and enforcement around tax collection, with a major shift toward enforcement of tax exemption certificates. Prior to the recession, the criteria for a state to accept an exemption certificate was much more lenient, perhaps due to a lack of technology being able to conduct a comprehensive exemption certificate audit.
Since then, the technology that states and businesses have access to for tax compliance has evolved and made it easier to scrutinize exemption certificates during audits. But what really put exemption certificates under stricter review since 2008 was the fact that an enormous number of businesses closed permanently and made it impossible for sellers and governments to obtain valid certificates during an audit.
While many of the same risks are present amid the pandemic, the complexity surrounding exemption certificates has exponentially increased since 2008. The Supreme Court decision in South Dakota v. Wayfair Inc. made it possible for authorities to collect sales tax on remote sales in their state regardless of the physical location of the seller. Today, tax-exempt sellers could potentially have an obligation to register to collect sales tax in 44 states even if not a single sale is taxable. Economic nexus has not only exacerbated the obligation to collect exemption certificates but added the additional burden of registering with states to collect tax.
Similarly, business operations amid the pandemic have also increased the complexity of collecting exemption certificates. For example, more business-to-business (B2B) transactions are happening online across numerous channels. Where historically a seller would be able to collect exemption certificates easily in 1:1 transactions, many are now processing transactions digitally across a number of online channels. The combination of economic nexus laws with expanding omnichannel B2B sales has created an environment where businesses must know where they have an obligation to register while also processing transactions and collecting certificates in near real-time online. For manufacturers and other B2B sellers responsible for collecting and storing exemption certificates for tax-exempt purchases, putting the technology and processes in place now to ensure that exemption certificates are accurately collected on every applicable transaction will be critical in avoiding another post-2008 scenario.
Tech for Exemption Obligations
Managing exemption certificates in a digital-first society requires intelligent tax compliance technologies to keep pace with changing rules and obligations. Manually collecting, tracking, and storing exemption certificates across channels, as well as manually tracking economic nexus obligations and registering in new states leaves companies vulnerable to human-error and ultimately audit risk. By enlisting the support of tax compliance software, companies can streamline their exemption certificate management processes and mitigate risk.
Tax solutions can easily integrate into a business’s existing e-commerce, enterprise resource planning (ERP), or other billing systems to manage certificates at checkout. For example, a manufacturer that sells through an e-commerce platform and a marketplace can incorporate line items in the checkout process to require businesses to digitally provide their exemption information before processing the transaction. Likewise, businesses can leverage tax software to more intelligently understand when they trigger new economic nexus obligations to streamline registration requirements and avoid unknown audit risk.
As we continue to move forward through the pandemic, it is inevitable that states will likely be looking to expand tax rules, increased enforcement, and adjust existing tax laws. As we learned from the 2008 recession, the enforcement of exemption certificates will likely be a primary target for authorities as they seek revenue. Manufacturers and other B2B sellers will need to understand their new obligations in the world of economic nexus and how to navigate certificate collection in an omnichannel environment to mitigate risk and maintain operations. For most, the manual management of tax compliance from registration to certificate management will be unsustainable and put them at risk. A technology-first approach to managing exemption certificates will enable companies to be proactive in preventing audit penalties and disruptions to their business.
Silvia Aguirre is vice president of certificate management at Avalara.
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